The Institutionalization of DeFi: Bridging Traditional Finance and Decentralized Finance
Decentralized finance (DeFi), built on blockchain technology, has garnered significant attention in the financial market for its ability to address issues such as opacity, intermediary costs, and high entry barriers associated with traditional finance. In recent times, the DeFi industry has been exploring the integration of real-world assets and established companies into its ecosystem, extending beyond on-chain limited assets like tokens and NFTs. This shift aims to enhance capital efficiency and foster greater collaboration between traditional finance and DeFi protocols.
The convergence of real-world assets and the DeFi market presents an enticing opportunity for both sides. DeFi protocols can attract substantial on-chain assets, providing liquidity and attracting users, while real-world companies can offer services to underserved regions across borders, leveraging smart contracts to reduce operational costs and provide more favorable capital options to consumers. This trend, referred to as "The Institutionalization of DeFi," signifies the growing integration of DeFi protocols with real-world assets and enterprises. Let us examine some examples of this interplay between DeFi protocols and real-world assets, both within and beyond the blockchain ecosystem.
MakerDAO stands out as a prominent collateralized lending platform built on the Ethereum blockchain. It empowers users to provide assets such as ETH as collateral, enabling the issuance of MakerDAO's decentralized stablecoin, DAI. Since mid-2021, MakerDAO has been operating Real World Asset (RWA) vaults, utilizing real-world assets to back the issuance of DAI. As of June 23, these RWAs account for approximately 66% of MakerDAO's income, with total assets under management reaching around $1.3 billion.
MakerDAO revenue by asset class (top navy blue is RWA), Source: Dune
RWA vault size, Source: Dune
Presently, MakerDAO hosts nine RWA vaults, each catering to different assets. Here are the key details:
- MIP65: Collateralized by U.S. short-term treasuries (80%) and investment-grade corporate bonds (20%)
- Blocktower: Focuses on investment products related to fintech and non-banking lending institutions
- OFH - SocGen: Backed by AAA-rated mortgage-backed loans
- ConsolFreight: Collateralized loans based on freight shipping documents
- FortuneaFi: Represents real-world assets generating cash flows
- Habor Trade Credit: Centered around export receivables financing
- New Silver: Engaged in collateralized loans for residential real estate development projects and mortgages
- 6S Capital: Provides collateralized loans for commercial real estate development projects
- HVBank: Offers various loan products provided by Huntingdon Valley Bank (HVB)
Among these vaults, MIP65 emerged in October 2022 and quickly became the flagship RWA vault, accounting for over 75% of the total RWA vault size. Unlike MakerDAO's existing RWA vaults, which collateralize DAI with physical assets, MIP65 employs USDC within the collateral to purchase U.S. short-term treasuries (80%) and investment-grade corporate bonds (20%). This approach ensures a stable $1 peg for DAI. The process involves purchasing iShares ETF from BlackRock, a global asset management company, through Switzerland's digital asset bank, Sygnum. Through MIP65, MakerDAO has transformed into a DeFi protocol that stabilizes DAI's price, secures stable income through treasury purchases, and extends financial services to real-world companies while holding a significant volume of real-world assets.
Monetary Authority of Singapore (MAS)
The Monetary Authority of Singapore (MAS) serves as the central bank and financial regulatory authority of Singapore. In November of last year, MAS embarked on an experiment named "Project Guardian" in collaboration with global investment bank JP Morgan, SBI Digital Asset Holdings (a subsidiary of Japan-based SBI Bank), and DBS Bank, Singapore's largest bank. Under this initiative, they conducted a trial to facilitate cross-border currency and government bond transactions using public blockchain technology. The experiment involved transactions between the Japanese Yen (JPY) and the Singapore Dollar (SGD), as well as the trading of Japanese and Singaporean government bonds. All these tangible assets were tokenized and traded on-chain, in real-time. The transactions were successfully executed by forking Aave, a prominent DeFi lending protocol, and deploying the contract on Polygon’s public blockchain network.
MAS pursued four key objectives through this experiment:
- Establishing an interoperable network to enable the trading of digital assets using public blockchain.
- Developing a DeFi protocol suitable for cross-border transactions.
- Exploring the feasibility of using tokenized capital issued by deposit-taking institutions.
- Designing regulatory measures to address market manipulation and operational risks associated with DeFi protocols.
In parallel with Project Guardian, MAS continues its proactive efforts to adopt DeFi protocols at a national level. Recently, MAS granted a Major Payment Institution (MPI) license to Circle, the issuer of the world's second-largest stablecoin, USDC. This license empowers Circle to provide digital payment services and domestic and international fund transfer services using USDC to various institutions within Singapore.
Source: Circle tweet
From well-established DeFi protocols to prominent global financial institutions and government entities worldwide, there is an ongoing drive to bring real-world assets onto the blockchain. However, there are several challenges that need to be addressed due to the nascent market conditions. The DeFi market size remains relatively modest, accounting for around 0.5% of the traditional financial market, leading to slower growth. Additionally, regulatory risks, primarily led by the U.S. Securities and Exchange Commission (SEC), still persist. Nonetheless, as more capital flows into the decentralized finance market and robust regulatory frameworks are established, ventures aiming to bridge the gap between the traditional financial world and DeFi will become increasingly appealing. Amidst the winds of forthcoming change, the convergence of traditional finance and DeFi, rather than their separate trajectories, holds the potential to pioneer a new market and instigate innovation within the financial industry. We must closely monitor the multitude of endeavors that lie ahead.
DeSpread, founded in 2019, is a consulting firm specializing in Web3 & blockchain. Consisting of practice leaders with many years of practical know-hows in all fields of Defi, NFT, Metaverse & Gaming, Network Validation and Web3. DeSpread provides solutions and go-to-market strategies to grow the protocol by actively participating in the ecosystem.
Writer: Declan Kim, Research Analyst at DeSpread
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