DeFi is a highly reflective system in its present form. The speculative trading of tokens accounts for a major portion of its capital growth and income. Speculation, on the other hand, fuels liquidity. As DeFi develops the fundamental liquidity primitives it requires, speculating will undoubtedly be the primary activity. However, for long-term sustainability and widespread adoption, DeFi must provide consumers with consistent sources of value. This has arguably already occurred, although gradually. DeFi has succeeded in producing actual services desired by eager customers, whether it is lowering the cost of capital by removing financial intermediaries or enabling users' exposure to synthetic assets. This, however, is insufficient to transform DeFi's speculative image, and many feel that in order to fully expand and make DeFi useful, it must be linked to the off-chain world – the actual world. Tokenizing real-world assets (RWAs) comes into play here.Many protocols are advancing the area by tokenizing things like house ownership, goods, loans, and so on. This article will look at credit-financing methods that use RWAs as collateral, as well as the traction they've gotten so far. To be clear, we define RWA credit-financing protocols as those that receive finance on-chain by pledging RWA off-chain as collateral. As a result, we remove from the scope of this analysis protocols that predominantly issue uncollateralized loans (such as Maple, TrueFi, and Clearpool). Furthermore, since borrowers are usually funds or market makers whose investment strategies depend on crypto markets, the development cycles of these undercollateralized lending protocols are completely entwined with crypto markets.&nbsp;<h2>Connects Real-World Credit to the On-Chain World</h2><h3>Goldfinch&nbsp;</h3><img src="https://cdn.builder.news/news/11eda137c684c6e88e59028438497b73.jpg" alt="goldfinch" title="goldfinch" width="600" height="315" class="lykafe0">Returning to RWA credit protocols, the market's biggest RWA financing moniker is now Goldfinch — a system that allows actual enterprises to join crypto lending markets without posting crypto collateral. Instead, loans are completely collateralized with assets and income off-chain. The Goldfinch ecosystem includes a few significant players:<ul><li>Borrowers: Entities seeking a loan must first be authorized by auditors, who do human-level investigations on borrowers to ensure their legitimacy.</li><li>Auditors: Auditors stake GFI to be chosen for voting. They gain GFI incentives by voting with the majority of other auditors in accordance with specified regulations. Because each auditor has a vote, each auditor has a Unique Entity Number (UEN) to protect against Sybil attacks.</li><li>Backers: investors that examine specific transactions and provide first-loss capital (junior tranche) to borrower pools. Backers may enter into off-chain legal arrangements with borrowers, such as forcing them to collateralize their on-chain loan with off-chain collateral. Through this technique, all loans on Goldfinch are now completely collateralized with off-chain assets. Early backers are rewarded with more GFI tokens, with the quantity diminishing when the borrower pool hits its maximum. This incentive is only available to the borrower when the loan has been satisfactorily repaid.</li><li>Liquidity providers:&nbsp;Liquidity providers are investors that offer second-loss capital (senior tranche) to a "senior pool," which automatically distributes capital across various borrower pools.</li></ul>The senior pool offers both diversity across borrower pools and seniority to backers' first-loss funds. When liquidity providers feed the senior pool, they are compensated with FIDU tokens. Liquidity providers may exit their position by redeeming FIDU for USDC at an exchange rate depending on the senior pool's net asset value, although they must pay a 0.5% withdrawal charge to protocol reserves. As interest payments are transferred back to the senior pool, the exchange rate for FIDU rises over time.Goldfinch has originated over $120 million in loans so far, with over $100 million still outstanding, ranging from FinTech loans in Asia to smartphone finance in Africa. Loan growth, on the other hand, has virtually stalled in recent months.Goldfinch's lending rates have increased in tandem with the fed funds rate, suggesting that borrowing expenses on the platform are growing. This might be a major factor in the slowdown of loan growth. Loan demand is also affected by the status of local economies, given the platform's present concentration on developing regions.Since the company's start, Goldfinch investors and liquidity providers have earned a total of $8.5 million in net interest income. So yet, no writedowns (bad debt) have occurred. Despite slower loan origination, investors are still receiving a similar amount as interest rates rise.In addition to the 0.5% withdrawal fee imposed to investors for redeeming their investments, Goldfinch maintains 10% of interest payments as protocol reserves. The protocol has earned almost $1.5 million in income since its launch. Revenue has remained consistent until H2 2022, which is unlike other DeFi protocols. Goldfinch offers a business plan that, unlike most others, is not heavily reliant on crypto prices and may be counter-cyclical. This is perhaps the most significant benefit from a business viewpoint.Protocols like Goldfinch employ public-ledger blockchains to connect firms with previously limited access to funding with crypto money that is continually looking for fresh returns. All of this may be accomplished in a timely and effective way. As seen in the pie chart below, the vast majority of Goldfinch's loan exposure is in developing market nations, which often have more difficult access to finance and financing than established ones.<img src="https://cdn.builder.news/news/11eda137c684e4568e59028438497b73.jpg" alt="goldfinch loan geo distribution" title="goldfinch loan geo distribution" width="600" height="395" class="lykafe1">Source: Dune AnalyticsSo far, the platform's cumulative loan book has fared well, but it's crucial to remember that this is not a risk-free business. The idea of "adverse selection" enters the picture, i.e., are you just sponsoring enterprises that lack the financial strength to acquire a loan from a conventional financial institution in their nation?Loans may still be defaulted on by businesses. Given that the collateral is not liquid ERC-20 tokens, liquidating these assets to reclaim lender money may be significantly more difficult than with crypto collateral. Models like Goldfinch's can never be completely trusted since they depend on third parties to maintain quality controls. In the worst-case scenario, the models are likewise reliant on meatspace courts and rules. That doesn't imply they're doomed to fail or aren't an essential business model, but it's critical to acknowledge that these dangers exist.<h3>Centrifuge</h3>Centrifuge is the second-largest RWA credit-financing procedure after Goldfinch. Centrifuge intends to introduce structured credit to the blockchain, letting investors earn returns on tokenized RWAs. Centrifuge has been in business far longer than Goldfinch and offers a much broader range of services than credit finance alone. Aside from loan origination, they also serve as an on-chain tokenization platform.Centrifuge's Tinlake pool, for instance, puts on-chain real-world firms (asset originators) that fund real-world assets like bills, mortgages, or streaming royalties. They accomplish this by tokenizing their financial assets and utilizing these NFTs as collateral in their Tinlake pool. The pool has a few significant players:<ul><li>Issuers: The legal entity is the issuer. A special-purpose vehicle (SPV) often "holds" the assets and receives Tinlake financing. In exchange for investments, they also generate TIN and DROP tokens and legally administer the pool.</li><li>Asset Originator: The asset originator produces the tokenized RWA and promises it as collateral for loans to the issuer.</li><li>Investor: Tinlake investors supply liquidity in return for yield and CFG benefits. Investors may buy TIN and DROP tokens, which represent the junior and senior investment tranches, respectively. The senior token (DROP) provides a consistent return. The junior token (TIN) has more volatility and shields the DROP token from defaults.</li><li>DeFi Protocols: To offer liquidity, DeFi protocols such as Maker and Aave may be connected with Tinlake pools. Tinlake's loan origination has been declining since mid-2022, similar to Goldfinch. Monthly loan originations fell 20% in November compared to June 2022, which isn't awful in the overall scheme of things.</li></ul>As previously stated, DeFi protocols may be used as a source of liquidity in Tinlake pools. This occurs when investors funding loans in Tinlake pools deposit the DROP tokens they get into the Maker vaults to borrow DAI, providing liquidity for an otherwise illiquid asset.<img src="https://cdn.builder.news/news/11eda137c6853eac8e59028438497b73.jpg" alt="maker dao rwa" title="maker dao rwa" width="600" height="378" class="lykafe2">Source: Dune AnalyticsSeveral Tinlake pool vaults have been linked with Maker since 2021. Tinlake has transferred approximately $20 million in assets to Maker's RWA vaults. However, Tinlake's RWA vaults have suffered falling growth since mid-2022, particularly when compared to Maker's other RWA vaults. This may be due to the comparatively large stability fees Tinlake's financiers must pay to get access to the Maker vaults. Tinlake's four vaults have stability costs ranging from 3.5-7% per year, whereas the other RWA vaults have stability fees ranging from 0-3%.<h2>Maker and Aave RWA Growth</h2>While Tinlake's percentage of Maker's RWAs has been falling, it is worth noting that Maker's RWA exposure, in general, is increasing. Maker's RWA vaults (including Tinlake) provide 58% of its income, indicating the project's potential in DeFi. With the US fed funds rate now at 4.25-4.5%, Maker's RWA vaults currently outperform DeFi money markets.This situation highlights the benefits of broadening Maker's collateral base. Crypto assets are heavily influenced by idiosyncratic risks specific to the cryptocurrency industry. RWAs are less vulnerable to these risks and may serve as a counter-cyclical holding. Dedicating a part of collateral to assets unrelated to crypto market circumstances offers a defensive income stream during periods of low market activity.Since December 2021, Aave has additionally included seven Tinlake pools in its RWA market. As a consequence, Aave depositors may receive interest on uncorrelated real-world collateral, while Centrifuge issuers can borrow stablecoins from the market. Stablecoin depositors will need to go through KYC and be whitelisted in order to join Aave's RWA pools. Centrifuge issuers form pools and may borrow stablecoins from depositors in exchange for DROP collateral. Since launching Aave's RWA market, TVL on the platform has peaked at $19 million but is presently sitting around $8 million, with borrowing at $2.7 million.Recently, Goldfinch and Centrifuge suggested becoming RWA processors for GHO, Aave's new stablecoin. In essence, this means minting and burning GHO up to a certain threshold. These RWA protocols, similar to how DAI is backed by RWA collateral, may be included as a collateral foundation for GHO.<h2>Asset Tokenization Prospects</h2>The future of asset tokenization is promising. We anticipate that RWAs will be tokenized in larger numbers as the advantages become more apparent. If the high-interest rate environment persists, protocols such as Maker may see the value of allocating some access to treasuries and investment-grade corporate bonds, both of which have historically been seen as safe havens for investors during weak markets.We also anticipate new sorts of assets being tokenized on-chain, as well as asset tokenization expanding beyond lending protocols. This year has seen the tokenization of foreign currencies and government bonds, in addition to real-world credit, being used as collateral to support stablecoins. Recently, the Singapore central bank used Aave and Polygon to perform foreign currency and government-bond transactions against liquidity pools composed of tokenized Singaporean government securities bonds, Japanese bonds, the Japanese Yen, and the Singapore Dollar. These pilot tests demonstrated that they were less expensive and more efficient than traditional clearing and settlement middlemen.The cyclical recession in 2022, if anything, has highlighted DeFi's responsive character and the necessity for procedures with genuine cash flow-generating operations.Not everyone is happy with the real-world asset tokenization story right now. Hardcore cypherpunks and purists of decentralization despise the idea of generating more centralized, on-chain collateral assets. They have a valid argument, given that these assets are points of failure in a decentralized economy. A protocol's dependence on centrally issued assets might jeopardize it. However, some degree of compromise is required until/unless trustless alternatives can be imagined and implemented. Protocols based on RWAs have shown advantages to DeFi business models.Although RWA-based protocols are now just a minor component of DeFi, their potential is enormous. In this article, we looked briefly at two RWA credit schemes that have been connecting the real world and DeFi. However, in order to encourage the expansion of RWAs, an environment with more clear rules and laws for digital asset regulation is required.Regulation is a significant uncertainty for crypto in general, and have defined limitations for on-chain tokenization and securitization may be a huge boost for the industry, bringing myriad additional RWA tokenization use cases to life.<div class="pr-block-special">Disclaimer: This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.</div>

This article will examine several credit-financing strategies that employ RWAs as collateral and the uptake they've received so far.

The case for real-world assets (RWAs) in DeFi