Why DeFi plus asset tokenization will take crypto to new heights


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In the past few years we have seen numerous attempts to bring real assets to the crypto market. However, none of them have proven to be massive among retail crypto users and traditional financial players.

Why hasn’t tokenization of real assets become a massive trend?

You have probably heard how almost anything can be symbolized – securities, art, real estate, to name a few. And there have been so many projects that promised to change the way we invest in assets, regardless of the type. At the same time, none of the projects managed to gain massive market acceptance.

Traditional market pros haven’t really found evidence that tokenization has improved the current fundraising processes for them. An overview of the tokenization of real estate has already been discussed.

You may also have difficulty finding real private investors who have acquired the rights to a famous work of art or part of Dracula’s castle. While most successful offerings have centered on private investors, basically nothing has changed for the crypto market, even for token asset owners.

Why have these offers not achieved mass acceptance? While the concept of tokenization promises a better and cheaper way to raise funds for issuers, there are almost no real benefits to the crypto market.

I’ve covered tokenization issues before in the form of a security token offering, but in short, it boils down to regulation (tokenized assets are regulated by the traditional rules) and the lack of a secondary market. Retail crypto investors cannot benefit from these two problems, and they basically don’t have to adapt to anything new, especially now that DeFi protocols are emerging.

What companies are looking for in raising funds

Corporate institutions have to exist in a world with complex and outdated rules. Hence, having a clear legal model for raising or lending funds is vital for them. With over $ 20 billion tied up in decentralized funding currently, this could pique the interest of corporate institutions and make them consider entering the market – especially when we consider that the common annual percentage in DeFi protocols is only $ 2 % to 10% is an additional cost to attract funds.

Yes, there are no out-of-the-box legal models that companies can use to attract or borrow funds from DeFi protocols in today’s marketplace. However, it is possible to create one with minimal effort, as the benefits of DeFi lending easily cover the expense of building such a system. DeFi may be able to offer corporate institutions loans on perfect terms, which can lead them to consider entering the market. In the meantime, corporate institutions will be ready to provide various types of stable assets to serve as collateral for their loans.

However, there is an urgent need for real assets to be used as collateral in DeFi protocols to prevent further market downturns in the future and to address the overcollateralization problem along this path.

Can current market participants act like this?

There are currently several attempts to bring real assets to the DeFi market. Most of them seem to accept a wide range of assets, mostly token bills.

The main problem with using these assets in a log is the lack of publicly available sources for pricing. This refers to the lack of transparency and the need to rely on a central party (valuation company, subscriber, etc.) in determining the price of the secured asset. There is also no mechanism for monitoring pricing in real time (as is the case, for example, when using crypto as security). These assets are generally illiquid. They are not traded on any marketplace or on digital OTC platforms. and there is no source of regular updating of information on their pricing – a crucial point in determining when the collateral will be liquidated.

There is no doubt that some of these assets could be insured, such as payment on bills, which means that in the event of a debtor default, the insurance company will pay. But here, too, the insurance process lacks transparency and lives completely outside the chain. It does not offer investors any real guarantees or real-time knowledge as to whether or not the insured event has occurred.

In addition, current solutions allow borrowing exclusively in crypto, which is not suitable for everyone. It’s not a bad thing, but it lowers the chance of attracting large institutions that need to get funding in fiat that is used for their day-to-day operations.

The main question that arises, however, is the ability for large logs to adapt real assets and use them as security. And it will be extremely difficult as they will have to change the borrowing process, build a system that will update the price of collateral, issue new assets, work with regulated companies and generally get the approval of the majority of current participants. Aave and Maker have been discussing the introduction of such a solution for over six months, and there is no clear date when it will actually go live.

What infrastructure needs to be built to bring traditional institutions to the DeFi market?

A perfect solution that enables the tokenization of traditional stable assets and is suitable for the DeFi market must meet several criteria.

  1. Real assets used by the protocol must have a transparent price source that is available to any user of the protocol upon request. This requires not only selecting an asset that can meet this requirement, but also creating a pricing oracle that will convey information about the collateral. Such an oracle should be tied to a transparent and trustworthy pricing source like Bloomberg Terminal rather than receiving proprietary data from a central party.
  2. The real assets used by the protocol should be as non-volatile as possible, generate fixed income securities to provide real cash flows for liquidity pools, and have a certain level of liquidity and market in the real world to handle the liquidation event in case it occurs on.
  3. The protocol must allow users to borrow money in fiat. For such purposes, another intermediary must be connected to the protocol to meet the exchange needs of users who want to borrow money in fiat and to act as a payment agent for them.
  4. Real assets used by the protocol should be digitally present and stored, for example, in a secure accounting system. To achieve this, an intermediary is required to operate such protocol connected systems.
  5. In order to defend the decentralized nature of the protocol and maintain trust at the highest possible level, the intermediaries associated with the protocol must be regulated, insured, selected and monitored by the protocol community under specified requirements. In addition, the community will decide on all other critical matters to the development and economic sustainability of the protocol, including the selection of assets that can be approved as collateral.

What can we expect in the future?

I anticipate that in 2021 we’ll see several initiatives to build new, real, asset-backed protocols, and hopefully they will be the ultimate solution to finally connect the traditional financial and crypto markets. They are more likely to adopt existing protocols in their current ecosystems only when new protocols are found to be functional.

Another area where real-world asset-based protocols could have an important impact is in stablecoins. There is a current trend among regulators, mainly in the United States, targeting all stable coins that have centralized issuers – like Tether (USDT) or USD Coin (USDC) – with discussions about the potential need to change the requirement for one these issuers have to impose a banking license. Decentralized stablecoins backed by real assets could solve this problem. However, it is a topic for a separate discussion.

But what about other tokenization attempts and STOs? Of course there have been successful cases. Large financial institutions are still easily interested in introducing such products as they can potentially save money. Most likely, due to the shortcomings mentioned above, these initiatives will focus on private offerings.

It is naive to believe that many crypto investors are willing to invest in unknown markets for the long term. Especially with large investment opportunities in the DeFi area. Until new regulations are put in place for the offering of token instruments (and there are no good signs in this direction), the tokenization of real assets in the form of an STO will, in my opinion, continue to be limited to closed offers without considering the global market.

The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Artem Tolkachev is the founder and CEO of Tokenomica. Artem has been a leading blockchain and tokenization opinion leader in the CIS region for over six years. He has been a lawyer and entrepreneur specializing in intellectual property and information technology since 2011. In 2016, Artem founded and led the Deloitte CIS Blockchain Lab. As part of this initiative, he led a number of innovative projects that included the implementation of blockchain solutions for businesses, the tokenization of real assets, the tax and legal structuring of security token offerings, the development of cryptocurrency, and blockchain legislation.