Author: Hippo Research
1. What is RWA?
Real World Assets (RWA) is simply real-world assets.
The narrative of RWA has been continuously developing in DeFi this year, and many speculate that it may become the catalyst for the next bull market. Currently, the existing funds in the crypto market are limited, and there has been a continuous outflow of funds from the crypto market this year. However, a bull market definitely requires a large amount of capital to enter. So, which sector can bring in a large amount of capital to kick off the bull market? RWA is undoubtedly one of the best targets, given its massive traditional capital volume, enough to bring about a thorough bull market in the crypto world.
Real-world assets of RWA are divided into tangible assets (such as real estate, commodities, collectibles, and other physical assets) and intangible assets (such as stocks, bonds, carbon credits, etc.). Tokenizing RWA assets is the process of mapping such off-chain real-world assets onto the blockchain to enhance the liquidity and composability of the assets.
2. Brief Historical Background
Talking about RWA cannot be separated from discussing DeFi. Currently, the main source of income in DeFi comes from collateralization, borrowing, leverage, contract trading, and spot trading fees. Those who have experienced a bull market know that DeFi is also one of the most active sectors during a bull market. The DeFi Summer after 2020 was a period of prosperity for various governance tokens, during which DeFi yields were very high, with APY yields of at least 20%, and many first-tier mining projects even reaching astonishing APYs of over 1000%, attracting a large amount of off-chain funds into the market.
At that time, the US dollar had not entered an interest rate hike cycle, and with DeFi yields being so high, the market did not pay attention to investment opportunities outside the crypto market. However, as the crypto market entered a bear market and the US dollar entered an interest rate hike cycle, the yield on US bonds exceeded that of the DeFi market, resulting in an inverted situation.
From a risk perspective, the DeFi market can be considered as close to a risk-free interest rate. APYs in pools like Curve and lending-type APYs in Compound can be considered relatively close to risk-free interest rates within DeFi. The protocols themselves do not generate very high returns. On the other hand, US bond yields have reached 5-6%, and this situation may continue for quite a long time. This inverted yield spread has led to a situation where many funds, instead of staying in the DeFi market, would rather return to the US dollar world to buy US bonds. Because the crypto market, compared to US bonds, has multiple layers of risk, such as contract risk, asset risk, and regulatory risk. For example, the recent hacker attack on Curve led to a continuous decline in the price of CRV, so the crypto market has added multiple layers of risk compared to US bonds. In addition to the aforementioned inverted yield spread, RWA assets, especially US bonds and tokenized US bonds, currently have a market of approximately $1.5 billion, and reports indicate that by 2030, the US bond market will reach $16 trillion, including MakerDao, which has also converted a large amount of its stablecoin reserves into US bonds.
The concept of tokenizing real-world assets has been around since 2017, when it was called STO. At that time, the concept of DeFi did not exist, and the overall narrative was relatively empty, lacking tangible targets, and focused more on equity products, such as issuing a company's stock or equity-like assets, with little involvement in bond-related products. However, when talking about RWA now, the focus is more on US bonds or fixed income assets. Therefore, these are concepts from different eras and cycles, with different narrative backgrounds.
Many users currently hold a large amount of assets in U-based assets such as USDT and USDC, because U-based assets themselves do not have a significant downside risk, and their investment demand is for stable and low-risk financial management. However, around 2017-2018, stablecoins were not widely used, and investors needed to convert their assets into BTC or ETH to invest in projects, so they had to bear the risk of BTC or ETH price declines. Therefore, the investment structure and background of users have undergone significant changes.
Compared to before, the structure of the entire market has also undergone significant changes. At the peak of DeFi Summer, stablecoins had a market value of nearly $200 billion, but at the time of STO in 2017, stablecoins did not exist, and everyone was playing with native tokens on the chain, such as BTC and ETH. From the previous bull market cycle to the current bear market, although the minting volume of stablecoins has declined, there is still $130 billion in minted stablecoins on the chain, with less than 10% estimated to be used for interest. So, this is a huge market, indicating that there is still nearly $110 billion in stablecoins lying on the chain, basically in a zero-yield state, and the demand for yield from this capital is definitely very high.
3. Why is RWA so important?
Similar to the introduction of Yu'ebao by Alipay, if Yu'ebao does not provide returns, many people will move their assets elsewhere to earn returns. Similarly, if this portion of funds on the chain can earn US bond yields, they will keep their funds on the chain. Calculated at around four to five percentage points, this is nearly $5-6 billion in interest. Currently, this money is being earned by issuers such as Tether, and they can earn approximately $4-5 billion in profit annually. This is one of the reasons why there is such a high demand for RWA. In the traditional world, the US dollar and US bond market is very large. In terms of the crypto world, there is currently approximately over $100 billion without returns. If RWA can be realized, this is also very beneficial for the crypto market, as we are concerned about the outflow of funds from the crypto market. If there is an interest market, similar to the returns generated by Yu'ebao in Alipay, this will reduce the outflow of funds from the crypto market, which I believe is one of the biggest benefits that RWA brings to the crypto market. If this over $100 billion without returns were to leave, the funds would stay in the crypto market, making returns more democratic and distributed on the chain, which is a very good and decentralized thing. Most non-Americans holding US dollars around the world cannot enjoy the returns of the US dollar and US bonds, yet they bear the pressure of US dollar inflation, which is very unfair. If US bonds can be tokenized and democratized, then non-Americans holding US dollars can also have the opportunity to earn returns while bearing the pressure of US dollar inflation, and this fairness is very important.
The Perfect Combination of Pricing Assets and Yield Assets
US dollar stablecoins can actually be considered the largest RWA, and now with the introduction of US bonds, this is equivalent to completely moving US dollar-priced assets and yield assets onto the chain. This is a very significant milestone for the crypto technology infrastructure. Moreover, this will drive a large amount of traditional finance to enter, such as realizing combinable fixed income products on the chain, and the source of fixed income may not be related to the cycle of the crypto market itself. These products may have the potential to be combined in many ways on the chain. Achieving this, I believe, is expanding the application ecosystem of crypto.
We have seen about four to five projects in the market that are moving relatively quickly, including Ondo Finance, Matrixdock, and Open Eden, which are mainly focused on US bonds. I think there are several key points here. One is compliance, meaning whether it can truly isolate bankruptcy risks structurally. Over the past year, various so-called compliant exchanges have experienced explosions and various negative risks, so at this point in time, trust in exchanges can be said to have been continuously decreasing, even for large companies like DCG, which have also had issues with insolvency.
Another key point is the competition faced by the issuer of RWA government bonds in DeFi projects. Although they have a cooperative relationship, for example, these asset issuers also hope that we will accept their assets as collateral or underlying reserves, I think they still have a certain competitive relationship with DeFi. For example, MakerDao has not gone through these platforms, and its RWA is mainly tokenized using its own trust and legal structure. However, its tokenization has not been circulated in the market and can be understood as purely on-chain, exchanging stablecoins for US dollars and then buying US bonds to generate returns, which can be reflected at the level of Dai holders. So, it has not cooperated with the current platforms in the market. MakerDao can now be seen as the largest holder of RWA assets, and it actually has a certain competitive relationship with DeFi project parties.
Imagine if you hold US dollars, stablecoins have already surpassed cash and bank deposits in terms of excellent liquidity, bringing about a greater liquidity premium. If interest, capital costs, and opportunity costs can also be compensated on the chain, then there is no reason to deposit money in a bank. I believe there isn't. Because currently, JPMorgan has approximately over $2 trillion in deposits with zero interest, all of which are used to buy US bonds. However, for many ordinary people, this threshold is too high, and the threshold for buying US bonds is also very high. Especially for those who hold US dollar assets but are not Americans, many overseas individuals hold US dollar assets, how do you buy US bonds? This is a very high threshold in itself. But if we can tokenize US government bonds on the chain, then people holding stablecoins can directly obtain US bond returns. For the crypto market, this not only retains $130 billion in funds, but also attracts more funds from the traditional financial market. This is a larger scale and has greater significance. In the past, we have always been concerned that these funds would leave the crypto market, and we always want to retain these funds. In reality, US bonds are the best way to retain US dollar funds. As long as the funds stay on the chain, they will have the opportunity to use various DeFi products and enjoy various crypto services. This way, the entire ecosystem will enter a virtuous cycle.
Many people leave because the market has turned bearish, and they may choose higher-yielding investments in the traditional world to capture the interest rate spread. This group of people may no longer have the motivation to leave the market, because they can already earn more benefits here. I believe that RWA US bonds are just the first step, and there are other bonds besides US bonds. Because bonds provide fixed income, which is crucial for the currency market. If we can bring most of the attractive high-quality bonds from the traditional financial market onto the chain, it will be the most organic growth for retaining funds in the crypto market and exploring new applications. It does not rely on the demand driven by the bull market cycle of the crypto market.
About MakerDao Configuring US Bonds
MakerDao's RWA architecture has been in existence for at least 5 years. Previously, their RWA strategy did not focus on US bonds, but rather on solar energy and real estate. The earliest projects were real estate projects and solar power plants. Because the founder is an environmentalist, he particularly wanted to transform MakerDao into green finance and make solar energy the core asset allocation of MakerDao. However, this proposal received some disdainful reactions in the community. In reality, there are many issues. The biggest problem faced by assets such as solar power plants is scalability. It is difficult to achieve large-scale operations because these assets face a lot of operational and counterparty risks. If you set up a solar power plant in China, you will face regulatory risks in the Chinese market. In the past 10 years, China's solar energy regulatory policies have undergone significant changes, with subsidy policies and various loan policies constantly being adjusted. Therefore, for a scalable asset, this kind of risk is not suitable. MakerDao has taken many wrong paths, previously collaborating with Centrifuge and investing a large amount of assets in real estate and solar power plants. However, these assets have not reached a large scale, mostly only tens of millions of dollars, and such asset investments cannot achieve scalability and are prone to default loan issues. With the rise in US bond interest, MakerDao gradually realized that US bonds are a good thing. Its RWA strategy is also based on this historical continuity, rather than a sudden decision to invest in government bonds. Because US bonds themselves are the most important risk-free interest source for all US dollar assets. It is illogical to create US dollar stablecoins without allocating risk-free returns such as US bonds. If MakerDao sets up a trust to hold US bond assets, it would at least reduce one layer of operational risk compared to the current indirect method through third parties. Because the third-party operating company itself has operational risks as a company. The team may also be trying to avoid regulatory risks. Why would regulators focus on these third parties? Because they are not only asset custodians, but also engage in trading, derivatives, lending, and complex issues related to anti-money laundering.
Regulatory Compliance Issues of RWA
I believe that regulation is definitely necessary when it comes to financial products. However, the attractiveness of RWA lies in the fact that it is detached from the previous sources of income in the entire crypto market. Previous income mainly came from trading, whether it was contract trading, spot trading, speculation, or token issuance. These income methods all face high regulatory risks. In fact, we have seen over the past few years that the reason why there is such a negative view of cryptocurrencies from a regulatory perspective is to some extent due to investor protection. The crypto market has indeed caused a lot of harm, with every explosion affecting tens of thousands of users. For example, FTX has tens of thousands of users, even millions of users. From a regulatory perspective, the main focus is still on investor protection. However, RWA assets, I personally think that retail investors generally do not have access to them, at least not at the asset level. Theoretically, I think it should not cause too much harm to retail investors. This actually makes it a simpler issue for regulation.
Looking back at the developments this year, if we look at RWA and LSD together, they have some similarities in that both aim to introduce new underlying assets to DeFi. In the LSD track, we see that the emergence of LSD has brought attention to previously marginalized tracks, such as yield tokenization. If US bond RWA can become a large-scale underlying asset on the chain, it may promote the outbreak of certain small-scale DeFi tracks. LSD and the dollar's bondization have very important similarities. We can consider the bondization of the US dollar as the LSD-ization of the US dollar, that is, pledging the US dollar. At their core, they are the same, both aiming to bring risk-free interest rates of different assets onto the chain. For example, ETH's LSD can actually be seen as an approximation of the risk-free interest rate in the crypto market, using ETH as the base, because many DeFi tokens are actually based on Ethereum, including various LP pools in Uniswap and Curve, all based on Ethereum. The yield of LSD actually represents the risk-free interest rate of Ethereum. Based on this yield, the Ethereum-based bond market may gradually emerge. This year's markets such as Pendle, we can see the trend of its TVL growth. Therefore, I am optimistic about US bond RWA, because with its emergence, new DeFi tracks based on the US dollar may experience explosive growth.
Development Path of RWA
It seems that these new US bond issuers are mostly in the Asian region, with a focus on Singapore and Hong Kong. Most of them are also operated by teams in Hong Kong or Singapore, but the actual structure may be set up using the Cayman Islands. On the other hand, the United States may place more emphasis on regulatory risks. I think that in the early stages, this area may probably follow a path similar to the early development of Tether, starting with offshore operations. I checked Ondo Finance, and it seems that their team is mainly in the United States, so they may be more cautious. Therefore, I think that Asian countries may have some first-mover advantages in terms of policies, with lower regulatory risks compared to the United States. An important point in the Asian region is the very high demand for the US dollar, with a very high market demand for offshore US dollars in Southeast Asia and Northeast Asia.
Future Prospects of RWA
However, from the perspective of retail investment, I think that the combinable returns of RWA will gradually permeate throughout the entire DeFi protocol. So in this regard, I think it is quite good for the issuers of decentralized stablecoins. In addition to Dai, we see that many stablecoins are also considering how to introduce RWA. In addition to LUSD, there are also recent discussions, such as Frax wanting to open a so-called master account at the Federal Reserve to directly hold US government bonds. Although I think that may not be so easy to achieve, you can see that they are also starting to consider how to introduce the RWA narrative. Another simple reason is that if there are decentralized stablecoins on the chain that have integrated US government bonds, many stablecoin issuers only need to integrate them. I believe that in DeFi, composability is a very important part. That is to say, I may not directly hold government bonds, but I can gradually obtain the returns of government bonds through various layers of associations in DeFi. I believe that after a year, US government bond assets may begin to penetrate various levels. This is the interesting aspect of the composability of DeFi. Its dissemination method is not to wait for each DeFi project to directly integrate government bonds as assets, but to gradually permeate returns through various combinations.
The current narrative is also Web3. If interest-bearing assets denominated in U-based or fiat-based currencies, such as US bond RWA, can smoothly flow out, I think it will have a very significant promoting effect on Web3. I believe this is a very important measure, at least to prevent funds from continuing to flow out. Currently, we can see that more and more projects that have issued tokens, as well as those in the primary market, are starting to get involved in the US bond and RWA tracks.
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