TLDR
The characteristics of RWA assets, such as high transparency and strong liquidity, make them the next race track for achieving large-scale applications in Defi after stablecoins.
There are roughly three development directions for RWA: public chains with a decentralized Defi-like experience, public chains with regulated whitelist transaction features, and transactions limited to private or consortium chains. The first direction has the highest composability and is the most desired development direction.
Currently, Defi lacks a good way to retain existing assets or introduce new ones. Traditional finance (Tradfi) faces liquidity, transparency, and transaction cost issues. Introducing RWA can to some extent solve the current problems of both and promote the integration of Defi and Tradfi.
Referring to the concept of RWA, we can extend to CWA (Crypto-World Asset), such as BTC ETF, which are financial instruments in the traditional financial market participating in the cryptocurrency market. The deep-seated demand for both can be attributed to investors' urgent need for the introduction of risk-matched specialized products to enhance financial efficiency.
Considering factors such as user transaction costs, asset holding costs, and compliance requirements, US Treasury bond ETF assets are the optimal choice for early-scale application of RWA. For the current development of RWA, compliance risk, counterparty risk, and US Treasury default risk are the main sources of uncertainty.
By introducing RWA assets, MakerDAO has currently achieved an adjusted yield of about 6.83%. Due to the low DAI deposit ratio, Maker can amplify the DSR to 1.86 times the RWA yield. Currently, MakerDAO offers a 5% yield to DAI depositors, slightly higher than the yield of US Treasury ETF, not only achieving substantial income through RWA yield but also bringing this income to DAI depositors on-chain.
As stablecoin projects gradually follow in the footsteps of CDP and begin to use RWA as their underlying assets, RWA in the stablecoin market will have exponential growth potential as the market share of stablecoin projects and the proportion of RWA assets increase, ranging from $15.96 billion to $21.50 billion.
With the improvement of regulatory compliance, RWA will start with standardized assets and gradually expand to non-standard assets. Combined with CWA, it will transform blockchain technology from the backend to the frontend. RWA will also become a key race track for the integration of Defi and Tradfi and achieve large-scale applications.
RWA Overview
Real World Assets (RWA) refers to traditional assets tokenized through blockchain technology, giving these assets a digital form and programmable characteristics. Under this framework, various types of assets—from real estate and infrastructure to art and private equity—can be transformed into digital tokens. These tokens not only represent the value of the assets but also contain multidimensional information corresponding to the physical assets, including but not limited to the nature of the assets, current status, transaction history, and ownership structure. Broadly speaking, widely used USD stablecoins are also a form of RWA, representing the tokenization of the US dollar. This article will step by step introduce how RWA can become the next race track for achieving large-scale applications after stablecoins.
With its unique multidimensional advantages, RWA assets have the potential to achieve large-scale applications in the blockchain ecosystem. Their high asset correlation and transaction transparency can build investor trust, while enhanced liquidity and cost efficiency strongly drive market activity and diversity. The introduction of smart contracts further enhances operational efficiency and simplifies compliance and auditing processes. These core features collectively pave the way for RWA to become the next race track for achieving large-scale applications after stablecoins, indicating its broad prospects in the blockchain and even the entire financial sector. However, RWA assets are diverse, and which assets will be the first to be scaled on-chain? What are the risks or challenges of on-chainization of different assets?
Overall, the tokenization market of fixed income assets and rare metal assets is currently relatively easy to achieve and has begun to take shape. Although the market value of gold tokenization has exceeded 1 billion (mainly represented by projects such as $PAXG, $XAUT), from the perspective of Defi's current pain points and demands, seeking standardized assets that can bring real yield to the chain, starting with fixed income assets such as US Treasury bonds/US Treasury ETFs is currently the easiest and most efficient way.
From the perspective of the blockchain and the strictness of KYC, RWA mainly has three development directions:
- Public chains with a permissionless experience
The first direction emphasizes maximizing permissionless transactions of assets on public chains to provide a user experience close to Defi. In this mode, real-world assets are tokenized and freely traded on public chains without centralized approval or permission, and asset transfers are not restricted. This approach maximizes asset liquidity and market participation while reducing transaction costs. However, this Defi-like experience also brings a series of regulatory and compliance challenges, including but not limited to anti-money laundering (AML) and KYC issues. Therefore, while this direction has obvious advantages, it also needs to address corresponding risks and compliance issues.
- Public chains with regulated whitelist
The second direction is a compromise, where assets may be traded on public chains but may be subject to some form of regulation or have certain thresholds, such as restricting participants through an address whitelist mechanism. In this case, only verified addresses added to the whitelist can participate in RWA transactions. This approach provides a certain level of liquidity and transparency while allowing regulatory authorities to conduct more effective supervision and compliance checks. Thus, it strikes a balance between permissionless and fully regulated modes.
- Private/consortium chains with complex KYC processes
The third direction involves RWA transactions on private or consortium chains, which typically involve complex KYC processes and stricter regulatory control, and currently have minimal asset composability. In this mode, verification nodes are usually government-verified and have certain institutional thresholds, ensuring the entire system operates in a highly compliant and controllable environment. Although this approach may limit asset liquidity and market participation, it provides the highest level of regulatory compliance and data security. This is the mode preferred by many governments and traditional financial institutions.
Why RWA is Needed?
Defi Perspective:
As seen from the Defi TVL data in the above figure, since the market panic and massive sell-off triggered by the UST decoupling in May 2022, the TVL of the Defi sector has been on a downward trend. Currently, projects and narratives are finding it difficult to attract off-chain funds and need to introduce new narrative structures and participants. Drawing on the aforementioned characteristics of RWA, on-chain tokenization of real-world assets to provide real asset value may be the best solution at present.
At the same time, in order to retain on-chain funds or attract off-chain funds, the high yield that Defi can provide is the key data that funds are chasing, and the pseudo-stablecoin yield of $UST has led to a lack of trust in high yields. RWA adding real yields backed by real-world assets to the protocol can effectively solve this problem.
Tradfi Perspective:
- Strong Regulatory Control and Limitations of Liquidity Tools
Despite significant progress in asset securitization and liquidity tools in the traditional financial system, such as Real Estate Investment Trusts (REITs) and Exchange-Traded Funds (ETFs), these tools are still subject to strict regulation and structural limitations. For example, REITs and ETFs typically need to meet a series of complex compliance requirements, which not only increase operating costs but also limit product innovation and market participation. Therefore, while these tools have improved asset liquidity to some extent, there is still significant room for improvement.
- Limitations in the Private Credit Sector
In the private market, especially in the private credit sector, there are various restrictions and unmet needs. These markets are often manual, slow, opaque, and have high operating costs. The capital matching process involves multiple steps from finding and qualifying investors and investment opportunities to initial capital allocation, secondary trading of assets, and management. These factors lead to irrational capital allocation and suboptimal customer experience.
- "Black Box" Problem of Complex Financial Products
When creating complex financial products, the traditional financial system often faces the "black box" problem, i.e., a lack of transparency and traceability, making it difficult to penetrate the underlying assets. This opacity not only increases risk but also limits the trust and participation of market participants. By mapping underlying assets to the chain and packaging assets into products on-chain through the composability of smart contracts, regulatory authorities only need to regulate the custody of underlying assets, allowing the process of creating complex financial products based on simple financial products to remain open and transparent, thus solving this problem. The convenience in terms of regulation may enhance the diversity and liquidity of on-chain financial products compared to traditional financial means.
Overall, the demands and challenges faced by TradFi mainly focus on improving liquidity, increasing transparency, and reducing costs. RWA provides effective solutions to these issues through tokenization and blockchain technology. Especially in the private market and complex financial product sectors, RWA is expected to bring unprecedented transparency and efficiency, thus addressing the core bottlenecks of the traditional financial system. By introducing RWA, the traditional financial system is expected to achieve higher capital efficiency, broader market participation, and lower transaction costs, thereby promoting the health and sustainable development of the entire financial ecosystem.
It is also evident that both traditional institutions or official institutions in Tradfi and Defi projects have been deeply involved in the RWA field for many years, seeking opportunities for synergy and integration between the two. This brings us to a concept that has recently received much attention—Bitcoin ETF, and thus referring to the concept of RWA, we can extend to a new concept—CWA (Crypto-World Assets).
RWA and CWA
As Bitcoin gradually becomes a mainstream investment category, major financial institutions are actively applying for approval of Bitcoin ETFs. This trend not only signifies the gradual integration of crypto assets into the traditional financial system but also provides us with a new perspective to consider these assets: the concept of CWA (Crypto-World Assets). CWA shares many similarities with RWA, mainly in terms of asset standardization and liquidity enhancement. However, while RWA primarily focuses on tokenizing real-world assets, CWA involves the standardization of crypto assets and related financial products in the real world. We can see the embryonic forms of both, represented by the on-chain issuance of US Treasury bonds/US Treasury ETFs and the approval and issuance of Bitcoin ETFs in the real world.
Like RWA, CWA also faces a series of regulatory and compliance issues. However, due to the decentralized and cross-border nature of crypto assets, these issues are more complex in the context of CWA. For example, the approval of Bitcoin ETFs needs to address multiple regulatory challenges, including but not limited to asset custody, price manipulation, and market supervision. But the introduction of CWA is expected to further enhance the liquidity and market participation of crypto assets. By combining crypto assets with traditional financial products, CWA can not only attract more traditional investors to the crypto market but also provide more investment and risk management tools for existing crypto investors.
Whether RWA or CWA, their deep-seated demands and reasons for emergence can be traced back to the introduction of risk-matched specialized products to enhance financial efficiency. Efficient financial markets lead to increased speculative behavior, further driving the demand for more assets and investment opportunities. In this context, both traditional financial institutions and Defi platforms need RWA and CWA to bridge the flow of funds, thereby attracting more users and capital. As new forms of financial innovation, RWA and CWA can not only meet the market's demand for diversified assets and stable yields but also promote the flow of funds to more efficient areas. By breaking down the barriers between Tradfi and Defi, RWA and CWA are expected to drive the entire financial ecosystem towards greater efficiency, transparency, and sustainability. This will not only improve the overall efficiency of the financial market but also provide investors with more investment choices and better risk management tools. This is also an important basis behind the large-scale application of RWA.
Why US Treasury ETF Assets?
Educational Cost
Let's consider why USD stablecoins have become the application area for mass adoption of cryptocurrencies? Why not Bitcoin or other native cryptocurrencies, or why not stablecoins issued by other sovereign countries?
Firstly, the educational cost for users is an important but often overlooked consideration. For most users, understanding and accepting new financial products and technologies takes time and effort. Secondly, compared to stablecoins issued by other sovereign countries, USD stablecoins are more easily accepted by users globally, and the US dollar itself is the world's primary reserve currency and trading currency, with widespread cross-border use, greatly reducing the educational cost for users. Therefore, leveraging users' understanding and trust in the US dollar, stablecoins pegged to the US dollar can gain market trust more quickly. Additionally, due to the global dominance of the US dollar, related educational materials and resources are easier to standardize and globalize, further reducing the difficulty of education in multilingual and multicultural environments. Lower user educational costs are often an important factor in achieving large-scale applications.
Similarly, this is also why we use US Treasury-related assets rather than bonds issued by other sovereign countries. US Treasury bonds are widely regarded as one of the safest assets globally, and their high credit rating and liquidity in the global financial markets reduce the resistance for users to accept new financial products or investment channels. High market transparency and audit standards provide strong information support for users, thereby reducing the ongoing education and marketing costs. Additionally, the stability and global liquidity of US Treasury bonds also help shorten the user learning curve, making it easier to accelerate the adaptation and acceptance of new users through community interaction and social endorsement. Of course, transparency and audit issues should not be overlooked. The US financial market is characterized by high transparency and strict auditing, providing reliability and credibility for US Treasury assets.
Real Yields
Tether ($USDT), as the most widely used USD stablecoin in the crypto asset field, has always faced issues of transparency and compliance with reserve assets. The lack of transparency provides Tether with the potential to overissue $USDT without sufficient reserves, conditionally using the overissued funds for other financial activities to generate profits. These profits are not returned to $USDT holders but are owned by Tether. This is particularly concerning in the current Defi environment, as it raises questions about how to more fairly distribute such potential profits to members of the Defi ecosystem. In this context, US Treasury bonds, with their relative stability, standardization, and lower risk characteristics, become a worthy consideration as the underlying asset for stablecoin issuers. Furthermore, US Treasury ETFs, relative to US Treasury assets, not only reduce regulatory risk but also make it easier for issuers to access this portion of assets and yields (see the comparison of eligibility for purchasing US Treasury and US Treasury ETF in the table below).
In summary, US Treasury ETFs are a powerful option that can help stablecoin issuers like MakerDAO address the transparency and counterparty risks associated with underlying assets such as $USDT and other centralized stablecoins. They also have the potential to drive the acceptance of crypto assets among the general public. Using US Treasury ETFs as underlying assets not only provides a more transparent and regulated investment avenue but also allows for fairer distribution of investment returns to all participants. This can have a positive impact on the DeFi ecosystem by meeting both public acceptance and regulatory requirements. Therefore, we are now seeing many stablecoin projects, like MakerDAO, starting to incorporate US Treasury yields into their collateralized stablecoins. It is believed that this will become a necessary element for CDP stablecoins (Collateralized Debt Position is a protocol that generates stablecoins by locking collateral in smart contracts) and even the stablecoin market, bringing real-world asset-backed real yields to DeFi. Compared to stablecoins like $USDT, stablecoins with RWA asset yields mapped on-chain are more transparent in terms of underlying assets and yields, and offer fairer profit distribution to investors. They also have higher credibility and acceptance for regulatory authorities, and although they may sacrifice some opaque benefits, they offer greater market stability with the cooperation of regulatory authorities. The mass adoption of RWA assets is at least a win-win-win situation for the stablecoin field.
Advantages of US Treasury ETFs
Referring to the comparison table of US Treasury and US Treasury ETF assets above, direct purchase of US Treasury bonds has higher requirements for investors in all aspects, especially for decentralized stablecoin issuers who already have compliance risks, or for other DeFi projects that want to obtain real-world asset yields. Therefore, if there is a reliable ETF issuer as a partner, directly purchasing US Treasury ETF assets is a lower-cost and more liquid way than holding US Treasury assets. Additionally, as shown in the table below, DeFi projects holding US Treasury ETF assets have various advantages over other real-world assets.
According to the viewpoint of Colin, a researcher at Mint Ventures (refer to 'The Only Answer for Mid-Term RWA: Ramblings on the Web3 Sovereign Bonds'), using US Treasury ETFs as underlying assets has the main advantage of greatly simplifying the asset management process. In this arrangement, all management responsibilities related to underlying assets, including liquidity management and rolling over of bonds, are handled by the ETF issuer and manager. This approach effectively reduces the operational burden and risk for project parties in asset management. Furthermore, US Treasury ETFs have not experienced significant risk issues to date, so project parties do not need to be particularly concerned about this aspect of risk. Currently, they only need to select the largest, most liquid, and standardized assets on the market to include in their portfolios. Compared to holding US Treasury assets themselves, US Treasury ETFs allow project parties to focus on their core business and delegate complex asset management tasks to professional ETF issuers and managers, thereby reducing operational risks and improving efficiency.
In summary, US Treasury ETFs as on-chain assets have multiple advantages, including their standardized nature, the potential as an early target for RWA exploration, relatively lower compliance requirements, and the ability to serve as income-generating assets. These advantages make them a worthy option, especially for project parties looking to explore and experiment with real-world asset tokenization early on. Of course, these considerations are based on the current limited scale of the tokenized asset market. According to the asset tokenization document released by the Federal Reserve Board in August, as the scale gradually expands, the vulnerability of ETF assets in the traditional financial market due to the high liquidity and composability of tokenized assets may lead to price fragility, or in other words, transmit price fluctuations in the crypto market to the traditional asset market. This is also a concern for investors and regulatory authorities, and effective solutions are still needed. Additionally, as US Treasury yields decline, the ability to find similar products will also be a major challenge for the DeFi sector.
How to Tokenize RWA Assets?
Although the RWA market has begun to take shape, it is still in the exploration stage, and project parties and financial institutions from different backgrounds in Defi and Tradfi are also trying different solutions for tokenizing assets. Combining the three development directions of RWA mentioned earlier, we can see that the closest to the Defi experience and the penetration of US Treasury yields into RWA asset returns is MakerDAO, which also incorporates DAI Savings Rate (DSR) into its operations. Ondo Finance is another example of a whitelist trading model, and the Hong Kong government has issued green bonds on a private chain through Goldman Sachs' tokenization platform GS DAP, among many other tokenization methods for real-world assets.
Tokenization Path for RWA Assets by MakerDAO:
Although MakerDAO began planning the development of RWA as early as 2020, the current situation is that, due to regulatory compliance, it has only obtained income from RWA assets, mainly US Treasury, through different institutions. This income is then brought on-chain and distributed to some DAI holders through DSR (DAI Savings Rate). In other words, at most, it can be considered as tokenizing the economic rights of RWA assets rather than ownership rights, but given that it is currently the closest way to obtain real-world asset yields in the Defi experience, it is hoped that with the improvement of regulatory compliance, MakerDAO and its partner institutions will further tokenize RWA assets and have greater composability. Next, taking the two main Vault Types currently holding US Treasury assets for MakerDAO, RWA007-A (Monetails Clydesdale) and RWA015 (BlockTower Andromeda & Centriduge) as examples, let's see through which paths these projects have already brought US Treasury ETFs on-chain.
I Monetails Glydesdale
Referring to the MIP65 proposal, we can gain a general understanding of how the third-party institution Monetalis is helping MakerDAO hold US Treasury ETF assets. Firstly, MakerDAO has proposed solutions to three major issues related to assets on the balance sheet, including the inability to generate income from stablecoins, especially $USDC and $USDP assets accounting for over 50% of the balance sheet, asset concentration risk, and negative public relations impact. They believe that by holding short-term government bonds, they can create some positive returns while reducing the risk exposure to existing stablecoin issuers.
The initial idea of MakerDAO is to manage the assets of each fiat-backed stablecoin ($USDC/$USDP, etc.) by setting a target debt ceiling and a minimum/maximum range for these assets. When the debt ceiling of a stablecoin's PSM pool exceeds the maximum limit, the excess funds are converted into cash and invested in short-term investment-grade bond ETFs to reduce the risk exposure to that stablecoin and potentially increase returns. Conversely, if the debt ceiling is below the minimum limit, the system allows for manual intervention, usually carried out by MKR holders. The overall mechanism aims to more effectively manage the supply and demand of DAI while balancing risk diversification and increasing returns. The choice of bond ETFs as an investment tool is primarily based on a comprehensive consideration of liquidity, simplicity, cost-effectiveness, and risk management, as mentioned here. ETFs not only provide high liquidity and asset diversification to reduce overall risk but also, compared to managed accounts, offer simplicity and cost-effectiveness, with the potential for some returns, although not high at the time. Additionally, as ETFs are managed and supervised by professional asset management companies and regulatory authorities, they also provide a certain level of transparency and security. From the perspective of risk control and income generation alone, it is difficult to see MakerDAO's intention to develop RWA by introducing US Treasury ETF assets through MIP65. However, through its collaboration with Monetails and the projects under MIP68, we can see MakerDAO's long-term plans for RWA development.
According to MIP68, Monetails describes MakerDAO's vision for RWA as follows: through institutions like Monetails, MakerDAO aims to introduce diversified high-quality RWA assets to achieve the integration of Maker and Tradfi, enabling credit assessment and other operations in a more flexible, innovative, and market-responsive manner, and realizing the vision of Clean Money for Maker. The most ambitious goal is for Maker to create and operate integrated services that integrate high-quality Tradfi and Defi, becoming an operator of a series of integrated services involving on-chain and off-chain integration of Tradfi and Defi, including RWA tokenization. This massive market is indeed very attractive, and we can see how Monetails is specifically implementing this.
First, find a stable integration point without significantly changing the daily operations of Defi and Tradfi to rapidly increase trading volume. Then, with a foundation of large-scale capital flow, gradually achieve more comprehensive on-chain integration. Ultimately, bring DeFi and traditional financial markets closer together, moving from experimentation to the mainstream. In other words, this is a basic plan for Monetails' RWA business development and serves as a complement to RWA businesses in various fields such as Centrifuge, Maple, and TrueFi.
So how is this specifically achieved? According to MIP68, there are roughly three main components:
ARENA is dedicated to solving the complex interactions between traditional finance and Defi, finding suitable integration points as breakthroughs for growth, including but not limited to compliance, operations, and technology, to achieve the organic integration and long-term development of both, acting as a bridge between the two.
On the TradFi side, Glydesdale is mainly responsible for managing and initiating relationships with financial institutions, building trust, analyzing and matching suitable products and demands, and implementing these relationships. It also addresses the conflicts and challenges between Defi and TradFi in practice. Currently, both have their inherent needs and expectations, but there is limited tolerance for compromise. The existence of Clydesdale is to provide an intermediary solution to bridge the gap between Defi and TradFi, especially for protocols like MakerDAO, providing a path to gradually attract and integrate large financial institutions.
At the same time, Lusitano is an asset management platform that specifically attracts and integrates teams with specific asset category experience and proven performance. By creating a flexible platform, it not only promotes deep integration between Defi and TradFi but also serves as an empirical tool to demonstrate the feasibility and innovation of Defi. The platform particularly focuses on driving teams towards ESG and the green economy, thereby establishing broader and more diverse cooperation between Defi and TradFi.
In other words, through the above plan, MakerDAO and Monetails, through their collaboration, clearly introduce RWA assets as collateral, providing real-world asset guarantees for DAO income. At the same time, it can be seen that both parties are aiming to participate in and expand into a broader market. Next, let's take a look at how BlockTower Andromeda and Centrifuge, which have also collaborated with Maker, operate.
II BlockTower Andromeda and Centrifuge's Approach
If the collaboration between MakerDAO and Monetails represents a deep push by both parties towards the RWA vision, then the three-way collaboration between MakerDAO, BlockTower Andromeda, and Centrifuge provides almost a complete set of solutions for other project parties to introduce RWA assets, especially as the latter two view their main mission as creating a repeatable, scalable, and reliable framework for RWA investments, which is a key link in the process of scaling RWA applications. At the same time, we can also see that at this point, MakerDAO has a greater ambition for the integration of Tradfi and Defi, a so-called ambitious plan aimed at pushing MakerDAO and DAI into a broader social and commercial sphere, especially in emerging markets and real-world applications.
Through its collaboration with the Centrifuge platform, MakerDAO indirectly holds real-world assets such as US Treasury bonds, a process that is highly innovative, combining the advantages of traditional finance and blockchain technology. First, the asset management company BlockTower Andromeda creates SPVs, each of which is associated with a fund pool set up on the Centrifuge platform. This setup ensures the independence of each fund pool and also gives each fund pool a certain legal identity, helping to reduce compliance and operational risks.
Borrowers issue NFTs corresponding to the real-world assets they hold (such as US Treasury bonds) through the SPV. These NFTs are considered the on-chain representation of these assets and are locked in the relevant fund pools on Centrifuge to extract the corresponding loans. This step is crucial because it provides additional transparency and traceability through blockchain, making external audits and risk assessments easier and more reliable. These NFTs are aggregated into asset pools, which are further divided into two types of tokens: $DROP and $TIN. $DROP tokens represent the senior portion of the asset pool with lower risk, while $TIN tokens represent the junior portion with higher risk.
As the primary debt purchaser for Centrifuge, MakerDAO directly integrates with Centrifuge's fund pools, allowing it to withdraw the corresponding DAI stablecoin directly from its Vault through $DROP tokens. This direct integration greatly simplifies the process of debt purchasing and management, improving the efficiency and usability of the entire system. Through this integration, MakerDAO not only gains robust returns associated with real-world assets such as US Treasury bonds but also more effectively manages and optimizes its balance sheet. To ensure investment security, Centrifuge has introduced a series of complex risk stratification and protection mechanisms. The two most important concepts are the "Minimum Subordination Percentage" and the "Epoch Mechanism." The former is used to ensure that senior assets ($DROP) have sufficient risk buffers to prevent unexpected losses. The latter is a redemption mechanism that allows token holders to redeem based on the cash flow of underlying assets, with $DROP holders having priority. These mechanisms together provide MakerDAO with additional risk protection.
However, this mechanism is not without risks. Firstly, the system involves multiple counterparties and complex contractual relationships, increasing compliance risk, counterparty risk, and legal risk. Secondly, although the setup of SPVs and fund pools to some extent reduces centralization risk, interactions with real-world assets may still bring other forms of risk, such as liquidity risk and market risk. Furthermore, as this model is relatively new, how to address potential security issues such as governance attacks still requires further exploration and resolution.
Undoubtedly, not every project party can gradually access RWA assets through institutions similar to Monetails, as MakerDAO has done. The indirect holding of real-world assets through infrastructure institutions like BlockTower Andromeda and Centrifuge not only simplifies the process and reduces costs but, more importantly, currently does not require bearing the legal compliance costs, while also providing access to a wider variety of assets. This infrastructure construction is crucial for realizing the vision of scaling RWA applications. However, at present, what MakerDAO has achieved is still only the "tokenization" of economic rights of RWA assets. If we consider the original concept of asset tokenization, Ondo Finance's approach to on-chain asset tokenization is more in line with the RWA concept.
Ondo Finance's Whitelisted Trading Model for US Treasury Bond Tokens:
The $OUSG token represents an investor's share in the Ondo I LP fund. Ondo I LP is a limited partnership registered in Delaware, which attracts on-chain investors to invest in and hold fund assets such as ETF assets. The $OUSG token is different from conventional cryptocurrencies or assets; it is a token associated with specific fund assets.
Technically, the $OUSG token is based on Ethereum smart contracts. It can track investors' fund shares on-chain and can be used in the subscription and redemption process of the fund. When investors wish to subscribe to the fund, they need to go through Ondo I LP's KYC/AML process, which typically involves providing personal identification and financial information. Once completed, the investor's Ethereum wallet address is whitelisted, allowing them to send USDC to the fund's smart contract for subscription. This process is completed by the smart contract, including fund receipt and share allocation.
After investors send USDC to the fund's smart contract, the contract automatically transfers the funds to the fund account held by Coinbase. Then, Ondo Investment Management (Ondo IM) converts the USDC to USD and transfers it to the cash account of Clear Street (a securities broker and qualified custodian) through a cooperative bank. After the subscription is completed, investors receive an equivalent amount of $OUSG tokens as proof of their share in the fund. These $OUSG tokens can be stored in an Ethereum wallet or used on other platforms (composability) and can also be used for future redemption operations.
When investors are ready to redeem their shares, they can send $OUSG tokens to the fund's smart contract to submit a redemption request. The smart contract automatically records this operation. Then, Ondo IM sells a sufficient number of ETF shares at Clear Street to meet the redemption request. The resulting USD is converted to USDC and sent to the investor's Ethereum wallet through Coinbase.
It can be said that Ondo Finance has found a compromise and has shown the composability of RWA asset tokens. However, due to compliance constraints, we cannot be overly optimistic about this whitelisted approach at this time.
Hong Kong Government's Evergreen Project:
In the Evergreen project, the tokenization of bonds is divided into multiple stages for issuance and subscription, with some stages taking place on the Goldman Sachs DAP platform. Initially, the platform is only open to platform participants, such as the Hong Kong SAR Government, the Hong Kong Securities Clearing Company (CMU), distributors, custodian banks, and secondary market traders, each of whom is assigned specific roles and responsibilities, with high entry barriers. For non-direct platform participants, their rights are held through custodian banks (similar to clients who have undergone rigorous KYC by banks).
For tokenized bonds, some steps are carried out off-chain, such as book-building and pricing. On the day of book-building and pricing, CMU creates on-chain smart contracts representing the actual rights of tokenized bonds and smart contract instructions representing Hong Kong dollar cash tokens. At this point, authenticated platform participants such as distributors need to transfer the corresponding funds to CMU's real-time gross settlement system (RTGS) account managed by smart contracts to participate in the subscription process on the platform.
The digital platform consists of smart contracts implemented by the Canton blockchain, responsible for interpreting and executing smart contracts, and the Hyperledger Besy communication and consensus ledger running on Ethereum nodes, both of which are private chains, providing higher security and privacy. It is worth noting that the visibility of certain smart contracts for different participants in the project depends on whether they are signatories and observers of the relevant smart contracts.
Finally, various payment and clearing activities throughout the bond's lifecycle, such as interest payments and principal repayments, are carried out using Hong Kong dollar cash tokens minted by the Monetary Authority. Smart contracts automatically handle these payment and clearing operations. Compared to using digital tokens not minted by the Monetary Authority or any central bank for trading digital securities, which may be specifically designed tokens for individual transactions, providing a unified Hong Kong dollar cash token for trading ensures the smooth operation of the entire Evergreen project.
In summary, the tokenization model for securities by the Hong Kong government can be considered highly compliant and controllable. However, this may only be an attempt by traditional institutions to use blockchain technology to improve the efficiency of financial asset trading and reduce costs, and may not necessarily be strong evidence of the scaling and growth of RWA applications.
Data Analysis
With the continuous interest rate hikes by the Federal Reserve starting in early 2022, the yields of US Treasury bonds have also increased significantly. The yield of the two-year Treasury bond, which averaged only 0.15% at the end of 2021, soared to an average of 4.5% at the end of 2022. It can be seen that MakerDAO's decision to introduce US Treasury assets is almost synchronous with the Federal Reserve's interest rate hike decision. Undoubtedly, at present, MakerDAO has earned a substantial income through RWA, and has also distributed a portion of the income to DAI holders. We can use data to roughly estimate the adjusted return rate of RWA assets for DAI depositors and the amplification factor of DSR penetrating into the income process of RWA assets.
As shown in the table above, the Adjusted Return Rate (ARR) is calculated by dividing the annual return of RWA (D, 0.11 billion) by the total DAI deposits (F, 1.61 billion). This adjusted return rate can be considered as the theoretical return rate that DAI depositors can potentially obtain through the MakerDAO platform, based on the current deposit ratio and the annual return of RWA assets, even though it is indirectly achieved through RWA assets. Additionally, the DSR (Dai Savings Rate) amplification factor is calculated by dividing the adjusted return rate (ARR) by the annualized return rate of RWA (E, 3.68%). This ratio reflects the increase in the return rate that DAI depositors can obtain through the DSR mechanism relative to directly holding RWA assets. A DSR amplification factor of 1.86 indicates that through the DSR mechanism, DAI depositors can achieve a nearly double annualized return rate compared to directly holding RWA assets. This amplification factor demonstrates the potential value and income advantage that the DSR mechanism provides to DAI depositors. In this scenario, the DSR mechanism seems to offer DAI depositors a higher return rate, enabling them to achieve better investment returns over the course of a year.
So why is the ARR almost twice as high as the annualized return rate of RWA? This is because the current DAI deposit rate is not high, allowing MakerDAO to distribute the income obtained from RWA to the relatively smaller-scale DAI depositors, which is also why we see Maker offering a DSR as high as 8%. But how do we determine if this is a Ponzi scheme? We believe that as long as Maker ensures the underlying assets and the transparency of profits and costs, if the historical average data of DSR is lower than the real returns of RWA assets, it indicates that the on-chain return rate is backed by real-world asset returns. A higher return rate will attract more DAI deposits, leading to an increase in the total DAI deposits, and thus an increase in the DAI deposit ratio, resulting in a decrease in ARR and the DSR amplification factor, meaning the same RWA returns are shared among more people.
In conclusion, MakerDAO's effective penetration of stable returns from RWA assets and distribution of income to DAI depositors has been successful. A transparent return rate backed by real-world assets is a major gap in DeFi at present and will be the most fundamental layer for the future scaling of RWA applications. Of course, US Treasury bonds may not always maintain such high interest rates, but for the sake of prediction, let's assume that MakerDAO can obtain a stable annualized return of 3.68% through RWA. With the increasing proportion of RWA as underlying assets and the DAI deposit ratio, we can conduct sensitivity analysis on ARR and the DSR amplification factor.
As shown in the table above, the left column lists different DAI deposit ratios, and the top row lists different proportions of RWA assets. As the DAI deposit ratio increases, the annualized return for DAI depositors gradually decreases, and the DSR amplification factor also decreases, meaning that the deposit returns for DAI are approaching or falling below the real returns that MakerDAO obtains from RWA assets. As MakerDAO increasingly uses RWA assets as collateral, its real returns also increase, and we can see that the DAI deposit rate and the DSR amplification factor also increase.
Currently, holding DAI deposits to obtain a near-risk-free deposit rate in DeFi is a promising development direction for MakerDAO, especially in the current environment where relatively high-risk-free rates can be obtained from US Treasury bonds. From this perspective, we can roughly predict the future market value of the RWA sector in the CDP market.
Based on MakerDAO's current 54.1% proportion of RWA assets, we can roughly estimate the market value of RWA in the CDP stablecoin market to be $4.24 billion. As mentioned earlier, with the large-scale application of RWA, the market share of CDP stablecoins, due to the stable and transparent returns distributed to stablecoin depositors from RWA assets, will also increase accordingly. Therefore, we conduct a simple sensitivity analysis on the market value of RWA in the CDP stablecoin market. (Unit: billion)
The table above lists the market share of CDP stablecoins on the left column and the proportion of RWA as underlying assets on the top. It can be seen that with the increase of both, the market value of RWA experiences a significant increase. Compared to the mainstream stablecoin USDC, this type of CDP stablecoin, which essentially comes with a deposit rate, is more transparent and offers a more reasonable distribution of returns to holders. It is reasonable to speculate that more projects will follow MakerDAO's lead in gradually replacing their underlying assets with RWA assets, which may only be a small part of the landscape of the large-scale application of RWA.
Conclusion and Outlook
Through in-depth analysis and evidence, we believe that RWA has shown significant market potential and long-term growth prospects. With the advancement of large-scale RWA applications, both the DeFi and TradFi fields will see numerous new opportunities, and may even achieve partial integration. However, the current unclear regulatory and compliance attitudes remain the main obstacles to the large-scale application of RWA. While we hope that RWA can achieve a similar experience to DeFi on public chains and permissionless systems once the regulatory framework is clear, we still need to be cautious about being overly optimistic in the short term.
By observing the relevant practices of MakerDAO, Ondo Finance, and the Hong Kong government, we have initially seen the various solutions and application possibilities of RWA. With the gradual expansion of RWA, we look forward to further leveraging its characteristics to address various issues faced by DeFi and TradFi.
Looking ahead, the development of RWA lays the foundation for innovative changes in the financial field. In terms of asset selection, RWA will initially focus on standardized assets such as US Treasury bonds, US bond ETFs, gold, REITs, and high-grade corporate bonds, which have mature trading mechanisms and high liquidity, providing a solid foundation for RWA. With technological advancements and market maturity, we expect RWA to gradually expand to non-standardized assets such as art, real estate, and private equity, which will require more innovative thinking and solutions, including the design of complex evaluation mechanisms and risk management strategies, and will also depend on the gradual improvement of regulatory and compliance frameworks.
In terms of user acceptance, RWA's strategy should focus on first meeting investors' demand for standardized assets, and then gradually guiding them to understand and accept non-standardized assets. This process not only requires carefully designed market education and promotion strategies but also requires in-depth analysis of investor needs to ensure that RWA can provide investment opportunities with substantial value.
Additionally, the combination of RWA and CWA is expected to drive the transformation of blockchain technology from the backend to the frontend. This transformation is similar to the evolution of the internet from backend servers and databases to frontend user interfaces and applications, greatly enhancing the usability and accessibility of the technology. At the same time, the combination of RWA and CWA will not only break the limitations of traditional financial markets but also provide investors with more and higher-quality investment choices. To achieve this goal, efforts and cooperation from various aspects are needed, including asset standardization, infrastructure development, market education, and regulatory compliance support.
In summary, RWA is highly likely to become an important track for large-scale application and the promotion of the mutual integration of DeFi and TradFi, following the USD stablecoin. We will continue to monitor the development of RWA and related regulatory policies to provide investors with accurate and timely market analysis.
References:
https://forum.makerdao.com/t/monetalis-evolution/14811
https://docs.centrifuge.io/getting-started/off-chain/
https://drive.google.com/file/d/1x89OjKjaqPLJI-W2-U7pXiS9H_zBOyUb/view
https://drive.google.com/file/d/1kDMvQ2drS0jfbv4uB5UAUbfcObmA-I0H/view
https://www.hkma.gov.hk/media/gb_chi/doc/key-information/press-release/2023/20230824c3a1.pdf
https://docs.ondo.finance/qualified-access-products/ousg/how-it-works
Disclaimer: This report is an original work completed by the student, @yelsanwong, at @GryphsisAcademy, under the guidance of @CryptoScottETH and @ZouBlock. The author is solely responsible for all content, which does not necessarily reflect the views of Gryphsis Academy or the organization commissioning the report. Editorial content and decisions are not influenced by readers. Please be aware that the author may own the cryptocurrencies mentioned in this report. This document is for informational purposes only and should not be used as the basis for investment decisions. It is strongly recommended that you conduct your own research and consult with independent financial, tax, or legal advisors before making investment decisions. Please remember that past performance of any asset is not a guarantee of future returns.
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