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How RWAs can realize the DeFi promise

The RWA ecosystem has grown significantly, becoming a transformative force in decentralized finance (DeFi), with over $10 billion in total value locked (TVL) in 2024, highlighting a surge in institutional investment.

How RWAs can realize  the DeFi promise

The RWA ecosystem has grown significantly, becoming a transformative force in decentralized finance (DeFi), with over $10 billion in total value locked (TVL) in 2024, highlighting a surge in institutional investment.

Building bridges with solutions tailored for emerging markets is crucial. Some companies are already providing essential funding to microfinance institutions using blockchain, which support small and medium-sized enterprises. At the same time, innovations like Celo’s Opera MiniPay are enhancing financial connectivity and creating vital liquidity bridges across economies.

This growth underscores the importance of integrating traditional assets with blockchain technology to create a more inclusive and equitable financial landscape. As technology advances and regulations evolve, the RWA ecosystem promises more liquidity and democratized finance.

Exploring the Ecosystem

In the evolving landscape of decentralized finance (DeFi), Real-World Assets (RWA) have emerged as a transformative force, bridging the gap between traditional financial systems and blockchain technology. The RWA ecosystem represents a fusion of physical and financial assets with the transparency, security, and efficiency of blockchain.

The concept of tokenizing real-world assets involves creating digital representations of tangible or financial assets on the blockchain. Theorically, this innovation allows for greater liquidity, fractional ownership, and seamless transferability of assets such as real estate, commodities, art, and even intellectual property.

This is an upcoming tendency that has been working in silence for a while and that recently expanded its’ TVL reaching over $10 billion in 2024, reflecting an influx of institutional investors.

More Than Just an Improvement

The current ecosystem within the RWA space has increased liquidity, but is predominantly made up of asset types like tokenized T-bills, real estate, and corporate debt. Much of this market is an improved versions of traditional finance.

This is not necessarily negative; it shows a thriving ecosystem due to upcoming adoption and regulation. Using blockchain for traditional financial products allows them to be integrated into DeFi platforms through various mechanisms. These mechanisms enable their use as collateral or investment vehicles, providing liquidity and opportunities for returns.

This integration aims to bridge the gap between traditional asset markets and modern decentralized finance systems.

B2B startups that target institutional and corporate customers are leading the path towards a digitized economy.

Centralization and Intermediaries

Despite the significant increase in market capitalization, there are still few solutions focusing on emerging markets.

Protocols like Goldfinch and Credix are focusing their efforts on reaching Micro Finance Institutions to lend them money. These institutions use the borrowed money to fund Small and Medium-sized enterprises.

As we descend the pyramid, the interest rates increase.

While this might be an improvement on the traditional system, its impact still limited and highly intermediated.

Considering we're dealing with real-world companies (not DAOs), some degree of centralization is necessary and will likely continue to be so in the future.

However, ultimately, the growth of the RWA ecosystem might resemble merely transferring funds from traditional finance technology to blockchain technology.

This is part of the adoption process, but we can aim to go even further.

Building Bridges

Sometimes, we become accustomed to our reality, forgetting the state of the world.

Twenty-five percent of the global population remains unbanked. Interestingly, this group produces over 50% of the food we consume.

Back in 2007, M-Pesa disrupted the Kenyan market with its revolutionary mobile money transfer service, onboarding over 1 million users in just one year.

In September 2023, Celo launched Opera MiniPay, a financial service integrated into the Opera Mini web browser, onboarding over 1 million users in six months.

We might see only numbers on the screen, but in real life, this is about people.

M-Pesa provided financial connectivity to a whole nation. Opera MiniPay can provide a new financial system to a whole continent, and RWA Lending may be the killer application for creating liquidity bridges between economies and countries.

To be more specific, existing solutions such as Arf and Huma Finance, which recently joined forces, are building a global liquidity and settlement platform that aims to revolutionize cross-border payments. This is just one example, but several protocols are being built on blockchain, leveraging its benefits to demonstrate the real potential of this technology in aiming for financial inclusion.

Old problems, new solutions;

In my research, I came across the RWA Investment thesis from Tioga Capital.

One of their arguments for being bullish about RWA says, "More generally, the IMF estimates that DeFi platforms have ~2X lower marginal costs compared to Banks and Non-banks in Advanced Economies, and ~4-5X lower marginal costs compared to Emerging Markets."

This is quite fascinating, especially when we connect this information to existing financial solutions aimed at emerging markets. A prime example is traditional micro-lending, a market currently exceeding $200 billion.

An industry that is still facing challenges. Capital deployment based on traditional credit scoring is hardly a reliable metric to use.

These emerging technologies aim to address fundamental issues within the micro-lending industry. Reputational-based credit scoring systems seek to provide a more accurate assessment of a borrower's creditworthiness by analyzing their behavior and social interactions rather than relying solely on traditional credit scores. This approach can potentially unlock financial services for individuals who have been historically underserved by conventional banking systems.

Similarly, some platforms are experimenting with game theory and incentive alignment to create sustainable lending ecosystems. By aligning the interests of lenders and borrowers through innovative mechanisms, these platforms aim to reduce default rates and enhance the overall stability of the micro-lending market.

Moreover, the integration of on-chain collateral and compensation funds offers additional security to lenders. These blockchain-based solutions ensure that there are tangible assets backing the loans, reducing the risk of default. Compensation funds can act as a safety net, providing coverage in cases of borrower default, thereby increasing lender confidence and participation.

A blue ocean opportunity

Regulation is on the horizon, promising more liquidity in the DeFi space. The technology is more advanced than ever, but before building, it's essential to consider the purpose.

Are we aiming to simply replicate traditional models on a blockchain stack? Are we trying to just improve them? Or perhaps, are we striving to create new, fair, lean, and decentralized models?

How do we decentralize real-world asset solutions and investments? How do we democratize traditional finance?

These are fair questions, but they have complex answers.

Nevertheless, these are challenges we're ready to accept and overcome.

We are in front of a blue ocean opportunity, a market difficult to quantify but surely immense in potential. This opportunity promises significant financial returns as well as profound impact. Just as M-Pesa did in 2007 and Opera MiniPay is doing now, we have in our hands tools that can reshape the lives of many people, providing them with opportunities and prosperity where there were none before.

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