RWA Lending Protocols: Bridging the Gap between Traditional and Decentralized Finance

The world of finance is undergoing a radical transformation. On one hand, we have the traditional financial system, which is based on centralized institutions, intermediaries, and regulations. On the other hand, we have a decentralized financial system, which is powered by blockchain, smart contracts, and peer-to-peer networks. Both systems have their own advantages and disadvantages. Still, they also have a common challenge: connecting and leveraging the vast and diverse pool of real world assets (RWA) outside the digital realm.

Real world assets are any tangible or intangible assets that have economic value and can generate cash flows, such as real estate, art, commodities, invoices, loans, etc. These assets represent a huge market opportunity, accounting for over $250 trillion of global wealth. However, they also face many barriers and inefficiencies, such as illiquidity, high transaction costs, lack of transparency, and limited access.

This is where RWA lending protocols come in. They aim to bridge the gap between traditional and decentralized finance by bringing RWA on-chain and unlocking their potential for lenders and borrowers. In this article, we will explore the benefits, challenges, and potential of RWA lending protocols in the crypto space.

What are Real World Assets (RWA)?

Real world assets (RWA) are any assets that have economic value and can generate cash flows but are not native to the blockchain. They can be tangible or intangible, physical or digital, and belong to various sectors and industries. Some examples of RWA are:

• Real estate: properties, land, buildings, mortgages, etc.
• Art: paintings, sculptures, digital art, etc.
• Commodities: gold, silver, oil, crops, etc.
• Invoices: accounts receivable, trade finance, etc.
• Loans: personal loans, business loans, student loans, etc.

RWA represents a vast market opportunity, as they account for more than $250 trillion of global wealth. However, they also face many barriers and inefficiencies, such as illiquidity, high transaction costs, lack of transparency, and limited access. These challenges prevent RWA from reaching their full potential and creating value for asset owners and investors, hence a need to tokenize them.

What are Tokenized Real World Assets?

Tokenized real world assets are RWA that have been converted into digital tokens that represent ownership or rights to the underlying assets. Tokenization enables RWA to be brought on chain and integrated with the decentralized financial system.

Tokenization has several benefits for RWA, such as:

• Liquidity: Tokenization allows RWA to be divided into smaller and more accessible units that can be traded on secondary markets or platforms. This increases the liquidity and marketability of RWA, which are often illiquid and hard to sell.
• Efficiency: Tokenization reduces the transaction costs and friction associated with RWA, such as intermediaries, paperwork, verification, and settlement. This makes the transfer and exchange of RWA faster and cheaper.
• Transparency: Tokenization provides more visibility and traceability of RWA, as the tokens and transactions are recorded and verified on the blockchain. This improves the data quality and accuracy of RWA, as well as the trust and confidence of the parties involved.
• Access: Tokenization opens up new opportunities and possibilities for RWA, as they can be accessed and utilized by a broader range of investors and users across the globe. This democratizes the ownership and participation of RWA, as well as the creation and distribution of value from them.

What are RWA Lending Protocols?

RWA Lending Protocols are decentralized platforms that enable lending and borrowing opportunities using RWA as collateral or credit assessment. They aim to bridge the gap between traditional and decentralized finance by bringing RWA on-chain and unlocking their potential for lenders and borrowers.

RWA Lending Protocols work by tokenizing RWA and issuing them as digital securities or tokens representing ownership or rights to the underlying assets. These tokens can then be used as collateral to borrow stablecoins or other crypto assets, or as credit assessment to access lower interest rates or higher loan amounts. Alternatively, investors can lend their capital, such as stablecoins or Ether, and earn interest from the borrowers who use RWA as collateral or credit assessment.

RWA Lending Protocols can be classified into two types: collateralized and undercollateralized.

• Collateralized RWA Lending Protocols require borrowers to deposit RWA tokens as collateral that exceeds the value of the loan they are taking. This provides security and assurance for the lenders in case of default or liquidation. Examples of collateralized RWA Lending Protocols are MakerDAO, Centrifuge, and Ondo Finance.
• Undercollateralized RWA Lending Protocols do not require borrowers to deposit RWA tokens as collateral that exceeds the value of the loan they are taking. Instead, they rely on other mechanisms, such as credit scoring, reputation systems, social verification, or governance, to assess the creditworthiness and risk profile of the borrowers. This provides more flexibility and accessibility for borrowers with insufficient RWA tokens to collateralize. Examples of undercollateralized RWA Lending Protocols are Goldfinch, Maple Finance, and Creditcoin.

Different RWA Lending Protocols

There are several RWA Lending Protocols in the crypto space, each with features, advantages, and challenges. Here are some of the most prominent ones:

Goldfinch

Source: Goldfinch Website

Goldfinch is a decentralized protocol that aims to provide credit access to underserved markets worldwide. It allows anyone to lend or borrow crypto assets without collateral, intermediaries, or centralized approval.

Borrowers can apply for loans by creating pools and setting their terms and interest rates. Auditors will audit the borrower to ascertain if they are qualified for loans and then approve their pool if they are eligible. Lenders can then review the pools and decide whether to fund them. Goldfinch uses a reputation system and a governance token ($GFI) to incentivize good behavior and align the interests of the participants. Goldfinch supports various types of RWA, such as solar panels, education, and agriculture.

How does Goldfinch work?

Goldfinch operates on four core components: the Borrower Platform, the Senior Pool, the Junior Pool, and the Auditors.

• The Borrower Platform: This is where borrowers can apply for loans, submit their business information, and repay their loans. Borrowers can be individuals, businesses, or lending platforms serving local markets.
• The Senior Pool: This is where lenders can deposit their USDC and earn interest from the loans. Lenders can also vote on the loan terms and parameters for each borrower. The Senior Pool has seniority over the Junior Pool regarding repayment and risk.
• The Junior Pool: This is where backers can deposit their USDC and earn higher returns than the Senior Pool but with more risk. Backers provide the initial capital for the loans and act as a buffer for the Senior Pool in case of defaults. Backers also earn GFI tokens, the governance token of the protocol, by staking their USDC in the Junior Pool.
• The Auditors: They are a group of trusted entities that perform due diligence on the borrowers, verify their identity and creditworthiness, and monitor their loan performance. Auditors earn GFI tokens by providing their services to the protocol.

What are the benefits of Goldfinch?

Goldfinch offers several benefits for the participants of the protocol, such as:

• For borrowers, Goldfinch provides a way to access affordable and flexible financing without the barriers of traditional lending systems. Borrowers must build their reputation and credit score on the protocol, which can help them access larger and cheaper loans in the future.
• Goldfinch allows lenders to earn passive income from their crypto assets and diversify their portfolio with exposure to real-world assets. Lenders have a social impact by supporting borrowers, creating value and opportunities in their communities.
• For backers, Goldfinch provides a way to earn higher returns and GFI tokens by taking on more risk and supporting the growth of the protocol. Backers have a say in the governance of the protocol by voting on proposals and parameters.
• For auditors, Goldfinch provides a way to earn GFI tokens and fees by leveraging their expertise and network in the lending space. Auditors help ensure the quality and security of the protocol by performing due diligence and monitoring the borrowers.

Goldfinch is a novel and innovative protocol that aims to democratize credit access and create a more inclusive and fair financial system.

Maple Finance

Source: Maple Finance Website

Maple Finance is a decentralized protocol that enables institutional investors to lend crypto assets to businesses and individuals. It leverages smart contracts, blockchain technology, and a network of trusted service providers to create a transparent and efficient lending marketplace.

Maple Finance uses a pool-based lending model to connect institutional borrowers and lenders. Borrowers can access capital from Maple’s pools, curated and managed by pool delegates. Pool delegates are responsible for performing due diligence, setting loan terms, and monitoring repayments. Lenders can earn interest by supplying liquidity to the pools. Maple Finance uses a governance token ($MPL) to reward the pool delegates and the lenders.

How does Maple work?

Maple operates on three core components: the Pools, the Lending Contracts, and the Service Providers.

• The Pools: These are where lenders can deposit their stablecoins (such as USDC or DAI) and earn interest from the loans. Each Pool has a Pool Delegate, who is responsible for selecting and underwriting the borrowers, setting the loan terms and parameters, and managing Pool’s risk and performance. The Pool Delegate earns a fee for their services.
• The Lending Contracts: These are where borrowers can request and receive loans from the Pools. Each Lending Contract has a specific interest rate, duration, collateral ratio, and repayment schedule. The borrowers can use the loans for various purposes, such as working capital, liquidity, or growth. The borrowers pay a fee for accessing the loans.
• The Service Providers: They are a group of entities that provide value-added services to the protocol, such as identity verification, credit scoring, collateral management, and debt recovery. The Service Providers are incentivized by earning MPL tokens, the governance token of the protocol, by staking their stablecoins in the Pools.

What are the benefits of Maple?

Maple offers several benefits for the participants of the protocol, such as:

• For lenders, Maple provides a way to earn attractive returns from their crypto assets and diversify their portfolios with exposure to real-world assets. Lenders can also choose from different Pools based on their risk appetite and preferences.
• For borrowers, Maple provides a way to access flexible and affordable financing without the intermediaries or inefficiencies of traditional lending systems. Borrowers can also build their reputation and credit history on the protocol, which can help them access larger and cheaper loans in the future.
• For service providers, Maple provides a way to earn MPL tokens and fees by leveraging their expertise and network in the lending space. Service providers can also help ensure the quality and security of the protocol by providing due diligence and monitoring on the borrowers.

Maple is a novel and innovative protocol that aims to bridge the gap between crypto and traditional finance and create a more inclusive and efficient lending system.

Centrifuge

Source: Centrifuge Website

Centrifuge is a decentralized protocol that enables users to tokenize and finance real-world assets on the blockchain. It allows users to create non-fungible tokens (NFTs) representing claims to real-world assets, such as invoices, mortgages, or royalties. Users can then use these NFTs as collateral to borrow stablecoins from Centrifuge’s lending platform, Tinlake. Tinlake uses a senior-junior tranche system to distribute the risk and return among the lenders. Lenders can choose to invest in either the senior tranche, which has lower risk and lower return, or the junior tranche, which has higher risk and higher return. Centrifuge uses a governance token ($CFG) to reward the users and the lenders.

How does Centrifuge work?

Centrifuge consists of three main components: the Centrifuge Chain, the Centrifuge P2P Network, and the Centrifuge Applications.

• The Centrifuge Chain: This is a proof-of-stake blockchain that provides security, scalability, and interoperability for the protocol. It uses the Substrate framework and is compatible with the Polkadot ecosystem. The Centrifuge Chain hosts the NFT registry, the asset originators, and the governance module.
• The Centrifuge P2P Network: This peer-to-peer network enables users to exchange data and documents related to their real-world assets. It uses libp2p and IPFS to provide a decentralized and censorship-resistant storage and communication layer. The Centrifuge P2P Network ensures the privacy and integrity of the data and documents, as well as the identity and reputation of the users.
• The Centrifuge Applications: These are the user interfaces and integrations that allow users to interact with the protocol. The main application is the Centrifuge Portal, which is a web-based dashboard that enables users to create, manage, and finance their NFTs.

What are the benefits of Centrifuge?

Centrifuge offers several benefits for the participants of the protocol, such as:

• For asset originators, Centrifuge provides access to liquidity and financing for real-world assets without intermediaries or high fees. Asset originators can also diversify their funding sources and reduce their dependence on traditional financial institutions.
• For investors, Centrifuge provides a way to earn attractive returns and diversify their portfolio with exposure to real-world assets. Investors can also choose from different risk and reward profiles based on the asset types, the asset originators, and the liquidity pools.
• For DeFi platforms, Centrifuge provides a way to expand their user base and collateral pool with real-world assets. DeFi platforms can also leverage the Centrifuge Chain and the Centrifuge P2P Network to enhance their security, scalability, and interoperability.

Centrifuge is a novel and innovative protocol that aims to bridge the gap between real-world assets and DeFi.

Benefits of RWA Lending Protocols

RWA Lending Protocols aim to bridge the gap between traditional and decentralized finance by bringing RWA on-chain and unlocking their potential for lenders and borrowers. RWA Lending Protocols have several benefits for both parties, such as:

• Higher and more sustainable yields for lenders: RWA Lending Protocols allow lenders to earn higher and more sustainable yields than traditional finance or other DeFi protocols. This is because RWA represents a huge and diverse market of assets that have different risk and return profiles, as well as different cash flow patterns. By lending to RWA, lenders can tap into a wider and more lucrative source of income, as well as diversify and mitigate their risk exposure.
• Access to cheaper and more flexible capital for borrowers: RWA Lending Protocols allow borrowers to access cheaper and more flexible capital than traditional finance or other DeFi protocols. This is because RWA Lending Protocols do not require borrowers to overcollateralize or sell their assets, which can be costly or impractical for some RWA. By borrowing from RWA Lending Protocols, borrowers can leverage their RWA to obtain capital that suits their needs and preferences, as well as preserve their ownership and participation of their assets.
• Diversification and innovation for both parties: RWA Lending Protocols offer both parties the opportunity to diversify and innovate their portfolio and activities. This is because RWA Lending Protocols support various types of RWA that belong to different sectors and industries, such as real estate, art, commodities, invoices, loans, etc. By participating in RWA Lending Protocols, both parties can explore and experiment with new use cases and business models in the crypto industry, as well as contribute to the growth and development of the RWA ecosystem.

Challenges of RWA Lending Protocols

Just like every DeFi sector, RWA Lending Protocols also face several challenges and limitations, such as:

• Regulatory and legal uncertainty and complexity: RWA Lending Protocols operate in different jurisdictions and sectors with different rules and standards for RWA tokenization and lending. This creates uncertainty and complexity for the participants, as they have to comply with various regulations and laws that may not be clear or consistent. This also exposes the participants to potential legal risks and liabilities, such as disputes, lawsuits, or sanctions.
• Operational and technical difficulties and costs: RWA Lending Protocols require a lot of operational and technical work and resources to verify, value, and custody of the RWA. This involves dealing with different types of RWA tokens and platforms that may not be compatible or integrated. This also consists of relying on third-party services or intermediaries, such as auditors, oracles, or liquidators, that may not be reliable or trustworthy. This creates difficulties and costs for the participants, as they have to ensure the quality and validity of the RWA and the transactions.
• Security and trust issues and trade-offs: RWA Lending Protocols rely on various mechanisms, such as collateral, credit scoring, reputation systems, social verification, or governance, to assess and mitigate the risk and fraud of the RWA loans. However, these mechanisms may not be sufficient or adequate, as they may not capture the true value and performance of the RWA, or they may be subject to manipulation or corruption. This creates issues and trade-offs for the participants, as they have to balance between security and trust, as well as risk and return.
• Scalability and interoperability challenges: RWA Lending Protocols face challenges in scaling and interoperating with the rest of the crypto ecosystem, as they have to deal with different types of RWA tokens and platforms that may not be compatible or integrated. This limits the liquidity and accessibility of the RWA loans, as well as the innovation and experimentation of the RWA Lending Protocols. This also creates challenges in bridging the gap between traditional and decentralized finance, as they have to overcome the technical and cultural differences and barriers.

Potentials of RWA Lending Protocols

RWA Lending Protocols have a huge potential to transform the crypto space and the financial system, such as:

• Growing demand and supply of RWA in the crypto market: RWA Lending Protocols can attract more demand and supply of RWA in the crypto market, as they offer new and better ways to utilize and monetize RWA. RWA Lending Protocols can appeal to various types of participants, such as crypto institutions and projects that want to stably manage their spare funds, DeFi protocols that wish to import RWA money pools into their platforms, and traditional asset owners and investors that want to access the benefits and opportunities of the crypto ecosystem.
• Enhancing financial inclusion and empowerment for underserved and unbanked communities and individuals: RWA Lending Protocols can improve financial inclusion and empowerment for underserved and unbanked communities and individuals, as they can provide them with access to capital and financial services that are otherwise unavailable or inaccessible to them. RWA Lending Protocols can support various types of RWA that are relevant and impactful for these communities and individuals, such as education, agriculture, healthcare, or social impact. RWA Lending Protocols can also leverage the features and advantages of the blockchain and DeFi, such as transparency, security, efficiency, and democracy, to improve the financial well-being and participation of these communities and individuals.
• Contributing to social and environmental impact and sustainability through RWA lending: RWA Lending Protocols can contribute to social and environmental impact and sustainability through RWA lending, as they can enable and incentivize the funding and development of RWA that have positive and meaningful effects on society and the environment.

Conclusion

RWA Lending Protocols are an exciting and promising development in the crypto space, as they offer new and better ways to utilize and monetize RWA. They also represent a bridge between traditional and decentralized finance, as they connect and leverage the vast and diverse pool of RWA outside the digital realm.