Explore: The Economics of Asset Tokenomics
Amidst the RWA buzz, how does these platforms actually make money and potentially achieve profitability?
Introduction
Asset tokenisation has been on the rise recently with banks and funds putting out detailed reports on the topic.
A few to mention:
ADDX & BCG projects asset tokenization to grow 50x into US$16 trillion opportunity by 2030
Investment bank Citi is betting on the blockchain-based tokenization of real-world assets to become the next “killer use case” in crypto, with the firm forecasting the market to reach between $4 trillion to $5 trillion by 2030.
There are many more reports which I collated over the year, will share them with you guys soon!
Unattractive Loans & Lack of Liquidity
The existing platforms are struggling to survive, problem being a lot of deals coming in but lack of capital deployed to fill the loan pools.
Examples:
Fazz Financial listed a loan on Goldfinch looking to raise $2M. They only raised $1.3M and a good sum came from the team themselves.
https://app.goldfinch.finance/pools/0x032f7299621c3b68e5d7aceabd567b65e2284da7#highlights
Clearpool has a loan pool for Wincent that is able to take up to $2M but the current amount lent is $300.
They also have a loan pool with Portofino Technologies that has capacity of $9M but their current loan size is $52K.
This really goes to show the drought in the system.
This problem stems from the massive rise in the risk free rate: T-bills are currently at all time high with 6 month yield at 5.6%. Couple this with a rise in loan defaults due to the impending recession and fall in consumer spending, emerging market private credit is not providing reasonable risk-adjusted return for people to park their funds in them.
Example of this is Validus Group’s corporate bonds on Bluejay Finance running 7-10%. Why take the risk of default for an extra 2-5% yield when you can rely on the US Govt to pay you interest?
Most platforms have gone to raise strategic rounds during this period to tide through:
Maple Finance $5M: https://maple.finance/news/maple-closes-strategic-funding-round/
Centrifuge $4M: https://www.theblock.co/post/182058/centrifuge-raises-strategic-round
The Important Question: Making Money
With all this buzz, the most important question here is: How do you make money with asset tokenisation?
1: Platform
This is a platform business, an intermediary that allows supply and demand to meet: Borrowers creating loan pools/tokenising their funds and Lenders who provide their stablecoins to earn the interest of these funds & loans listed. The business model of such platforms is as such:
Charge a loan origination fee/ Fund tokenisation fee for borrowers setting up on your platform: 1-2% is reasonable (honestly depends from case to case, based on the type of fund being tokenised)
Spread: Arbitrage the lenders by setting a lower interest rate than the actual. This can also be 1-2% or less (depending if it is a money market fund or private credit deal)
Assumption: your platform has sufficient mindshare and track record to attract the funds & investors. This isn’t true for most platforms that are out there. To bootstrap this, existing connections and aggressive BD is necessary.
2: White Label
With all the rage of tokenisation, many funds want to dip their toes on this new primitive to experience and trial the great cost savings it brings with smart contract automation for: fee distribution, fund administrative work, setting up of pools, Whitelisting criterias / certified underwriters etc.
Dev studios out there are building up tokenisation platforms and selling it to funds.
This is something I see in blockchain foundations as well. There are tokenisation departments in a few of them already: Polygon, Hedera, Avalanche and more.
For them, their motivation is to drive capital and transactions on their chain, fairly simple.
How difficult it is to build this platform? I’m not too sure but it requires a few key components:
Platform:
KYC capabilities (can work with Quadrata passport for this)
Smart contracts vault/loan pool
Interest pricing mechanism
Token creation: senior & junior tranches
Credit scoring (can work with Credora for this)
I will just include this for those who are doing the full stack.
Offchain:
SPV
Fund manager (regulated) (can liaise with a third party) (most projects leave this out)
Fund admin
Third party auditor
Token issuer (if necessary) (regulated)
Custodian
The disruptor of the economics: Entrance of Tradfi
Currently the existing platforms are trying to gain market share and fulfill the whole stack, owning the fund and fund manager as well.
But all that I have talked about above can be easily disrupted by the incumbents building their own platform, which isn’t difficult.
One fund that has done so is Helicap and their recent $2M raise for Helix Finance that provides the tokenisation platform for their fully licensed fund that has already processed $180M in private credit.
Franklin templeton and UBS has already dipped their toes too.
Franklin OnChain U.S. Government Money Fund:
UBS Tokenised VCC Fund: https://www.forbesindia.com/article/cryptocurrency/ubs-launches-tokenised-vcc-fund-on-ethereum-blockchain/88715/1
Imagine the rest of the big boys coming in. Where do the existing platforms stand then?
Beyond Asset Tokenization: The Power of DeFi Composability
The transformative potential of Decentralized Finance (DeFi) goes beyond mere asset tokenization. While tokenization streamlines processes and opens doors to global capital, DeFi magnifies the intrinsic value of these assets.
1: Recursive Lending
This concept has generated significant interest, particularly in relation to on-chain T-bills. While current T-bill yields are already enticing – with the 6-month rate hovering around 5.5% – integrating them with DeFi can elevate their yield potential.
To quote Variant Fund’s insights:
“Holders could potentially boost the yield on their U.S. Treasuries by tokenizing them, using them as collateral in a DeFi lending market, borrowing stablecoins, acquiring more Treasuries, and cycling through this loop. This is merely one application. Incorporating off-chain assets into DeFi, combined with crypto-native mechanisms, paves the way for innovative products exclusive to the crypto realm.”
Read more from Variant Fund: https://variant.fund/articles/why-bringing-real-world-assets-onchain-is-important/
Lets do some simple math on this:
Note: This can amplify yields, but it also amplifies risks.
1. Initial Investment:
Let's start with 1 T-bill (for simplicity's sake, we'll treat 1 T-bill as having a value of $100, but the unit is arbitrary). This T-bill yields 5.5%, so in one year, you'll earn $5.50.
2. First Leverage Loop:
Use the T-bill as collateral to borrow $50 (at a 50% loan-to-value ratio) and buy 0.5 of a T-bill.
Now you have 1.5 T-bills, which will yield $8.25 in one year.
3. Second Leverage Loop:
Use the 1.5 T-bills as collateral to borrow $37.50 and buy 0.375 of a T-bill.
Now you have 1.875 T-bills, which will yield $10.31 in one year.
4. Third Leverage Loop:
...and so on.
The mathematical series for this is a geometric series, where each term is the product of the previous term and a constant ratio (in this case, 0.5 for the 50% LTV). The formula to find the sum of a geometric series is:
S = a/(1 - r)
Where:
S is the sum of the series.
a is the first term of the series.
r is the common ratio.
Note: Recursive leverage is not infinite due to various factors such as interest on the borrowed money, liquidation risks, and platform constraints. Furthermore, if T-bill prices were to fall, you could get liquidated.
The interest rates could amplify beyond the 11% of the initial $100 if the cost to borrow is less than the yield from the T-bills. But remember, this all assumes no borrowing costs and no risk – which is a significant oversimplification.
Always be cautious with leverage and make sure to account for all potential costs and risks.
2:Boosting Liquidity in Private Credit
Private credit agreements typically involve prolonged lock-ins, posing challenges for those desiring short-term liquidity to seize emerging opportunities. The DeFi realm offers a remedy: as high-quality deals emerge, they can spawn liquidity pools. Participants can then combine private credit tokens with stablecoins to furnish liquidity to peers wishing to liquidate their stakes ahead of term. This is a quantum leap from the constraints of traditional markets.
3:More Layers with LP-Fi
Imagine a liquidity pool where users can deposit both USDC and asset tokens. Upon contributing, they receive an LP token. This LP token not only symbolises their stake but can also be integrated into numerous DeFi protocols. The beauty of this is twofold: the underlying asset token keeps accumulating yield, and simultaneously, users can engage in diverse transactions using the LP token. This is the advent of yield bearing tokens and can definitely be a massive trend in the next bull run.
Conclusion
This is an ever growing and innovating space and any written piece will be outdated soon. I expect more projects to be raising seed rounds around products that build on RWA. To help you and I keep up to date with the quantum changes, here are some relevant links:
Impossible Finance RWA Lending & Tokenised US Treasuries Landscape Dune Dashboard: https://dune.com/impossiblefinance/rwa-lending-landscape