Real-World Assets and Lending Pools: A Perfect Match

Within the realm of DeFi, one of the most transformative developments is the introduction of real-world assets as collateral in DeFi loans. This ties together the digital decentralised finance world and the traditional world of physical assets and opens up new opportunities and efficiencies. 

In this article we will explore the concept of tokenised real-world assets, how they work in lending pools, as well as the various challenges for various types of real-world assets.

‍

The articles in this series are extracts from the E-book: Lending Pools Unpacked, Now available for download.

The tokenisation of real-world assets (RWA) explained

The tokenisation of real-world assets is the process of creating a (fractionalised) digital twin of a physical asset that can be held, bought, and traded on a blockchain.

The tokenisation process comes with a variety of benefits, such as the ability to exchange and own the asset in a more secure and transparent manner. Additionally, it enables things like tracking the provenance of the asset, proofs of labour, and more.

The tokenisation of assets also allows them to be divided into smaller parts, making them available to a wider range of investors. Additionally, these assets can easily be traded on global marketplaces, increasing their availability to a wide range of investors even further. 

Real-world asset tokenisation is not limited to certain types of asset classes either. Instead, tokenisation has the potential to benefit a diverse range of asset classes such as tangible assets like real estate, art, precious metals, and luxury goods, as well as intangible assets such as financial instruments, invoices, and carbon credits.

Fractional ownership of properties, for instance, is possible through the tokenisation of real estate, allowing investors to buy and sell small percentages of high-value properties. Similarly, the tokenisation of art can make art investments more accessible to a broader range of investors by allowing them to buy and sell fractions of high-value pieces. 

Lastly, tokenisation can potentially solve some of the challenges linked with traditional ownership structures. Tokenisation enables more transparent and efficient ownership structures that can reduce expenses, fraud, and disputes. Smart contracts can also automate many of the processes associated with asset ownership, including transfers, payments, and maintenance.

‍

The RWA tokenisation process

The process of tokenising a real-world asset consists of 3 steps: 

‍

1. Pre-tokenisation step: All the steps that happen in the real, non-digital, world before the asset is tokenised and put on a chain.
2. Tokenisation step: Putting all relevant data and data pointers on a blockchain and creating the tokens.
3. Post-tokenisation step: The distribution of the tokens and the management of the physical asset and tokens.

‍

Pre-tokenisation step

The main parts of this step are highly dependent on the type of asset that is being tokenised, although it can generally be divided into formalising the value of the asset, verifying ownership of the asset, and ensuring the right processes are in place in order to take care of the maintenance and management of the physical asset, as well as legal processes in case of liquidations, dispute resolutions, and enforcement.

‍

Tokenisation step

Once the pre-tokenisation step has been completed. It is time to make a digital representation of the asset in the form of tokens. The main parts of this step are making sure all relevant information about the asset is either put on a blockchain or pointed to from the blockchain, as well as creating the tokens of the real-world asset.

‍

The connection between relevant data in traditional databases and data on the blockchain is facilitated through the use of (decentralised) oracles in order to ensure all relevant information is accurately represented on the blockchain. These oracles collect data from traditional databases and broadcast it to the blockchain.

‍

Post-tokenisation step

After the previous steps have been completed and the tokenised asset has been created, it’s time to start distributing/selling the tokenised assets. When using the tokenised assets as collateral in DeFi loans, this step usually means transferring the tokenised asset to a platform/underwriter/protocol so it can be used as a collateral.

‍

Part of this step is the perpetual management of both the physical asset and the tokens based on the rules previously set. With an art piece, for example, this could include the storage of the piece, maintenance of the piece, insurance of the piece, etc., as well as the management of the tokens, including the management of the information about the token. This information may also be stored on the platform on which the lending pool is available.

‍

Real-world assets in lending pools

Once tokenised, these real-world assets prove valuable as collateral in DeFi loans, enabling people to receive capital in novel ways. This section goes over the exact role of RWA in lending pools and the benefits this gives, as well as the process of actually using an RWA in a DeFi loan.

‍

The role and benefits of RWA in lending pools

In the context of lending pools, real-world assets serve as collateral, underpinning the foundation of asset-backed lending. This collateralisation process involves locking up one or more tokenised real-world assets to secure loans, thereby creating a dynamic ecosystem that offers numerous advantages, such as:

‍

• Unlocked liquidity: Liquidity locked in illiquid assets can be unlocked without having to sell the asset. This enables asset owners to be more flexible and have better access to capital.
• Enhanced security: RWA-backed loans benefit from the inherent security and value of tangible assets. This collateralisation minimises the risk for lenders, as they have recourse to the underlying asset in the event of default.

• Diverse asset classes: DeFi lending pools can accommodate a wide range of asset classes, from real estate and art to precious metals and luxury goods. This diversity enables borrowers to leverage various assets as collateral.
• Fractional ownership: The fractionalisation capability of tokenised assets empowers borrowers to utilise a portion of their high-value assets as collateral. This fractional ownership model democratises access to DeFi loans, enabling a broader spectrum of users to participate.
• Global accessibility: Tokenised RWA can be easily traded on global marketplaces, increasing their availability to a wide range of investors. This accessibility extends to borrowers seeking liquidity through DeFi loans.
• Efficient ownership structures: Tokenisation streamlines ownership structures, reducing administrative expenses, fraud potential, and disputes. Smart contracts automate various aspects of collateral management, such as transfers, payments, and asset maintenance.

‍

The process of using real-world assets in lending pools

Now, let's delve into the process of integrating real-world assets into DeFi lending pools, especially from the perspective of asset owners seeking to leverage their RWA as collateral in a DeFi loan. This can typically be done in two ways, namely by approaching an underwriter who operates a lending pool on one of the various DeFi lending platforms, or by operating a lending pool yourself. We will explain both below. 

‍

Loan via underwriter

The first avenue for RWA owners seeking to obtain a DeFi loan using a RWA as collateral is to collaborate with an underwriter that operates one or more lending pools. These underwriters specialise in financing and already have one or more lending pools set up. The process of obtaining an RWA-backed loan via an underwriter usually involves the following steps:

‍

1. Initial consultation: The process begins with an initial consultation between the RWA owner and an underwriter. During this conversation, the asset owner outlines their goals, the specific asset they wish to tokenise, and their desired DeFi lending pool integration.
2. Asset evaluation: The underwriter assesses the RWA's eligibility for tokenisation. This evaluation includes verifying the asset's ownership, its market value, and its suitability as collateral within the DeFi lending ecosystem.
3. Tokenisation: If the asset meets the criteria, the underwriter proceeds with the tokenisation process. This involves creating a digital representation of the real-world asset on the blockchain, typically in the form of tokens. All relevant information about the asset is accurately recorded on the blockchain or linked to it.
4. Integration into the lending pool: Post-tokenisation, the tokenised asset is integrated into a lending pool. This can be a lending pool managed by the underwriter or a specific DeFi protocol that accepts external assets. The asset owner now has the option to use their tokenised asset as collateral to secure DeFi loans.
5. Loan application: Asset owners can apply for DeFi loans using their tokenised RWA as collateral. The amount they can borrow is determined based on various factors, including the asset's value, the lending pool's parameters, and the specific DeFi protocol's terms.
6. Loan repayment: Borrowers are responsible for repaying their loans within the agreed-upon terms, including interest and any additional fees. Failure to repay may result in the liquidation of the collateralized RWA.

‍

Loan through self-managed pools

Alternatively, some RWA owners may opt for a more customisable and decentralised approach. In this case, RWA owners can launch their own lending pool, allowing them to better connect with their community and have a lower cost of funds as compared to working with an underwriter. The process of obtaining an RWA-backed loan  through a self-managed lending pool usually involves the following steps:

‍

1. Pool creation: Asset owners initiate the process by creating their lending pool using a DeFi lending platform or protocol. They outline the rules, terms, and conditions for collateralising their RWA within the DeFi ecosystem.
2. Tokenisation: Similar to the underwriter-led process, tokenisation of the RWA occurs. This involves creating digital tokens that represent fractional ownership of the real-world asset. This step can be handled by the asset owner or a designated party within the community.
3. Integration in the lending pool: The tokenised RWA is integrated into the lending pool. Here, RWA owners can access the pool's DeFi lending functionalities, offering their tokenised assets as collateral.
4. Loan creation: The asset owner can now create a DeFi loan by providing tokenised RWA as collateral. The lending terms are governed by the rules established during the pool's creation.
5. Loan management: Asset owners who use their tokenised RWA as collateral remain actively involved in loan management, including monitoring their loan status, interest payments, and adherence to the pool's rules.

‍

Both underwriter-facilitated and self-managed approaches provide avenues for RWA owners to harness the potential of their assets within the DeFi lending landscape. These processes empower asset owners to actively participate in the DeFi ecosystem while unlocking value locked in illiquid assets for financial opportunities.