Physical asset-linked projects will foster stability in DeFi
05:06, 28 January 2022
High profile decentralized finance (DeFi) protocols such as Aave and MakerDAO have seen significant bouts of volatility in recent weeks but a move away from purely digital underlying could provide stability in the future.
The recent collapse in crypto prices has captured the headlines but one knock-on effect has been in decentralized lending systems where users can trade, lend and borrow digital assets without using third parties.
Typically loans are over-collateralised and a liquidation process kicks in when the value of this collateral falls below a preset level. With ether currently trading at about $2,200, down from its all time high of about $4,800 this has resulted in record levels of liquidations on DeFi apps.
Mass liquidations in DeFi
However, according to Kirill Bensonoff, co-founder at DeFi real estate lender New Silver, as more physical assets get traded in decentralized ecosystems it will smooth over volatility in a sector that is still overwhelmingly linked to digital currencies.
“We saw recently that MakerDAO had mass liquidations and there was a lot of uncertainty, with the DAO stablecoin fluctuating 10%, plus or minus. So it didn’t always hold the US dollar one-to-one.”
“So while New Silver’s main role is to enable faster borrowing and increase liquidity for the real estate sector it is also providing these protocols with more stable assets,” he tells Capital.com on a video call from the US.
Crypto assets dominate DeFi
Bensonoff concedes that generating greater stability will be a long-term process. Since its launch in the middle of 2021 the firm has accrued assets worth $25m and it is on course to achieve total assets under management of $100m by the end of 2022.
However, this is still a fraction of the total amount of digital assets currently traded in the DeFi sector.
“We are still some way from physical assets driving the DeFi sector. There’s currently somewhere between $10 and $15bn locked into the system and it’s 99.9% crypto. But if real world asset adoption continues in DeFi then at some point we should see less, less volatility. Absolutely.”
Capital.com has previously interviewed firms which are looking to tokenise real world assets such as property and paintings but New Silver’s business model works in reverse.
Loan origination
Essentially New Silver is an old-fashioned loan originator, which markets to real estate investors, underwrites loans and finances them with its own capital. Once the loan is financed instead of distributing to the traditional capital markets in the form of asset-backed securities (ABS) it instead turns to the DeFi sector.
It does this in partnership with DeFi real world asset specialist Centrifuge.
“After a loan is financed in the real world, we take it turned into a non-fungible token (NFT) with Centrifuge. Once it’s an NFT it’s on the blockchain that represents that particular loan, and it then can be added to a pool of loans, which investors can access.”
Just as a traditional ABS deal is divided into tranches, the loans are converted into tokens with different levels of risk which are minted on MakerDao.
Regulating stablecoins
“We have two different classes of tokens, a senior and a junior, which is similar in the way a mortgage-backed ABS is divided into a senior and a mezzanine tranche.”
US authorities are currently looking at regulating the stablecoin sector which MarkerDao is one of the leading players, but Bensonoff says that he does not anticipate that New Silver’s business model itself will come under the regulatory microscope.
The firm only accepts accredited investors, which in the US, where the firm is regulated, means people with an annual income in excess of $200,000 or a net worth over $1m.
And unlike many players the broader DeFi sector itself New Silver conducts know your customer and anti money laundering accreditation checks on all its counterparties.
Bringing trust to the system
In anycase Bensonoff says that an increased regulatory focus on stablecoins could benefit the DeFi sector.
“There’s a lot of talk about potentially regulating stablecoins such as USDC and DAO but probably some of those tokens have now gotten too large for regulators to ignore. But that’s not necessarily a bad thing.”
“I think. It’ll give people a peace of mind that, you know, when they’re when they USDC in their digital wallet that it’s actually backed one-to-one by US dollars, and that regulators are overseeing that this is the case.”
“That will bring more trust to the system, which in turn will entice more institutional investors to market and create further liquidity.”
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