With a total value of more than 13 billion US dollars locked, Decentralized Finance (DeFi) truly shook the crypto world last year. It provides a new way of making money for the crypto market. At the same time, DeFi is now only a niche trend, with huge potential to set off a revolution in the commercial loan market. In order to grow up from infancy, DeFi urgently needs to connect with real-world assets and exist in an environment that can be used by real companies, corporate customers, etc.
As a concept, DeFi really seems to be a win-win solution for those who already hold cryptocurrencies, because they can finally get some passive income from incentives and yield farming; for borrowers, because they Can benefit from loans, the terms of which are not available in traditional venues.
Volatility and overcollateralization
However, DeFi has several problems to be solved urgently. For all parties involved, the first major disadvantage is the over-collateralization in response to volatility.
In most cases, the agreement requires the borrower to secure at least 150% of the loan value. So, suppose you want to borrow 100 dollars. This means you will have to use a loan of at least $150 as collateral. Therefore, if the value of your collateral drops below $150, your loan will be subject to a liquidation penalty.
Overcollateralization is a major obstacle to achieving one of DeFi's main goals: to make financial services truly accessible. The stablecoins issued by the DeFi protocol will have the same problem because they also require overcollateralization.
The volatility of the collateral has caused a total loss of 6.65 million Dai (about 6.65 million US dollars) for Maker, and more similar cases may be caused in the future.
Lack of connection to real-world assets
This question may be questionable, because many people in the entire encryption field want to stay in their playground and be isolated from the world. However, encryption technology is becoming a part of the global financial system. In order to stay, encryption technology must be connected to the outside world, otherwise it will definitely not have any growth.
But aside from my personal views and beliefs, the lack of connection with real-world assets hinders the DeFi field in many ways. First, it does not allow traditional companies to borrow funds, because they cannot provide anything and can only use cryptocurrency as collateral. The second problem is the lack of real cash flow behind the agreement token, which means that the price of the agreement token lacks stability, and the agreement token is the main tool for incentives. In the long run, the above issues limit the further development of DeFi as a paradigm. The most important thing is to cause the loss of the value of the agreement tokens and the risk of default.
Considering all the issues, the DeFi field needs an infrastructure that can bridge the gap between real-world assets and the DeFi ecosystem, allowing anyone to use real-world assets as collateral to borrow money from the agreement.
So, can any real-world asset be used? Not exactly. Assets must meet simple criteria to solve the above problems.
The asset must be stable to resolve volatility and overcollateralization issues.
Assets must generate periodic fixed income to generate real-world cash flow.
The price of collateral assets must be determined in a transparent manner, based on several mature and recognized sources.
Assets that meet these standards and can solve the above problems appear in the form of bonds or fixed income securities.
Why would bonds be a win-win solution for traditional and DeFi markets?
The DeFi loan agreement alone has locked in more than US$5 billion, and more than US$13 billion has been locked in as a whole. This will be a perfect way of corporate lending without the need for account building and marketing.
In addition, the transfer of traditional financial products to an open source and decentralized world has greatly reduced the number of intermediaries needed to attract financing and minimized its costs. In the current system, bond issuance costs may include fees paid to exchanges, payment agents, trustees, banks, lawyers, and rating agencies.
From the perspective of investors, they will get an agreement with stability that has never been seen in the market. The use of bonds prevents the overcollateralization of the agreement and ensures the stability of assets, even during periods of high volatility in the crypto market, thus eliminating the risk of liquidation.
Most importantly, the use of real-world claims and debts will allow the agreement to obtain fixed periodic income, which can be distributed among investors. Basically, it will allow DeFi investors to benefit from the income generated by the collateral and the interest paid by the borrower.
Obstacles to establishing such a system
Generally speaking, DeFi and traditional finance are independent of each other. The first and most obvious problem is that DeFi borrowing requires collateral in the form of digital assets. Currently, there is no existing infrastructure in the DeFi protocol to use real-world assets as collateral.
The next question has a lot to do with the structure of the entire DeFi market. Borrowers can attract funds strictly through encryption from the DeFi protocol, and the same situation also occurs in interest payments. Since enterprises operate in the traditional system, borrowing funds and debt repayment must be set in legal tender.
The last problem is that there is no traditional legal framework for borrowing from the agreement. There is no formal agreement, which brings difficulties to the accounting treatment of borrowed funds.
to sum up
I believe that the DeFi market urgently needs to establish a standardized bridge with the traditional financial market to ensure stable growth. At the same time, corporate institutions—including holders and issuers of debt securities—will be willing to take advantage of the essence of DeFi infrastructure and benefit from loan terms that traditional venues cannot provide.
The connection of the legal currency cash flow mixed with fixed regular income will allow DeFi investors to benefit from the income generated by the collateral in the agreement, as well as the interest paid by the borrower. At the same time, stable real-world collateral, such as bonds, minimize the risk of liquidation and ensure the stability of the agreement.
In order to achieve this goal, the DeFi market needs complex infrastructure solutions to ensure that corporate institutions comply with current regulations and enable them to obtain funds and repay loans in legal tender. At the same time, the operation of this infrastructure needs to take into account the interests of the DeFi community, so it is necessary to ensure the correct interaction between bonds and agreements.