RWA - Reshaping the Narrative on Real Yield
Oct 19, 2023
During the DeFi summer of 2020/21, TVL was skyrocketing and users were enjoying lucrative yield opportunities. Many protocols began launching native tokens to juice their APYs and stay competitive. This caused lots of fast moving money in search of the next big opportunity.
With tokens fueling yield, they had to continue rising in value for APYs to remain high. While the market is pumping, everything is great, but that can change fast. The low liquidity environment coupled with the current bear market spotlighted the flaws of these unsustainable business models.
None of the tokens had any real value behind them. The value was fueled by newcomers. Sound familiar? A name that arose for all this was ponzinomics.
Starting in late 2021, TVL in DeFi began its plummet from over $177 billion to $35.17 billion as it stands on 18 October 2023. With no real value being created it became hard to sustain investors. At the same time, US Treasuries have been extremely attractive as they offer a risk free yield averaging 5%.
With a risk free rate backed by the US Government, the web3 space has been challenged by the ability to offer an on-chain risk free rate. This forces innovation, but we ask, how sustainable are the existing on chain options?
Let’s look at the options.
Does real yield exist in DeFi?
Stablecoin Staking: Many argue that staking or LPing stables is a risk-free rate. While risk may be low, stable coins are not always risk-free and the yield earned from them is below the US Treasury rate. Here's why.
Stability - As seen this past year, many stable coins have de-pegged from $1. Oftentimes, the underlying issue is the collateral used to back them. When backing a stable coin with crypto, the treasury is relying on a volatile asset, so when prices drop…
Yield - Stable coin yield is oftentimes very low in crypto, especially in a bear market like today. The large protocols with the lowest risk are offering around 2%. This is not worth it compared to TBills paying out a 5% APY.
Staked ETH as a risk-free rate? Recently there has been a lot of talk about $stETH being a low risk investment. This is false for a number of reasons. The first being the volatility of $ETH. The yield is only justified if the yield earned from stETH compensates for a loss in token value.
If stETH drops in price, say 10%, a user is still losing money in dollar amounts. They would be better off taking their dollars elsewhere. At the same time, when a user leverages their position by borrowing ETH for stETH, it leads to liquidation risk.
In the past, $stETH has depegged from $ETH. If this were to happen, it can lead to a massive liquidation event as the price drops and users redeem their staked holdings. With this lingering fear, stETH is far from risk free.
Even with regular Ethereum staking, many investors see it as the best option on-chain. If a token can drop 50% over the course of a year, even with an APY of 5%, investors are still losing money. Instead of holding, they are much better off using their capital elsewhere.
How does RWA provide attributable & sustainable real yield?
There rises a need for a new and sustainable narrative, and Real World Assets has the potential to dominate the on-chain growth in the coming years.
Traditionally the real world asset class does not even include financial assets, but encompasses anything physical that has a practical utility such as real estate, commodities; natural and agricultural resources, infrastructure, machinery, and equipment. Financial instruments have a more abstract representation. However, when RWA are discussed in crypto, they are various tokenizable assets from real estate and precious metals to stocks, bonds, and financial derivatives.
The variation of tokenized RWA in crypto is already diversified. Total value locked (TVL) of real world asset categories amounts has just crossed the $600 million dollar mark. Comparatively, The TVL in DeFi stands at $35 billion. From this perspective, RWA to date comprises 1.7% of the decentralized finance market, yet since Q4 2021 we have witnessed the growth and steady performance of the RWA class. Moreover, looking at the potential total value of digitalized real world assets in traditional finance, there is a massive upside potential for tokenized RWAs.
RWA market cap and share change. Source: Galaxy Research
Why The Spike In Interest in Real Estate RWAs?
Real estate RWAs: market cap by issuer. Source: Galaxy Research
The unsustainable yields in decentralized finance (DeFi), which led to the collapse of many major crypto projects in 2022, have prompted investors to seek sustainable, real yields — such as the ones available with tokenized RWAs. Investors are now looking for transparent explanations of where these yields come from, making tokenized RWAs more attractive due to their clear yield sources and increased recognition from traditional finance players.
Real estate is one area in which tokenization has had a significant impact. As things stand, it is one of the largest asset classes in the world, with an estimated $613 trillion value in 2023. Between Q1 and Q3 2023, the value of on-chain real estate grew by 102%, or approximately $90 million.
One key catalyst has been the fractionalization of a high cost of entry investment product into more affordable parcels, thus lowering the market entry for many investors from lower economic backgrounds. However, now that individuals can invest in fractions of houses, buildings or even resorts, more people can participate, fueling the growth, often diversifying their liquidity outside stocks and bonds.