Bridging Traditional Finance to DeFi by Tokenizing Real-World Assets

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Despite all the innovation, transparency and speed it offers, blockchain technology has yet to fully convince traditional finance institutions to take part in DeFi, mainly due to poor user experience and compliance concerns. Thankfully, new use cases have started making a name as the middle ground between fully regulated markets and the “Wild West” of decentralized finance, and tokenizing real-world assets is among them.

The permissionless design of decentralized finance surely opens up an appetizing market where anyone can participate, and everyone plays by the same rules while all pricing is recorded on-chain for the rest of the market to verify. It has two key features that would make any TradFi institution thirsty: DeFi is global and always on. It means that anyone can access a decentralized exchange (DEX) or a liquidity pool 24/7 and from anywhere in the world.

With all the accessibility and readiness of DeFi, however, it provides little use to traditional finance. First, the lack of a better user experience limits DeFi adoption to those who can understand how advanced mechanics of blockchain-based liquidity pools and automated market makers work. 

The second and more important reason why there’s a gap between TradFi and DeFi is regulatory concerns. After all, poor user experience can be solved by billion-dollar companies by simply onboarding the necessary talent. However, traditional finance institutions must also adhere to strict compliance rules. An institutional investment firm can’t spontaneously deposit millions of dollars into a liquidity pool, no matter how attractive the yield or how extensively audited the smart contract is.

So, how can TradFi benefit from DeFi’s broad array of digital assets that can be traded 24/7 with consistent pricing and much faster settlement? 

Traditional finance seeks familiarity

As with any major evolution, traditional finance’s adoption of DeFi would require at least one familiar factor remaining in the trade. And that’s exactly how real-world asset (RWA) tokenization works: Thanks to the immutability and true digital rights provided by blockchain, the ownership of any real-world asset can be converted into a digital token. 

An RWA can be a physical asset, such as real estate, commodities and fine art, or a financial asset, including loans, contracts and royalties. Turning the most-traded assets of traditional finance into blockchain-based tokens would enable a 24/7 and global market for ownership rights to these assets. It would open a two-way bridge where people from anywhere in the world can instantly participate in the trading of cornerstone TradFi assets while traditional finance institutions can dip their toes in the uncharted waters of DeFi in a very familiar environment.

The massive potential of tokenization of real-world assets led to a significant jump in the total value locked (TVL) in the related DeFi protocols. DeFillama charts show that in just six months, the RWA category enjoyed a tenfold increase in its TVL, jumping from $200 million in April to well over $2 billion as of October. 

So, it’s only natural that the overall development and building efforts in the DeFi ecosystem are shifting toward bridging traditional finance to blockchain through RWA tokenization. The multi-faceted process of bringing real-world assets requires multiple DeFi participants to solve different parts of the equation. For example, institutional investors who seek asset-backed RWA tokens can check Backed Finance, tokenization platform that enables the creation of tokenized RWAs, including stocks, bonds, and ETFs, in a fully-backed manner. 

Using the ERC-20 Backed Tokens, users can invest and trade real-world assets or redeem them anytime for the underlying asset’s cash value. Institutional traders can have a sense of familiarity when creating their on-chain investment strategy by utilizing structured products dispensed by the platform.

Using the tokenized real-world assets as the foundation, the DeFi ecosystem can build a whole new sector of use cases and protocols to onboard investors from both institutional and retail. From overcollateralized stablecoins to risk-adjusted yield from derivatives such as options contracts, DeFi can now bring the blockchain-based digital asset market to TradFi, only limited by how much risk traditional investors want to shoulder and how much capital they want to invest.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Nikolai Kuznetsov

Nikolai Kuznetsov is a financial analyst and professional trader. Based in Israel, he has been trading in multiple markets and educating traders as a teacher and mentor. Nikolai has extensive experience in stock market analysis, investment research and in various assets such as cryptocurrencies, FX, commodities, equities and bonds. In the last decade, Nikolai has devoted his energy and skillset to the crypto market, contributing analysis pieces, trade commentaries and op-eds to publications such as Cointelegraph, Forbes, TheNextWeb, and, among others. He also holds a black belt in Brazilian Jiu-Jitsu.

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