DeFi Pivots towards Hard Assets and Tokenization in Search of Capital

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Decentralized finance (DeFi) champions are turning their attention to traditional assets such as US Treasuries, currencies, and private equity after the crypto market's recent meltdown led to months of stagnation. Previously, DeFi projects were able to offer triple-digit returns in an era of ultra-low interest rates. However, due to the more favorable yields available in the relative safety of traditional markets, more blockchain projects are attempting to sell hard assets. Advocates of DeFi, in need of new capital, are considering their options after a string of setbacks, including this week’s regulatory pushback on a Binance-branded stablecoin.

The declining appetite for risk among investors ahead of a possible recession and after last year's multiple crypto blowups, including the algorithmic stablecoin TerraUSD, has led to the need for change. DeFi trading volume has more than halved from a high last year, and the value of its related tokens has been stagnant for months.

To chase higher returns, DeFi protocol MakerDAO invested $500 million in Treasuries and corporate bonds late last year, while Ondo Finance launched a fund in January, allowing stablecoin holders to also invest in bonds and Treasuries. Meanwhile, advocates have been looking for opportunities in currencies and have praised efforts to “tokenize” investment funds by KKR & Co., Apollo Global Management Inc., and Hamilton Lane Inc.

Tokenizing hard assets is nothing new, but it has mainly appealed to a narrow audience of investors with limited access to dollars. For them, it can be easier to buy dollar-pegged stablecoins like USDC than to open a US-dollar account with a traditional bank.

Moreover, real-world asset loans require significant structuring and diligence, including verifications such as Know-Your-Customer and US investor accreditation processes, which Goldfinch requires.

US regulators are also working on a proposal to make it harder for crypto firms to be considered “qualified custodians” in order to hold client assets for money managers.

Without clear legislation, custody firms are discouraged from supporting DeFi initiatives. This lack of a regulatory framework is a significant hurdle, according to Andre Cronje, a core contributor at Fantom Foundation, the developer of the Fantom blockchain.

In the meantime, the industry will either need to get risk-free assets to blockchain or convince investors to embrace “a broken crypto ecosystem,” said Austin Campbell, an adjunct professor at Columbia Business School. With interest rates as high as they are, crypto-focused DeFi is asking investors to take on all the risk, including hacks, for a return potentially lower than a US Treasury bill, he said.

Overall, DeFi champions pivoting towards hard assets, currencies, and tokens can be a way to adapt to the changing market and attract new capital. However, without clear regulatory frameworks, DeFi's growth potential may be hindered in the short term.