In crypto, the pursuit of “risk-free” returns is tied to asset tokenization


John Ge, Founder and CEO of Matrixport

The main macroeconomic conversation today is focused on the direction of interest rates. As the market faced the “unknown unknown” implications of global liquidity shocks and banking crises, the nascent metaverse of digital assets did not survive. Crypto has always been considered a high-risk alternative asset strategy in traditional finance, and for good reason. After numerous insolvencies in bankruptcy courts, a significant lack of confidence in the cryptocurrency industry and the explosion of FTX have added to the industry’s malignancy.

In this challenging market environment, finding viable investment options that offer attractive risk-adjusted returns can feel like an Indiana Jones adventure full of twists and turns and uncertain outcomes. Crypto’s appeal as an asset class is on the wane, with Treasury yields now outpacing the attractive returns previously available in decentralized finance (DeFi), leaving investors wondering about a single quest(ion) – where should they put their money next?

Search for the Holy Grail

When investors are risk averse, the safe harbor of risk-free rates beckons, and the most discussed approach is to own US Treasury bills or T-bills. Despite its risk-free label, owning promissory notes is actually not without potential risks. As illustrated by the collapse of Silicon Valley Bank, holders are exposed to duration risk with changes in prices that may occur before the note matures.

However, with the recent rise in interest rates, short-term bills have become even more attractive, with credit risk-free yields approaching 5%. The best way to achieve a true risk-free rate is through a reverse repo backed by US government securities. The closest proxy for the risk-free rate in digital assets is the local rate on Ethereum, but of course this comes with inherent risks. After all, it is not supported by material assets.

So where is the sweet spot? This perennial search for the “holy grail” of risk-free returns may lie somewhere in the form of real-world asset tokenization.

Navigate the map

Digital tokens representing stocks and mortgages are not a new idea. In the post-FTX era, discussion of real-world assets secured on the blockchain has gained renewed attention. It has great potential to systematically improve the financial economy by expanding the collateral pool.

Tokenization of real estate offers increased liquidity and access to new investors, while tokenization of insurance policies can reduce costs for consumers by increasing industry stability by transferring risks. Combining real-world asset tokenization with DeFi opens up even more positive Sharpe ratio opportunities to diversify portfolios and provide investment returns with relatively low risk.

One such way involves the marriage of bills and stablecoins. Tokenization of promissory notes allows investors to diversify their fixed portfolios while accessing the attractive returns currently provided by promissory notes through the use of smart contracts.

In the future, tokenized promissory notes could be used for 24/7 exchange or as the underlying collateral for DeFi credit protocols, allowing investors to tap into the broader DeFi ecosystem and generate additional income beyond promissory income.

While these use cases are clearly attractive, there is still work to be done on 24/7 liquidity while maintaining returns close to the risk-free rate. We will also need to see the progress of the oracle price to make sure these stable tokens can be used as collateral.

In theory, such solutions are attractive propositions that hold the keys to unlocking the wealth that comes with the interoperability of traditional and digital assets. The pool of real-world asset tokenization is huge. Large institutions known for their long-term bets are already collaborating to explore new paradigms through Project Guardian.

More DeFi use cases

With more than $130 billion in stable tokens in circulation and a certain fixed 4.2% annual risk-free interest, increasing the tokenization of MDB only.[1] According to the proposal, this single application of tokenized real-world assets has the potential to generate up to $5.5 billion in revenue.

Indeed, the tokenization of real-world assets allows DeFi access to some of the largest financial markets, and in return, traditional capital markets and DeFi protocols become accessible to all — benefiting significantly from higher capital efficiency and opportunities to trade previously illiquid assets. All will not change with the enhanced security and transparency offered by blockchain technology.

But even as the concept of asset tokenization gains momentum, it’s still too early to tell how long it will take to reach the mainstream—a major hurdle is regulation and compliance. The recent cryptocurrency contagion sees regulators working against the tide in the industry’s quest for tokenization; It may be related to the fear of its systemic risks, which exacerbate the vulnerabilities of the entire financial system.

For this to work, asset managers and investors must ensure they are dealing with reliable counterparties and familiar with regulatory and compliance issues. Asian DeFi solutions have made progress, gaining compliance umbrellas and regulatory approvals, but this will continue to play an important role in attracting investors to such solutions in “DeFi-shy” jurisdictions such as the US.

On the right track

While many may have shied away from relatively high-risk investing in the bear market of 2022, asset tokenization and its “risk-free” returns are attracting investors again. A suggestion? Be prepared to reap the benefits of continuous liquidity on the chain, while also accessing TradFi’s more favorable returns in this challenging climate.

Today, many stablecoins are backed by treasuries, with the proceeds going solely to the issuer as part of their portfolio allocation. The evolution of a new “sacred” investment, where the worlds of TradFi and DeFi combine to create a financial ecosystem that supports both permissioned and permissionless assets, could usher in a new era of finance, regulatory considerations aside.

Time will tell, but one thing is certain. An adventure awaits us.

About the Author: John Gee, Founder and CEO of Matrixport

With nearly a decade of experience in the crypto-finance and blockchain industry, John is focused on scaling the company to provide one-stop cryptocurrency financial services. He oversees the company’s business and product strategy, identifying emerging opportunities in the digital asset industry to expand into new customer segments and markets.

Under his leadership, Matrixport became Asia’s largest cryptocurrency financial platform, achieving a unicorn valuation within two years of its inception.

John was previously a founding director and head of investment and financing at Bitmain Technologies. He started his career as an analyst in a venture capital fund. He graduated from Hangzhou Dianzi University with a degree in Business Administration.

[1] As of April 6, 2023

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