The use of decentralized finance (DeFi) in traditional finance could grow in the coming years as new protocols attempt to support the securitization of real-world assets, according to a new research report from credit ratings agency S&P Global Ratings. .
Real-world asset financing, or RWA, is likely to be a key area of interest for DeFi protocols going forward, S&P says in a report titled “DeFi Protocols For Securitization: A Credit Risk Perspective.”. Although the sector is still in its infancy, S&P highlighted several benefits that DeFi could bring to securitization, such as lower transaction costs, improved transparency of asset pools, reduced counterparty risks and the possibility of expediting the settlement of payments for investors.
“The initial development of DeFi was primarily focused on applications that provide financial services within the cryptocurrency ecosystem, such as crypto-backed loans, investment tools for crypto-assets, and cryptocurrency trading platforms”wrote analysts Andrew O’Neill, Alexandre Birry, Lapo Guadagnuolo and Vanessa Purwin, adding:
“These initial use cases were largely disconnected from the real economy. RWA funding has emerged as a topic in the DeFi space, with lending protocols offering traditionally originated lending, based on borrower subscription rather than backed by crypto assets pledged as collateral.”
However, DeFi securitizations are not without risk. S&P identified legal and operational risks associated with its issuance, as well as the possibility of a mismatch between fiat-denominated assets and digital currency liabilities. Addressing these risks could be the difference between a strong DeFi securitization industry and one that fails to attract interest from traditional finance.
S&P Global Ratings is one of the Big Three rating agencies on Wall Street. While the firm is investigating DeFi protocols, it does not currently rate any projects.
The DeFi industry rose to prominence in mid-2020 when the promise of higher yields and easier access to credit markets attracted native cryptocurrency investors.. By most metrics, DeFi activity peaked in the third quarter of 2021: in November of that year, the total value locked (TVL) on DeFi platforms eclipsed $180 billion.
Asset tokenization, or the process of issuing security tokens that represent actual tradable assets, has long been seen as a viable use case for blockchain technology.. According to Ernst & Young, tokenization creates a bridge between real-world assets and their accessibility in a digital world without intermediaries. The consulting agency believes that tokenization can “provide liquidity to otherwise illiquid and non-fractional markets.”
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