DeFi securitization of real-world assets poses credit risks, opportunities: S&P

DeFi securitization of real-world assets poses credit risks, opportunities: S&P

According to a new research paper from credit rating agency S&P Global Ratings, the use case for decentralised finance (DeFi) in traditional finance could rise in the next years as new protocols aim to facilitate the securitization of real-world assets.

S&P said in a paper titled “DeFi Protocols For Securitization: A Credit Risk Perspective” that financing of real-world assets, or RWAs, will likely be a primary priority area for DeFi protocols in the future. Although the market is still in its early stages, S&P highlighted various benefits DeFi might bring to securitization, including as lower transaction costs, improved transparency on asset pools, lower counterparty risks, and speedier payment settlement for investors.

“The early development of DeFi was primarily focused on applications providing financial services within the crypto ecosystem, such as lending collateralized by crypto assets, investment tools for crypto assets, and crypto trading platforms,” wrote analysts Andrew O’Neill, Alexandre Birry, Lapo Guadagnuolo, and Vanessa Purwin.

“These early use cases were largely distant from the real economy. The financing of RWAs has arisen as a theme in the DeFi domain, with lending protocols giving typical loans based on borrower underwriting rather than credit underwriting backed by crypto assets pledged as collateral.”

However, DeFi securitizations are not without danger. Legal and operational risks were recognised by S&P, as well as the possibility of a mismatch between fiat currency assets and digital currency liabilities. Addressing these concerns could mean the difference between a thriving DeFi securitization market and one that fails to attract traditional funding.

S&P Global Ratings is one of Wall Street’s three major rating companies. While the company is investigating DeFi protocols, no projects are currently rated.

The DeFi industry surged to prominence in mid-2020, attracting crypto-native investors with the promise of better rates and faster access to credit markets. Most measures indicate that DeFi activity peaked in the third quarter of 2021, with the total value locked (TVL) on DeFi platforms surpassing $180 billion in November of that year.

Asset tokenization, or the process of generating security tokens that reflect genuine tradeable assets, has long been regarded as a feasible application for blockchain technology. Tokenization, according to Ernst & Young, bridges the gap between real-world assets and their accessibility in a digital world without intermediaries. Tokenization, according to the consultancy firm, can “bring liquidity to otherwise illiquid and non-fractional markets.”

 

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