By John Ge, Matrixport Co-Founder and CEO
The underlying macroeconomic narrative today is singularly driven by the direction of interest rates. As the market reels from the “unknown” consequences of global liquidity shocks and banking disruptions, the nascent metaverse of digital assets has not been spared. Crypto has always been considered a high risk alternative asset strategy in traditional finance and with good reason. A significant trust deficit pervades the crypto industry following multiple insolvencies mired in bankruptcy courts and the FTX implosion adding to the malfeasance of the industry.
In this challenging market environment, finding viable investment options that offer attractive risk-adjusted returns can feel like an Indiana Jones adventure, full of unexpected twists and an uncertain outcome. The attractiveness of crypto as an asset class is at an all-time low, with Treasury yields now outpacing the previously attractive yields available in decentralized finance (DeFi), leaving investors pondering a single quest (ion) – where should they invest their money next?
Quest for the Holy Grail
With investors risk averse, the safe harbor of risk-free rates takes hold and the most talked about approach is to own US Treasuries or Treasuries. Despite its risk-free label, owning treasury bills is in practice not without potential risks. As illustrated by the demise of Silicon Valley Bank, owners are exposed to duration risk with price movements that can occur before Treasury bills mature.
However, with recent interest rate hikes, short-term Treasuries have become more attractive than ever, boasting yields close to 5% with no credit risk. The best way to gain exposure to the true risk-free rate is to use reverse repos backed by US government securities. The closest proxy to a risk-free rate in digital assets is native staking on Ethereum, but, of course, this comes with its own inherent risks. After all, it is hardly backed by tangible assets.
So where is the sweet spot? Perhaps this ongoing search for the “holy grail” of risk-free returns lies somewhere in the form of the tokenization of real-world assets.
Navigate the map
Digital tokens representing stocks and mortgages are not a new idea. In the post-FTX era, the discussion of secure tokenized real-world assets on the blockchain has garnered renewed attention. It has immense potential to systematically improve the economics of finance while expanding the pool of what can be secured.
The tokenization of real estate offers increased liquidity and access to new investors, while the tokenization of insurance policies could reduce costs for consumers by creating more stability in the sector through risk transfer. Combining the tokenization of real-world assets with DeFi will open up even nicer high Sharpe ratio opportunities to diversify portfolios and while delivering investment returns at relatively low risk.
One of these paths involves the marriage of treasuries and stablecoins. Treasury bill tokenization allows investors to diversify their stablecoin portfolios, gaining exposure to the attractive yields currently provided by treasury bills through the use of smart contracts.
In the future, tokenized treasury bills can be used for 24/7 token trading or as primary collateral for DeFi lending protocols, allowing investors access to the DeFi ecosystem. broader and to generate additional returns beyond the yields of Treasury bills.
While these use cases are clearly attractive, more work needs to be done to achieve 24/7 liquidity while maintaining returns close to the risk-free rate. We also need to see progress on Oracle pricing to ensure these stable tokens can be used as collateral.
In theory, such solutions are attractive propositions, holding the keys to unlocking the treasure chest of benefits that come with the interaction of traditional and digital assets. The treasure of real-world asset tokenization is considerable. Large institutions known for their long-term bets are already collaborating to explore new paradigms through Project Guardian.
More DeFi Use Cases
Focus on T-Bills tokenization alone, with over $130 billion in stablecoins in circulation and 4.2% annual risk-free interest offered, this unique application of tokenized real-world assets alone holds the potential to capture a yield chest of up to $5.5 billion.
Indeed, the tokenization of real-world assets allows DeFi to tap into some of the largest financial markets and, in turn, traditional capital markets and DeFi protocols are made more accessible to everyone – effectively benefiting from greater capital efficiency and opportunities to trade previously illiquid assets. All transactions are immutable with the increased security and transparency that blockchain technology provides.
But even if the concept of asset tokenization is gaining momentum, it’s too early to say how long it will take to reach the mainstream – a critical hurdle being regulation and compliance. The recent crypto contagion sees regulators working against the grain in the quest to tokenize the industry; likely perpetuated by fears that its systematic risks amplify vulnerabilities across the financial system.
For this to work, asset managers and investors will need to ensure that they engage with strong counterparties and are familiar with regulatory and compliance issues. Progress has already been made by Asia-based DeFi solutions that have received compliance protection umbrellas and regulatory approvals, but this will continue to play a vital role in getting investors to adopt such solutions in more jurisdictions.” DeFi-shy” like the United States.
On the right track
While most might have steered clear of the relatively high-risk investment that is crypto during the 2022 bear market, the tokenization of assets and its lure of “risk-free” returns is bringing investors back into the fold. Proposal? Reap the benefits of continuous on-chain liquidity while simultaneously exploiting TradFi’s more favorable returns in this challenging climate.
Today, most stablecoins are already backed by treasuries as part of their wallet allocation, with the loot going only to its issuer. Regulatory considerations aside, the evolution of this “holy grail” investment will likely usher in a new era of finance where the worlds of TradFi and DeFi merge more seamlessly to create a financial ecosystem that supports authorized and unauthorized assets, in unison.
Time will tell but one thing is for sure. We are going on an adventure.
About the Author: Co-founder and CEO of Matrixport, John Ge
With nearly a decade of experience in the crypto finance and blockchain industry, John is focused on scaling the business to provide one-stop crypto 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 valuation of unicorn status within two years of its inception.
John was previously co-founding company director and head of investment and finance at Bitmain Technologies. He started his career as an analyst in a venture capital fund. He graduated from Hangzhou Dianzi University with a major in business administration.
 As of April 6, 2023
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.