Centrifuge 101 Questions

  1. What are alternative solutions that asset originators use to unlock liquidity today? How do they fall short compared to Centrifuge?
  2. Why did you choose a blockchain-based solution for this problem?
  3. Why do asset originators care about increased liquidity? (bonus points for specific use cases from current/previous asset originators)
  4. Can NFTs representing RWAs be enforced in a court of law?
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Hi @davidbentzon, thank you for your post and welcome to the community! These are great questions and I think the information would be very valuable for others as well.

Q1. What are alternative solutions that asset originators use to unlock liquidity today? How do they fall short compared to Centrifuge?

Credit is essential for a functioning economy and is a key driver for business growth. In today’s financial system, only the largest businesses get direct access to liquid capital markets. Most depend on banks, non-bank lenders, and private capital sources for their capital needs. The lack of an open and transparent marketplace denies these smaller businesses access to competitive interest rates mostly due to market inefficiencies and transaction costs. The average cost of capital for the Global 2000 is ~1%, compared to >15% for SMEs. This cannot be explained by the average default rate of SMEs of ~2%. The lack of an open and transparent marketplace denies SMEs access to competitive borrowing rates.

We provide access to both investors that traditionally would not have access to this type of market and a unique source of capital with less barriers and lower rates.

Q2. Why did you choose a blockchain-based solution for this problem?

We chose to use blockchain to solve this problem because it enables multiple parties to achieve agreement on shared information without a trusted intermediary. In the traditional credit market, financing real world assets requires many intermediaries to function, such as in the case of a bond issuance, intermediaries include a lead manager, managers, lawyers, paying agents, fiscal agents, auditors, registrars, transfer agents, calculation agents, listing agents, rating agents, and process agents. All of these intermediaries add to the upfront and ongoing costs, increasing the barriers for small and medium enterprises compared to large corporations who as discussed above already have lower costs of capital. It is also very inefficient and slow.

Q3. Why do asset originators care about increased liquidity? (bonus points for specific use cases from current/previous asset originators)

Issuers provide loans to Asset Originators in the real world by bringing the AO’s asset on chain and funding it from the pool. The more liquidity available in the pool the more assets they can fund, which will create a greater return for pool participants.

For specific use cases I would encourage our current issuers to chime in @Harbor @JeremyKim @prankstr25 @alec_caurisfinance @AleG @ErnestoVila @Stu

Q4. Can NFTs representing RWAs be enforced in a court of law?

For this question, I would refer you to point 1 from this fantastic answer provided by @Eli previously Real World legal questions regarding NFT's & Smart Contracts - #6 by Eli

I hope this provides you with further clarity and a glimpse into the motivators that push us to be all in on RWAs :slight_smile:

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Thank you so much for the comprehensive answer.

A few clarifying questions related to Q1 and Q2:

Q1.

Re: 1), I totally buy that individual SMEs have a ridiculously high cost of capital relative to F500 companies. This needs to change. However, from my (limited) understanding, Centrifuge is not underwriting individual loans to SMEs. Rather, Asset Originators bring a portfolio of loans and price the risk as well by setting the Fixed Rate.

Ultimately, what I’m curious about is why Asset Originators choose Centrifuge to access liquidity rather than just going to the banks. You would think the Goldman Sachs and Morgan Stanleys of the world would be happy to underwrite these portfolios of debt assets - no? This is where I might be totally wrong!

Q2.

I’m still trying to wrap my head around the need for blockchain here. Among other parties, you mention lawyers, auditors, and rating agents as part of the status quo of financing of RWAs. Surely, there are lawyers, auditors, and credit ratings involved in how AOs tokenize their assets on Tinlake. In many ways, you can view the asset originators as a trusted intermediary between a) people looking for a yield on their stablecoins and b) individual SMEs looking to finance CapEx.

I think the best way for me to understand the unique value creation enabled by blockchain is to get a grasp of how Asset Originators would go about accessing liquidity in case Centrifuge/Tinlake was not around. Specifically, what is it that’s broken in the web 2.0 world that blockchain uniquely solves in the context of accessing liquidity against a basket of debt assets?

Sorry for the lengthy post, but I really want to understand how it works :raised_hands:t4:

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Good day DavidBentzon and welcome :wink:

Q1 was raised during the Defacto Community Call №2
I would like to share it with you:

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No worries, always happy to dive into the weeds and provide more clarity.

The reasons an Issuer may come to the Centrifuge are many and are often unique to their specific situation. They may have possibly reached the limit of funds they could utilize from traditional sources, are eager to jump into DeFi, or simply wish to diversify their sources of capital as to not rely on a single source.

Issuers have the ability with Centrifuge to scale with more investors investing in the pool and thus providing more and more liquidity. While on the other hand, a bank or private capital source may have a cap on the amount of capital allocated.

Obviously the Goldman Sachs and Morgan Stanleys may be happy to underwrite these portfolios but may have difficult, long, and costly processes in order to underwrite these portfolios, although I can not speak to their exact processes as I am not familiar with their underwriting practices. There is also chance that the issuer’s and asset originator’s portfolios and assets are too small to justify the needed time and cost spent by larger firms.

Regarding the benefit of bringing assets on-chain through blockchain, the general use case comes down to 3 simple points: efficiency, error redundancy, and transparency.

The current system is inefficient with many intermediaries added into the mix leading to capital being more expensive and slower to receive, as well as, prone to human error. Within the traditional system there are often clerical errors as information, in its many forms, is transferred from one intermediary or partner to another. That transfer also adds unnecessary delays and increases the cost.

Here is a great clip from the Felix Hartmann Show where Ari Paul of BlockTower Capital expands on the benefits he perceives of bringing assets on-chain as well as a real world example of human prone errors in the traditional system.

There are still aspects of the original web2/traditional system at play here and many will remain in Web3. We are working piece by piece to change the system and make it more efficient, consistent and transparent.

I would also add from the investor perspective the great part of blockchain is the transparency available on a digital ledger. I personally see a future where funded assets on-chain are even more transparent and provide more details. Obviously we are still early on in the development of Web3 infrastructure and there is a ways to go, but already we are seeing the use of blockchain for capital funding help individual investors be more involved in creating more efficient capital markets.

@ImdioR also provided a great real use case as discussed by Defactor!

Hope this helps!

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Again, thank you for taking the time to put together such a comprehensive answer.

I think we’re getting closer but there is still one area I don’t understand yet.

Why do we need a blockchain-based solution?

I can understand why massive TradFi players don’t want to underwrite individual loans. It’s simply not scalable for them to do so. I can also imagine how inefficient and costly their underwriting process is even for portfolios of individual loans.

This creates a market opportunity for helping underwriters of small loans (Asset Originators) get access to liquidity. That’s clear. We also know there is demand because HNWIs and family offices are looking for uncorrelated assets to increase their risk-adjusted expected returns.

The next step is to back out the best solution to solve the supply side. Is the optimal solution blockchain-based? A simple way to answer that question is to compare it with a web 2.0 solution. The best one I could find is percent.com.

If I were an asset originator with a portfolio of e.g. consumer loans from Kenyans and I was looking for liquidity, there are two questions I care about:

  1. How fast can I access the liquidity?
  2. How much do I need to pay for the liquidity?

I’m going to put my annoying but curious community member hat on again.

What I’m curious about are the specific characteristics of a blockchain-based solution that allow for a faster and cheaper way for AOs to access liquidity. If there are none, why use blockchain in the first place?

I hope I don’t come across as a troll because I am genuinely curious and want to believe in the technology you have built. Because if you are right, you will have unlocked trillions of $$$ in value.

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Hi @davidbentzon, you don’t come across as a troll at all - you raise very important and relevant questions that will benefit everyone in the community to hear the answers to. We appreciate your interest in Centrifuge.

I am personally no financial expert, but I will give my two cents as to why I think a blockchain based solution makes sense.

To me, blockchain based solutions are about two things mainly; interoperability and transparency. In this post, we have mainly been focusing on the advantages from an Asset Originators perspective - another aspect to it is the investor’s perspective. This is where the interoperability comes in.

We recently announced Centrifuge Connectors (so far in collaboration with Avalabs, Moonbeam and Nomad, but I expect many more to follow). In short, this means that in the future, it will be possible to invest in RWAs directly from other blockchains. This means that we are not limiting ourselves to our own ecosystem, but will be able to tap into liquidity from a much bigger crypto ecosystem.

Once a pool has launched directly on Centrifuge Chain, and liquidity starts flowing in, Asset Originators can basically access capital instantly. If we look at the Total Value Locked (TVL) on Tinlake (the dApp on Ethereum where the pools currently are), we see a clear trend - it has been constantly growing, regardless of market conditions. In contrast, we can see that the overall TVL for DeFi in general decreases when market conditions are not good.

As mentioned above, all pools are currently on Tinlake so all transactions are paid for in ETH, which can be quite expensive. When the pools launch directly Centrifuge Chain, transaction fees will be paid in CFG (the native token) and it will be a fraction of what it costs today.

In addition to @sirj’s responses and my humble input, I think it would also be helpful to hear it from the horse’s mouth.

@Harbor @JeremyKim @prankstr25 @alec_caurisfinance @AleG @ErnestoVila @Stu it would be great if you guys could chime in and provide some information as to why you chose a blockchain based solution (as an addition) to your businesses.

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Hi David.

Very good questions, thank you for asking. Critical thinking is always appreciated :slight_smile:

I recommend to take a look into this medium article which explains in detail why business want to launch their assets on Centrifuge chain and answers maybe your second question:

And in general: there are plenty of reasons why Blockchain will succeed: e.g. I came accross an article today where security analysts reported, “nearly 80% of cyberattacks are identity-based”. Some cryptoprojects (coughs Kilt protocol which is working together with Centrifuge) try to solve that.

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Hey @Rhano - thanks for offering your perspective. It’s helpful.

Here are some of my reflections in response to your reply:

This is really cool.

However, this is not exactly what I mean when I ask about how fast I can access liquidity. I’m more interested in knowing how fast the process is from enquiring about liquidity until a wire hits my bank account.

Point A: “Hey, I would like to borrow against my portfolio of debt assets.”

Point B: “$x millions just my bank account.”

How do crypto-rails reduce the time from A to B relative to a web 2.0 solution? This is the key.

Again, I think the above misses the point slightly. I’m sure the transaction fees related to moving the money will come down. No doubt.

I’m actually more interested in understanding how crypto-rails reduce the remaining costs of getting access to liquidity. Do AOs pay lower upfront fees to create a pool on Tinlake relative to a web 2.0 solution such as percent.com?

In other words, if one were to provide a web 2.0 solution to help AOs get access to liquidity, why would you say that’s a bad idea? What is it about the technology that makes it superior?

I would absolutely love to understand why the current AOs chose Centrifuge over competing solutions. Would be very grateful for their input!

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Hey @Tjure07! Thanks for chipping in.

The benefits you highlight are really cool.

However, what is the benchmark they are being compared with? Lower transaction fees, multiple tranches and flexible loan models are all great but if I can get these things at a web 2.0 shop such as percent.com, why should I care as an AO? The article does not explain this.

Now on Tinlake Centrifuge pays all the fees for setting up the pool. On Polkadot and Pools on Centrifuge Chain it will be a few CFG.

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Haha @davidbentzon you are certainly not a troll and I appreciate what you are bringing up. I would also add as @Rhano mentioned, I am also not a financial expert. :slight_smile:

From my perspective it comes down to cost of capital and providing a space to allow for scalability. With a fund like Percent investors know what is shown to them, with our end goal of transparency, we are working towards a future where investors can be more involved and educated regarding their investments thus leading to a scalable source of capital as more investors join in for Issuers.

An Issuers main focus is reducing cost of capital but also ensuring they have multiple reliable sources of capital that can grow with them as they scale. I would not suggest a Issuer rely on a single source as this can prevent growth.

So to answer why blockchain- blockchain benefits the investor by providing clarity and a trust-less system for investments. This growing source of capital can then be utilized by Issuers while reducing the middle man cost.

Regarding the process, we have a Proposal system that a potential Issuer would go through with the inclusion of the community for making the decision whether a pool launches. It is not a simple click and you are in, instead it is a rather lengthy process to help find the right issuers. You can view the current POP process here but we are always learning and tinkering to make it more efficient and effective.

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:cyclone:

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Happy to chime in from our perspective as an issuer. There’s a lot of benefits of putting securitization on chain, I’ll focus on a common benefit ACCESS

Let’s look at this from two lenses: Issuer and Investor

  • Structuring a securitization vehicle in a traditional setting is quite costly which is a barrier for entry for issuers with portfolios of less than $100mm USD. Centrifuge’s infrastructure allows an issuer to launch a securitization at minimal cost
  • Issuers have access to a new set of investors: Crypto native retail investors, institutions, DAO treasuries as well as integrations with other DeFi protocols
  • Investors gain access to asset classes historical reserved for large institutional players with the ability to diversify across different pools with a very low minimum investment ($5,000). Think of how ETF’s shook up the wealth management business.
  • Investing and Redeeming in pools is “self service” for investors with daily automated reporting on NAV calculations

Bryan

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Thanks for the link. Interesting concept for sure and as far as I’ve seen they are operating since 2018 with around $750M underwritten so far. That’s pretty big and compared with them Tinlake is relatively new (the first revolving pools launched in October 2020).

I see here a few limitations compared to Centrifuge and Tinlake:

(1) Due to the nature of revolving pools, Tinlake offers open-ended investments (as long as financing is needed, the pools stay open and investors can keep their investments in the pool). The investment types range from short-term (30 days) to long-term (up to 36 months asset maturity for some assets)

(2) Right now, Tinlake pools are open for investments in DAI stablecoin but in the future maybe other stable assets - less dependend on the 1:1 Dollar-equivalent - could be used for investments.

(3) Underwriting could be done in a decentralized manner by giving the voting power to the community

These are just ideas but that’s the power of decentralization

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How much is a few CFG compared to what you would pay elsewhere (i.e. with a web 2.0 solution)?

I can only reply to the first part of your question.

1 CFG = 0.44$
With 2-5 CFG you should be ok :upside_down_face:

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Hi David,
Thanks for the interest and the questions. Please find below my two cents:

In our case there was not alternative solution. Consolfreight is a company incepted since its foundation in the Defi space. After looking for funding in the traditional financial system with no success, we were able to conduct pilots with Maker and Centrifuge. This means that Defi gave Consolfreight the chance to test and proof new business cases and opportunities. As Bryan mentioned previously, the cost of setting this structures in a traditional way can be expensive and limit the chance of Small financial companies to enter the market. Also, traditional funding often comes with strict mandates that are roadblocking the innovation of financial services, for example credit insurance in each transaction. One of consequences of this is the huge service gaps in products like Trade Finance, inventory finance or even factoring. Blockchain solutions and ecosystems will facilitate better risk mitigation practices decreasing barriers of entry for SMEs, and it will change restrictions in the use of funds for advance underwriting processes.

From the investors side, it is important to mentioned that Defi is opening the chance to retail investors to participate in projects that previously were only available to people or companies with deep pockets, that democratisation of investment is providing alternatives sources of liquidity for AOs. On the other hand, the onchain capabilities allow investors to have a better visibility of the assets used as collateral and risk management.

Regarding your final point about NFT representing RWAs, it really depends on the jurisdiction. Our view is that at some point it will be enforced in a court of law and there have been few cases in UK that are already indicating this. At the moment, it is still necessary to tight NFT and the RWAs through a contractual agreement.

Hope this helps

Thanks

Alejandro

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To add to to what @AleG mentioned regarding NFTs

Regarding your final point about NFT representing RWAs, it really depends on the jurisdiction. Our view is that at some point it will be enforced in a court of law and there have been few cases in UK that are already indicating this. At the moment, it is still necessary to tight NFT and the RWAs through a contractual agreement.

The NFT simply represents the RWA that the issuer funded on-chain. The Issuer would hold some sort of agreement with the borrower that would include a section on the event that the loan is not repaid what happens with the RWA that was collateralized in order to borrow. Then the issuer can follow their own default practices before paying back the asset on-chain.

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Good day AleG
Thank you for your reply and participating.
I would like to add my exp. from the investor side, I would like to add that I was able to invest in different pools from Italy and invest in CF4, Harbor just with a few clicks.
After my successful investment, my friends who usually keep USD in the bank transferred them on-chain and invested too. As I know he is very happy with his choice.
So DeFi, Centrifuge, Pools connect investors with Issuers/AO wherever they live.

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