Centrifuge’s Perspective of an RWA Facilitator for GHO

Centrifuge’s Perspective of an RWA Facilitator for GHO

Hey Aave community! Asad here, working on protocol partnerships for Centrifuge, to share our perspective of an RWA Facilitator for GHO.

TLDR: Centrifuge is the trusted infrastructure for bringing credit on-chain. The Aave community can leverage the Centrifuge ecosystem as a full-service RWA Facilitator. This will provide a foundational market of stability and volume for GHO.

Centrifuge was the first to introduce Real World Assets (RWA) to DeFi in 2018, and has worked successfully for over two years to integrate these assets into DeFi protocols.

The Centrifuge protocol connects RWAs to DeFi by creating a fully transparent market which allows borrowers and lenders to transact without unnecessary intermediaries. This lowers the cost of borrowing, provides borrowers with cheaper financing, and provides DeFi investors with a stable source of collateralized yield.

To make this vision a reality, two critical components are required:

  1. Composability with DeFi: RWA collateral shouldn’t exist in a parallel world, but needs to become integrated with the on-chain ecosystem as much as possible. This means becoming collateral for stablecoins, allowing them to be borrowed, and ultimately, traded amongst on-chain participants. Fully integrating RWA with the DeFi ecosystem begins to unlock trapped liquidity and provide critical funding for illiquid assets.
  2. Reliable and Trusted Infrastructure: To properly facilitate RWA lending requires institutional partners, sound legal frameworks, and a high-degree of transparency. The platform that connects investors and borrowers together must appropriately account for the risks and give all actors a sense of reliability. Blockchains enable a rich environment of immutable and visible data, and this must be leveraged to provide a secure and robust infrastructure for the RWA ecosystem to flourish.

With the launch of GHO, Aave has an incredible opportunity to continue building roads into the real world, making a real economic impact, and bringing diverse and quality collateral on-chain. We propose to build an RWA Facilitator together with the Centrifuge and Aave communities that would integrate directly with the Centrifuge protocol and leverage this ecosystem to bring this vision to life.

In this article we want to share our perspective on what an RWA Facilitator for GHO could look like, as a collaboration between the Aave and Centrifuge communities.

What RWA Can Do for GHO

Real world assets provide a fundamental opportunity for growth, stability, and sustainable yields. They offer access to diversified and quality collateral that can provide a foundational marketplace for GHO.

What are RWA assets? RWA is a reference to specific items, typically off-chain, that can serve as financial collateral. These assets represent promises to pay (such as a billing invoice) or they have some intrinsic value (such as a real-estate property). These collateral assets are ultimately what forms the backbone of credit, the financial instruments that borrowers use to fund their business and economic needs. While there is practically a whole world of assets that can fit this definition, the assets best fit for DeFi today are those with a shorter-term duration, provide practical recourse in event of default, and exist in well understood markets.

RWAs provide two key critical benefits for DeFi protocols: stability and volume.

Unlike crypto assets, RWA is tied to more stable and predictable supply and demand characteristics. Meanwhile, crypto markets are notoriously volatile and prone to speculative boom-and-bust cycles. For on-chain protocols, RWAs provide a critical opportunity to diversify away from this volatility, and gain exposure to more stable yields.

And while crypto-native use cases are a growing market, they simply lack the volume of demand when compared to conventional markets. RWA collateral represents trillions of dollars worth of volume and borrowing demand - the total addressable market for global trade alone is 180 trillion USD. This doesn’t even cover the world of real-estate, revenue based financing, and so much more - ultimately trillions of dollars of long-term borrowing needs, hungry for liquidity.

Real world assets can serve as a foundational market for GHO. Centrifuge has been hard at work developing the critical pieces necessary to bring RWAs to life in the on-chain economy. The GHO RWA Facilitator is an opportunity for Aave to integrate these pieces, bringing RWAs on-chain at scale, and leveraging the full benefit of the Centrifuge protocol and ecosystem.

Why Centrifuge?

For Centrifuge, real world assets allow us to take the best concepts from traditional finance and build fundamentally better financial infrastructure. With the protocol and on-chain primitives, the Centrifuge ecosystem and partners, our community is building a protocol to support the entire world of credit coming on-chain.

Centrifuge Pools offer an on-chain securitization platform to serve borrowers and investors. Securitization is a technical financial concept that is used to enhance the liquidity and adjust the overall risk characteristics of credit instruments. It is one of the many key fundamentals to making credit work as an asset class, and Pools are designed with this in mind. Each Pool is typically structured with multiple tranches of investments, where senior investors are protected by the capital provided by junior investors. The junior lenders, who receive a higher-yield, offer “first loss” collateral that is used to create an overcollateralized effect and provide protections for senior lenders.

Additionally, every investment in a Pool is secured by actual real-world collateral. Assets are represented on-chain as Non-Fungible Tokens (NFTs), and any asset that can be tokenized can be financed. Through this, all investments in the pools are secured as fully collateralized loans.

Finally, the legal framework developed by the issuers provides the critical glue that brings the off-chain and on-chain together. Every Pool is supported by legal agreements that provide investors with recourse to the issuer and other legally protected rights. This legal framework provides a high-quality level of protection and reliability, and is the critical component that allows the integration of the physical off-chain world with the on-chain protocol.

With this in place, the overcollateralized, legally secured, senior investment positions provide stable yields and an effective risk-managed portfolio position. A GHO facilitator would be able to leverage these benefits, knowing the Centrifuge protocol as the trusted infrastructure for RWA.

An RWA Index Token

Centrifuge Pools are a powerful concept. To enable their usage at scale, the community is considering building an Index Token for the Centrifuge protocol. This functionality will allow an index to be created that contains a portfolio of RWA Pools, without needing an investor to manage each individual investment. This approach could allow Aave to best leverage Centrifuge protocol and leverage our community of credit experts, issuers, and providers to obtain the portfolio of assets that best meets Aave’s needs.

An Index Token can enable a critical characteristic: diversification - better known as “the only free lunch in finance”. Through an Index Token, a single investment can represent a portfolio of senior positions in several Pools, representing different collateral types, and reducing the impact of an adverse risk event in any one pool or with any one asset type. A properly constructed portfolio could include uncorrelated assets, smoothing out any further potential volatility in returns.

Through approaches like this, we can realize the goal of the Centrifuge ecosystem in building a qualified community of RWA experts and allow users of the protocol to benefit directly from this expertise. Rather than needing to underwrite each individual collateral investment, the Aave community could leverage the Centrifuge Credit Group, one of the newest subgroups in our DAO, similar to Aave’s partnership with Gauntlet. Aave can have the benefit of working with quality partners as the Centrifuge community continues to onboard institutional partners, like Blocktower Capital.

For an Aave GHO facilitator, this approach could provide the best RWA experience possible. Aave can utilize the powerful capabilities of Pools and the Centrifuge Ecosystem, but through a single interface with an Index Token. GHO can begin onboarding high quality RWA collateral, providing a reliable source of yield, stability, and volume.

Centrifuge and Aave can continue working together to bring more RWAs on-chain and enable DeFi to serve as the foundational infrastructure for the future of finance.

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Good day Khan
Thank you for sharing this information.

I fully agree with you, that assets should be diversified in order to avoid volatility. And this is one of the key points for AAVE.

But can you explain which benefit will be for Centrifuge? How GHO could help Centrifuge for those who are not familiar with the concept and argument?

What is your expectation in terms of growth for both protocols?

Great to see you @ImdioR! Good questions.

The beauty of crypto is the composable lego blocks that can connect ecosystems together. Put simply: Centrifuge gets access to Aave’s liquidity. Aave get’s access to Centrifuge’s assets. Now supported by a stable unit of account backed by the Aave ecosystem.

Each protocol benefits from the specialization of the other. Centrifuge as securitization infrastructure for real world assets. Aave as infrastructure for DeFi collateral. When we first partnered with Aave and built the RWA Market, both protocols had to rely on the liquidity of other stablecoins. GHO represents a very smart opportunity for Aave to improve stablecoin liquidity directly - which means better liquidity for real world assets.

Our hope is for Centrifuge to provide access to a foundational asset class for the growth and stability of GHO.

Centrifuge should be able to offer an institutional-grade partner, hiqh-quality assets, and a well run and transparent governance process. And GHO needs a foundation for long-term fundamental value, sustainable models for growth, and effective risk management.

I would love to see GHO onboard a real world asset facilitator in the early-stages of growth. I think RWA is a useful aset class for collateral diversification and ecosystem growth.

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Thank you for your reply Asad.

Do you have any number in your mind just to understand what should be a minimum investment (Of course ±)?
1-3-5-10-30-50 or maybe 100m ? :innocent:

What is the timeline (±) for implementation according to AAVE and Centrifuge governance process?

I think the summer of 2023 is a good early milestone to have in mind. Depending on when GHO launches and market conditions of course.

I expect the risk teams in Aave’s community to have a stronger view on this. Perhaps a cap so that RWA is no more than 5-10% of circulating supply is the right place to start. That could be anything from 10m - 100m depending on growth of GHO and the timing of an RWA facilitator

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Yeah, reasonable time!

That would be great!
Thank you Asad.