Bridging offchain assets to DeFi
Decentralized Finance is primarily about trusting the code and not the people behind the code.
Dealing with offchain assets as collateral poses a fundamental challenge: If the offchain party defaults how is the enforcement achieved.
Consider an example where on Compound wBTC is used as collateral and some DAI is borrowed. If the borrower does not pay then the wBTC is automatically liquidated.
However on a protocol that deals with offchain assets as collateral, example being the OTL, or DMM for instance, this becomes a tricky affair.
If you tokenize a house or a car or an invoice and the borrower does not pay then someone has to go and do the enforcement manually offchain.
This poses a few immediate challenges
- You have to rely on the enforcer and not just the code, this immediately goes against the core tenets of DeFi (and also raises some securities related concerns)
- How fast can the liquidation be done and at what value
Any DeFi play that deals with offchain assets needs to have a clear plan on addressing these issues.
Let's start with the second question first.
Not all offchain assets are created equal. The key attributes which matter to us are
- Ease of acquisition and sale, programmability of the process
- Real time price
When someone is using a real world asset as collateral, you need to have some sort of a real time feed into what that assets current price is to determine whether or not it is still a sufficient collateral.
And that is only possible if there is extremely high liquidity.
For instance you may have the mona lisa which you paid a $10 Million for (in theory). You wish to borrow against it, but there is no liquid market for the mona lisa so it is very hard to know what it its exchange value is in real time.
You might get a buyer for $100 Million or you might get one for $1 Million.
This makes such assets really hard to use as collateral.
Plus the process of actually making the sale is quite drawn out and definetely requires manual intervention. Same goes for real estate, used cars, and so on.
Listed Stocks, Commodities and other such assets on the other hand have a liquid market and have a real time price feed. They are volatile but you know exactly what they are priced at any point in time.
In addition you are able to liquidate them on demand and this process can also be triggered via automated algorithms which can be triggered via a Smart contract DAO.
As more distribution is achieved assets that are further on this scale can be progressively used as collateral, but listed assets lend them as a perfect use case.
We are building a bridge via Smart contracts that can automatically trigger API calls to buy and sell shares on demand which can then be used to liquidate the collateral if such a need arises.
Programmable on demand ability to liquidate the collateral goes a long way to make offchain assets possible in the DeFi world.
Eventually we will see businesses leverage the IDO (Initial DEX Offering) process instead of doing an IPO and achieve capital at a far lower cost. At that point once these assets become more blockchain native the process will become increasingly easier.
However this will require the revenue streams to be onchain and only those businesses with no room for revenue leakage would be a fit.
For instance a pizza shop which takes in its money in cash will not be a good fit.
However an online shop that accepts payment purely in crypto would be a perfect fit.
While KYC in its conventional sense in DEFI is a bad idea, there is definetely a need for some mechanism to establish persistent identity in a decentralized manner.
For instance on twitter you may not have your real name, but as you do more posts and gain more followers, the handle you have becomes a persistent identity without necessarily doxing you.
Having such a solution would make it possible to establish credit scores which will make undercollateralized lending possible. Right now all (almost all) DEFI requires over collateralization which restricts the use cases.
A website with high traffic (verifiable via analytics), youtube channel with a number of subscribers, instagram influencer accounts are all potential real world assets which are virtual enough to be tokenized and used as collateral.
Gaming power ups like a special sword or a spaceship in a MMORPG could again represent tokenizable assets which become increasingly valuable with the rise of online gaming as a spectator sport.
The next bit that needs to be decentralized is the operations of the platform itself. In this regards we are big fans of what Compound did by giving away control of the platform to the community once a product market fit was achieved.
The users of the platform can vote on which assets to allow, what interest rate models and collateral factors etc to allow.
We intend to do this as well on a very highly accelerated time frame.