Credentials: Low hanging fruit for real world asset tokenization
Probably the biggest problem in real world asset tokenization is how can offchain defaults be handled.
Most defi activity revolves around speculating on crypto. Sophisticated infrastructure exists to create money markets, derivatives, automatically executing contracts based on certain conditions.
However all of these are currently siloed to serving only onchain assets.
The reason is quite simple, Cefi relies on trusting the issuer while defi relies on trusting the code and not the issuer.
When you invest in a company or a bond or any non blockchain fiat based fintech you are trusting them to do the right thing when you give them the money and you also expect the countries laws to hold up in the event of a dispute.
In the defi world it does not work like that. You do not have to trust anyone. You look at the code, and look at the collateral. The borrowing party has to put up some collateral and if they do not repay as promised the collateral is liquidated.
This only works if the collateral is onchain.
If the collateral is offchain then you have to rely on offchain human actors for enforcement, which introduces fallibility. What if someone put their house as collateral, borrowed the money and then disappeared. Who is going to enforce the loan, and what if the enforcer does not do what they were meant to do?
Till date there have been only imperfect solutions for this, which we have discussed in previous articles. These included the enforcer putting up some onchain collateral. Operating a DAO for the anchors and collateralizing its tokens.
None of these are great solutions, and for the longest period of time I thought that till more transactions come on chain we will always be forced to deal with imperfect solutions.
Which means defi investors have to trust the enforcers if real world asset tokenization is to work for the time being.
But perhaps there is a way.
Let us investigate.
Consider a transaction in which there are 2 parties, A and B
A is buying a product P from B. In return A is paying money to B.
This contract can be tokenized as seen in previous articles and we can treat this as a receivable on part of B who can then go and factor it. Factoring is a great place to do defi stuff due to the regulatory exemptions.
However how do you ensure that A is going to actually pay the money when the invoice comes due?
And how do you enforce defaults?
What if the product A is buying is a virtual product, like a piece of software.
In the event A does not pay, his access could be remotely disabled by cancelling his license.
However A may decide that he only had a short time frame use of the software or decides to go for a pirated copy. Just being a virtual product is not enough, it has to be something that the user values enough that he/she desires to own it for the period of their lives and wants it to be known publicly that they do own it.
A digital piece of art? Crypto kitty?
Sure they are unique digital assets which are desirable to some, but I would really question their value as collateral. Push comes to shove people would happily lose their cryptokitty and disappear. Plust these assets are often owned anonymously and with limited downside if the user no longer has ownership of them.
Plus ideally it has to be an asset that the user gets only after they have completed paying for it, but are engaged in a contract which entitles them to own it after a period of time.
Derivative future forward contracts could be one example, but they come with tons of regulations plus they carry the same enforcement challenge.
As a parent, the single most important thing to me is my child and securing his future.
I am prepared to pay whatever it takes to ensure that.
Recently a company in India launched a receivables factoring play that allows schools to get a lumpsum payment discounted by 5% instead of waiting to get monthly fees.
So if the School monthly fees are $1000 for a 10 month term, the school has a receivable of $10,000 over ten months.
The school wants the money now, perhaps it wants to pay for the construction of a new facility building.
It approaches a bank which lends it against the receivable, $9000.
The banks keeps the $1000 when it is paid.
Normal factoring you would say, and you would not be wrong.
However in this case, if the parents do not pay the school withholds the marksheets, and does not promote the child to the next grade and refuses admission the next year.
This sounds inhumane, and quite frankly something no parent will permit in their right mind. Unless you are Cronus.
The company has a default rate of exactly 0 on about $20 Million of loans processed in a short period of time.
However just having a strong asset is not enough.
Recently in Australia there was a company called Rocket Shoes, which did credentials on the blockchain. I am not across how it was done, but if I were to do it it would be a non transferable non fungible token which would sit in your wallet and be publicly accessible.
The presence of this token in your wallet would be evidence that you have a certain qualification. Diplomas and Degrees can be put on the blockchain in this fashion.
If the credential is tokenized then its creation can be linked via smart contracts to the payments of fees.
Which means only when the parent pays the instalments on time and only when he has paid it in full will a flag be set automatically that would allow the diploma to be issued. The School can still hold the qualification if the kid has not put in his homework or flunked the exams etc. But this serves as a control that can be exercised by the smart contract directly.
Credentials on the blockchain can eliminate fraud and allow public verifiability of someones qualifications. Receivables are a great fit for defi due to the regulations. And finally by controlling the issuance of these blockchain native credentials you have a brilliant real world asset that can plug into a money market and can be promoted to the core defi community.
There are still some open attack surfaces which astute observers will point out, but they are still far less than most other situations and can be minimized with a series of one time validations.