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Hi readers,
In today’s newsletter, Peter Gaffney of Blue Water Financial Technologies says that the right systems and processes must be in place to properly tokenize the trillions of dollars worth of potential real-world assets.
Then, Ari Pine of BlockFills posits that BTC-backed loans could be a great way for traditional finance institutions to engage with crypto at scale.
The ultimate goals of tokenization include full-fledged secondary trading markets for alternative private assets, integration and portability into the DeFi ecosystem, and greater investment accessibility. While there are a number of platforms and service providers offering tokenization-as-a-service, there have typically been inherent limitations associated with bringing existing legacy assets on-chain in a dynamic manner.
Tokenizing a portfolio of loans from a middle-market direct lender may create an opportunity to use the portfolio collateral as non-crypto collateral within DeFi applications like Moonwell, Aave or Morpho, for example. The ideal real-world asset lending workflow taken from Blue Water’s Opportunities in Tokenization 2025 report is displayed below.
Importantly, the concept will likely fail if the direct lender only marks its portfolio holdings quarterly, semi-annually or annually, as that timeline drastically lags the usual real-time execution expected within digital asset markets. To truly unlock the trillions of dollars of current, performing alternative assets in the universe there must be an operating system or systems that enable end-goal applications; these applications include decentralized exchanges, decentralized lending platforms and peer-to-peer collateral transfers from which to constantly draw financial asset data. But doing this for DeFi applications is not feasible by sifting through tens or hundreds of Excel spreadsheets and siloed files in an attempt to ingest asset-level data.
Below are some additional factors for consideration in shifting towards blockchain environments:
Transparency and proof-of-metrics — “metric” being anything including reserves, holdings, state, authorization, etc. — are the lifeblood of crypto markets. Bringing legacy assets on-chain in a meaningful way will require above-average levels of transparency, at least for direct investors and participants.
Any operational speedbumps inhibiting a 24/7 operating schedule will reduce trust and increase execution risk in the eyes of crypto investors. That means manual employee updates, edits and working hours will decrease the attractiveness of real-world assets to the crypto markets.
As a combination of the first two points, seasoned crypto participants will likely require a holistic solution enabling real-time monitoring of the off-chain assets backing their tokens and near real-time execution speed, whether that be trading, subscriptions, redemptions or loan processing.
For example, Inveniam’s blockchain-based operating system displayed here enables private assets to bridge into crypto-native ecosystems that they previously could not.
These points are not as threatening to newly-issued digitally-native assets like Tradable’s $1.7 billion in loans or Figure’s $10+ billion in HELOCs, since the full life cycle and associated data of these products began and still exists on-chain. However, for the trillions of dollars worth of existing assets that many in the field are targeting, porting operating and lifecycle data from an array of Excel sheets to an operating system that can ingest the data, credential it on a blockchain, and ping that data out in real-time will put things at the goal line.
Platforms such as the Inveniam operating system displayed above and Accountable, as well as blockchain layers like Chainlink and Pyth, provide some low-hanging fruit for asset managers and capital markets players to get token-ready by onboarding to blockchain rails.
– Peter Gaffney, vice president, Blue Water Financial Technologies
Institutional Outlook
The Opportunity in High Yield Crypto-Backed Loans
Despite all of the positive news about digital assets coming from the new administration, the crypto ecosystem still isn’t fully integrated with the U.S. banking system. Even with the removal of “Operation Chokepoint 2.0” restrictions, institutions and individuals aren’t able to access the money markets with the level of efficiency that traditional Main Street, let alone Wall Street, is able to.
This has created an opportunity for many crypto native-entities to take advantage of what they do have — good collateral — and to use that collateral to borrow U.S. dollars (USD). The result is an asset-backed loan that has the potential to yield more than it “should.”
With junk bond spreads less than 300 basis points (bps) above U.S. Treasuries, BTC-backed loans may offer more yield than junk bonds with less risk than investment-grade bonds. Using current market conditions and a standard credit default modeling technique, BlockFills estimates a fair value of 150-200 bps over USTs for BTC backed loans, yet they currently trade at 400-600 bps over USTs.
Overcollateralized BTC-backed loans may present a great opportunity for traditional finance institutions participating in crypto at scale, in a fashion that is reminiscent of prior innovations like mortgages and junk bonds. These transactions can be structured in a Tri-Party arrangement, which is when two parties engage a third party as a trusted custodian for funds held in escrow. This removes the need to custody crypto, handle margin calls and deal with selling the collateral under default conditions.
Crypto market participants and businesses simply do not have full access to the USD banking system. These BTC-backed loans are a possible solution to fill the gap. The collateral is good, tradable and liquid in both on- and offshore markets. This compares favorably with default conditions in corporate loans where bankruptcy proceedings can last for years (or decades).
A portfolio of such loans does not represent diversification since all these loans would be backed by cryptocurrency. However, that does mean that a portfolio may be hedged using the options* market, which has also become liquid in both listed and OTC markets for BTC.
The BTC-backed loan market is an opportunity that bridges crypto and traditional finance. It’s not meant to provide the sort of “degen” returns that may be available in outright positions but instead speaks to the sorts of investment parameters that come with vocabulary recognizable to the Patagonia vest-wearing crowd. Terms like “excess risk-adjusted return” and “harvesting premiums” are reminiscent of the 80s and 90s.
