Centrifuge: Where DeFi Meets Real World Assets

The Centrifuge Crypto Protocol: Bringing Real World Assets On-Chain

With hundreds of billions of USD in total value locked (TVL) in decentralized finance (DeFi) protocols as of November 2021, the DeFi sector is already disrupting the financial technology (FinTech) status quo. However, most DeFi projects exist and operate entirely within the technological bubble of the DeFi space alone. There has been minimal crossover between the parallel economies of legacy financial services markets and the DeFi sector. Centrifuge is here to change this, and is well on its way to unlocking on-chain functionality and access to the planet’s real world assets (RWAs).

While there are various projects that allow for the tokenization of real-world assets like real estate or traditional financial products, Centrifuge is taking a more asset-agnostic, wide-ranging approach that allows users to bridge a far greater spectrum of RWAs over to the DeFi space — and in a way that benefits asset originators and investors alike. The Centrifuge blockchain mainnet went live in April 2020, and its approach is already demonstrating its potential to unlock multiple multi-trillion RWA markets worldwide. Centrifuge is on track to catalyze a wave of DeFi activity that is tethered not to abstract intangible assets, but rather to the real world.

Collateralization & Tokenization of Real World Assets via Tinlake

Centrifuge’s flagship decentralized application (dApp) is Tinlake, an open marketplace and investment dApp built on Ethereum. Tinlake allows users to turn real-world assets into digital assets that can be used to issue interest-bearing stablecoins. The tokenized RWAs can be anything from a stake in a business endeavor, loan provider, or physical assets. Once tokenized, Tinlake assets can be freely transferred and used across the vast ecosystem of DeFi products and services. Tinlake also enables stablecoin issuers to offer stable stores of value that are backed by collateralized asset pools. Since investors have different risk-reward profiles, the Centrifuge Tinlake dApp is designed to provide a way for users to invest in the same asset through different classes of investments.

Here’s how it works: Each time an asset originator bridges an RWA using Tinlake, they convert their assets into non-fungible tokens (NFTs) that are embedded with relevant legal documentation. Unlike most NFTs on platforms like OpenSea and rarity.tools, Centrifuge’s NFTs are tokenized representations of individual assets, such as an invoice or a mortgage, that can be used as collateral in Tinlake. These NFTs play an essential role in lowering the barriers to entry for originating and investing in assets, scaling asset financing and liquidity, and creating bridges between the real world and DeFi. From there, these users can create an asset pool collateralized with their tokenized RWA NFTs and use it to issue two kinds of ERC-20 tokens: Drop tokens and Tin tokens.

Drop Tokens and Tin Tokens Can Benefit Different Investor Types

Drop and Tin tokens behave similarly to how tranches work in two-tiered financing structures within the traditional finance world. Within this framework, Drop tokens assume the role of the senior tranche, while Tin tokens can be seen as the junior tranche. In terms of investment payouts, Drop crypto returns are determined by a fee function that has a fixed interest per pool, which compounds every second. By contrast, Tin crypto holders do not have a guaranteed return, and their rewards are a function of how much value the Drop token contract leaves behind once it has collected its payout.

This means that Tin token holders take second priority to Drop token holders when earnings from borrowers are paid out to the funders. However, just like in the traditional finance world, these “junior tranche” Tin token holders can potentially generate much higher returns than Drop token holders. In other words, Tin crypto holders incur more risk than Drop crypto holders, but are also eligible for more upside depending on the performance of the investment. And while this dual-token structure is meant to help asset originators provide optionality to investors and therefore enhance their own liquidity, Tinlake’s RWA-backed pools can also be deployed with just the Tin token if so desired.

The interest that investors accrue from DROP and TIN crypto holdings can be redeemed at any time. The Centrifuge DeFi integration with MakerDAO means that asset originators can automatically draw DAI on Centrifuge loans as well. The Centrifuge crypto team is currently working on similar integrations with Aave, and as more crypto assets are added to Centrifuge’s Tinlake ecosystem, investors and asset originators alike will be able to benefit from enhanced optionality.

How Centrifuge Chain and Centrifuge Coin (CFG) Work

The underlying Centrifuge blockchain architecture is called Centrifuge Chain. It is a Proof-of-Stake (PoS) blockchain built on Parity Substrate – a platform that allows users to create semi-autonomous distributed blockchain systems on Polkadot (DOT) and Kusama. Centrifuge’s on-chain transactions are optimized for the small subset of specific operations, which allows for faster execution of logic, transaction finality, and extremely low transaction costs. And while Tinlake is built on Ethereum and currently communicates with the Centrifuge Chain via a Chainsafe bridge, the dApp and will soon be fully migrated to the Centrifuge Chain, with the goal of becoming an independent decentralized financing protocol that interoperates across different blockchains and funding sources.

Centrifuge Chain is powered by the Centrifuge coin (CFG), which is designed to incentivize users to maintain a robust, decentralized system to power a growing array of Centrifuge DeFi applications. CFG coins can be used to pay for transaction fees, staked for block rewards, or used to participate in Centrifuge blockchain governance. Therefore, as Centrifuge’s offerings and user base expands, the increased usage and value of the network will likely be reflected in the CFG coin in myriad ways.

While Centrifuge Chain is currently a sovereign chain, the project is in the process of transitioning into a parachain on Polkadot. This will allow the project to bridge over to other chains within the Polkadot ecosystem, as well as achieve a higher level of on-chain security at a lower cost — thereby helping Centrifuge to focus its efforts on building out its core features. Polkadot plans to auction off its first parachain slots, and in order to secure a slot, Centrifuge is hosting a Crowd Loan from DOT holders in a parachain Loan Offering and offering CFG coins as a reward.

An Interconnected World of Finance

In the legacy finance world, only the largest investors and institutions have generally been capable of directly accessing vast capital markets and dealing with historically illiquid assets in a fluid yet secure way. As a result, smaller businesses and investors have often been unable to benefit from competitive interest rates due to institutional gatekeepers, structural market inefficiencies, and high transaction costs. The Centrifuge crypto project has set out to address these issues by providing easier ways for retail investors and institutional investors alike to bring their real world assets onto the blockchain and tap into new markets and investor bases. Further, while the goal for many in the DeFi space is to curb the influence of borders, centralized banks, and government-controlled currencies, it’s essential that DeFi projects provide easy and attractive onramps for legacy businesses and ordinary investors. This is the Centrifuge remit, and its growing user base is a testament to its unique approach in bridging the real world and the blockchain.