What makes a real world asset useful in DeFi?

The assumption that once a token is onchain DeFi can use it is very common.

Tokenization only changes where the record of ownership stays, it doesn't change the underlying function.

Consider this: two tokens were created, both of them represent real world assets, exist on the blockchain and have their records transparent, but something is different:

  • Token A represents an asset that its holders can verify, it can be transferred under clear rules and can be used as collateral in a financial market with established risk control.
  • Token B represents an asset whose price is difficult to establish, its redemption process is complicated and because of this no protocol can actually interact with it


Both tokens A & B represents tokenized assets.

However, financially they are worlds apart

tokenization is not the hard part, it is only the starting point

the real challenge comes after the token is created if it is to function in DeFi


what makes the token useful

why should a protocol accept it

what does the ownership experience look like for a holder?


with tokenization the representation, transferability and integration of an asset is changed, but its underlying legal structure, economics and risk doesn't change

that a token represents a cooperate bond does not make its issuing company more credible

tokens can exist independently as a software but its financial meaning is dependent on the system that connects it to the asset

the moment there's a trace of weakness in that connection, the applications built around the token inherit uncertainty

For a token to work inside DeFi certain things need to click

  • There must be legal certainty

A token holder wants to know what they actually own, they want to know what they're entitled to.

so clarifying whether they own the asset directly, they hold a beneficial interest in an entity that owns the asset, or if it just gives them exposure/privileges to the assets financial activities

considering tokenized bonds....

a cooperate bond is a representation of a debt obligation. The issuer makes payments according to the bonds terms and performs all obligation such as paying the principal at maturity etc.

now if the bond is tokenized, the operational structure must clearly explain how the token holders rights are connected to the obligations

questions like, who holds the bond, how are payments collected and distributed, if the issuer defaults what happens, must be answered

In DeFi it matters because financial protocols function based on predictable rules

clear rules facilitate sound decision making


  • Valuation

knowing what the asset is worth per time is critical

good valuation that is supported by appropriate risk parameters, reliable data and understanding of how the token trades should be integrated

if not, highly liquid markets whose valuations are considered complicated would be a problem for DeFi protocols when collecting price information


  • Liquidity

liquidity is basically the bridge between tokenization and utility

having an active market that allows token holders sell when they want to is very important for DeFi integration

for a lending protocol to accept an asset behind a token as collateral, the protocol does not only consider the asset's worth but how much it would recover if sold quickly

that credible curve of recovery if something goes wrong is necessary


  • Risk Management

what if the market begins to drop?

A tokenized real world asset introduces risks that may not have been prepared for

with smart contracts and all, the system can be automated to liquidate an asset to avoid critical loss

But what about the asset's off chain operations and settlement processes, cause these are two system's which do not operate at the same speed

Asset specific risk management processes should be implemented

there would always be risk but having specific methods of handling it cuts the losses


  • Integration

This is the final and most important layer for me

An asset must have an interface that is compatible with other applications for it to be used with them

Therefore its composability is very important

Whatever application it is being integrated with must be able to build on its functionality

It must be compatible both technically and financially


Collateralizing all tokenized assets seems like a great idea until it is not

they are not automatically good DeFi collateral


A good example is a lending market. A borrower deposits collateral and receives a loan, the protocol sets limits based on the collateral's characteristics and risk profile

The moment it becomes too risky, the protocol would want to liquidate to recover their funds


Imagine two assets, one with a credible liquidation route, dependable valuation and another with limited trading activity, unclear exit conditions, unstable valuation

These two assets are obviously tokenized but accepting them under the same conditions would be crazy and some protocols may decide not to accept the second asset at all

Which is proof that financial utility is dependent on more than availability of the asset

Tokenization is not enough, building an infrastructure that allows these assets to participate in the financial market effectively is the most important thing

By connecting legal and custody infrastructure, data infrastructure, market and liquidity infrastructure, risk and integration infrastructure and finally user education tokenized assets can function effectively as these layers reinforce one another


For tokenized assets to become financial infrastructure every stage of its financial lifecycle must work well enough so that the next one can depend on it.