The Real World Asset Thesis Part 1: Bringing U.S. Treasuries to DeFi
Introduction
The COVID-19 pandemic and the resulting lockdown policies that halted the global economy was undoubtedly one the most significant disturbances to the financial system since the 2008 Financial crisis. To mitigate COVID-19’s economic damage, the Federal Reserve implemented the single greatest liquidity injection in History into financial markets expanding its balance sheet and the M2 monetary supply to unprecedented levels. This injection of liquidity and supply chain issues caused inflation to deviate well above the FEDs 2% target rate. To bring inflation back down to the FEDs long-term target inflation rate, in March 2022, the FED began to hike interest rates, to which the federal funds rate now stands at 5.25-5.5%. Future rate hikes have now become data-dependent, with the market expecting interest rates to remain higher for longer. This means the risk-free rate offered by U.S. Treasuries is mostly higher than the yields from deploying USDC into a DeFi money market protocol like Aave or Compound.
Yields offered in the DeFi application layer are mostly variable and inherently unsustainable since elevated attractive yields are a function of the demand to borrow and speculate or liquidity mining incentives. Since the risk-free interest rate is so high, many DeFi protocols have adopted an RWA strategy to invest in short-term U.S. Treasuries, such as MakerDAO and Frax Finance. Beyond DeFi-native stablecoin providers, this report will explore U.S. Treasury products offered by traditional asset managers like Franklin Templeton & WisdomTree plus protocols such as Ondo Finance, Backed & Maple Finance. But before we do that, we need to outline what are real world assets (RWAs), the functioning of the U.S. Treasuries market and the benefits of tokenisation for RWAs.