Finance for most real-world assets (RWAs) has been limited to large businesses that get direct access to liquid capital markets. Many businesses depend solely on banks for their capital needs which involves a siloed process to apply for financing. The core vision for decentralized finance (DeFi) is to open up finance that is free of intermediaries and easily accessible to all. DeFi that has a real-world impact makes financing available to businesses regardless of geographical location and social status, it is a financial system without any barriers to entry. Centrifuge provides the first openly accessible, end-to-end solution to enable real-world assets to gain access to financing.
What is Centrifuge?
Centrifuge is a proof-of-stake blockchain built on Kusama, a Polkadot parachain, which enables users to bring RWAs on-chain as privacy-preserving non-fungible tokens (NFTs) to unlock financing for any type of assets using DeFi. Centrifuge aims to democratize access to capital for small and medium enterprises (SMEs) and provide investors with new opportunities to earn safe, stable yields on their stablecoins.
The Centrifuge chain has been built using Substrate and is going to be home to their decentralized application (dApp) which hosts their smart-contract marketplace, Tinlake. This is a marketplace for tokenized real-world assets which connects investors and asset originators to provide bankless liquidity. Centrifuge is building scalable infrastructure to bring RWAs on-chain, and make DeFi the defacto way to access capital for businesses around the world.
What is the use-case for Centrifuge?
The total value locked (TVL) in DeFi has risen from $700 million in December of 2019 to a peak of ~$200 billion in 2022. TVL growth has been driven by investors locking up their on-chain assets. The RWA market, which encompasses real estate, corporate bonds, and all physical assets, is valued in excess of $200 trillion. Centrifuge aims to bridge the gap by turning DeFi into the best infrastructure to borrow and lend money against these assets. Centrifuge has taken an asset-agnostic approach to allow users to bridge endless forms of RWAs to the world of DeFi. The tokenized RWAs can be used in the broader DeFi economy to unlock liquidity for asset originators.
Most DeFi protocols have existed within their own bubble with little to no cross-over with RWAs. The addition of RWAs to the already booming DeFi economy could be a catalyst for new innovations of DeFi activity that is not tethered to intangible assets, but rather to the real world.
How does Centrifuge work?
Centrifuge has built a dApp called Tinlake, which is a smart-contract-based financing platform that connects businesses seeking financing and investors willing to provide liquidity for financing. It has been built on Ethereum and acts as a marketplace that offers various ‘pools’ with different options for investors.
By way of a simple example: a real estate company may be looking to expand its operations and are in need of financing. They would have assets (real estate) which can be used as collateral. These assets can be tokenized using privacy enabled NFTs which represent the assets on-chain. These tokenized assets will now form part of an asset pool that is collateralized by the RWAs on the Tinlake dApp, investors can now choose from these various pools and provide liquidity and in return earn a yield for doing so.
Tinlake has four key entities that take part in the marketplace to make it all possible:
- Issuers are special purpose vehicles (SPVs) that “hold” the RWAs and act as the legal manager of that pool, they draw the financing from Tinlake and issue the TIN/DROP tokens to investors.
- Asset originators are entities that are looking for financing. The asset originators pledge their RWAs (Real estate, invoices, or royalties) to the issuers in return for financing. These RWAs act as collateral in the form of tokenized NFTs that can be seen on-chain and vetted by the issuers
- Tinlake investors provide the liquidity that gets lent out to issuers. They earn a yield on their investment and earn further Centrifuge token (CFG) rewards. At present, there are two investment tranches that Tinlake investors can choose from; namely TIN and DROP. This refers to a Junior/Senior investment structure that is commonly seen in traditional finance.
- DeFi protocols such as Maker and AAVE act as a deep source of liquidity through direct integrations. Users of these De-fi protocols can have direct access to different pools that Tinlake has to offer.
Once the asset pool has been created and is collateralized with the tokenized RWA NFTs, issuers will issue two kinds of ERC-20 tokens: Drop and TIN tokens
DROP and TIN tokens explained
Centrifuge uses a tiered investment structure with two tranches in a pool. A junior and senior tranche that offers investors different risk profiles. The junior tranche offers a higher return but assumes more default risk while the senior tranche offers a lower return with less risk. The TIN token represents the junior tranche and the DROP token represents the senior tranche.
- The riskier, first-loss token
- Earn a Variable yield + CFG rewards
- Tin token only gets a return on their investment if DROP token holders have all been fully redeemed
- More ‘stable’ token
- Fixed interest + CFG rewards
To participate in the pool, investors need to purchase one of these tokens by going through a whitelist process on the Tinlake platform. Centrifuge uses a Securitize integration to verify investors’ accreditation status. Once investors have been approved, they can lock their DAI into the pool in exchange for TIN or DROP tokens.
Revolving pools – How does this work?
Tinlake pools are structured as open-ended pools where investors have the option to join or leave at any time. To redeem their investments, investors lock their TIN/DROP tokens into the dApp and collect DAI corresponding to the current price of the tokens.
Centrifuge has developed a solver mechanism that matches redemptions and investments to ensure a pool’s risk metrics remain in place to ensure that asset originators have a consistent source of liquidity while investors can have the freedom of investing and redeeming at their will.
Integrations with Maker DAO and AAVE
Centrifuge has integrated with AAVE and MakerDAO to create new pools and bring more liquidity to asset originators on Tinlake. These integrations enable investors to use USDC or DAI and diversify their portfolios by earning yield against stable, uncorrelated RWAs. AAVE and Maker are two of the largest DeFi protocols in crypto and bring credibility, huge amounts of liquidity, and ease of access to asset originators that are looking for financing. Businesses now have access to new credit facilities that operate 24/7, run on open-source smart contracts with no intermediaries, and provide near-instant liquidity with low costs of capital.
The integration with Maker has brought further benefits to the MakerDAO ecosystem by diversifying the collateral that backs DAI. Maker has a formal target of 33% RWA reserve backing for its DAI currency (it’s currently ~.5%), to diversify its reserve away from crypto-assets and boost protocol reserve income.
The ETH/DOT relationship
Centrifuge is already bridged to Ethereum, so users can already access the deep liquidity in the largest DeFi ecosystem in the world. Centrifuge Chain supports the ChainSafe Bridge Pallet which enables users to securely move assets between Centrifuge Chain and Ethereum. It is a bi-directional blockchain bridge to allow data and value transfer between both chains. Once the Centrifuge parachain is live, Tinlake will launch on the Centrifuge chain with asset pools running natively and benefitting from the liquidity in the Ethereum and Polkadot DeFi ecosystems.
The Centrifuge Chain – Why is this needed?
Scalability and the ability to focus on the business logic of their product by leveraging the capabilities of Substrate. The architecture of Substrate allows a project like Centrifuge to draw on common features and resources in the Polkadot ecosystem to move faster and implement new upgrades securely and efficiently. The key benefits are:
- Speed – Optimizing for financial supply chain-specific use cases allows for faster execution of logic and safety of transactions. With Substrate, Centrifuge can customize low-level protocol logic to ensure speed.
- Affordable transactions – Centrifuge used Substrate to build a chain optimized for fast, affordable transactions. They opted for Substrate’s proof-of-stake consensus to further reduce transaction costs.
- Storage – A “state rent” model that requires users to pay for continuous availability of their data encourages decentralization because fewer resources are required to run a node. Substrate allows developers to create cutting-edge storage optimizations.
- User/Developer Experience – Building a custom Substrate chain enables rapid improvements for the user and developer experience for Centrifuge. Users require privacy, and this is something Substrate allows Centrifuge to build for directly — targeting the features they need from the start.
Centrifuge recently secured its position as a parachain on Polkadot and is looking to grow DeFi on the network through partnerships with Moonbeam, Acala, and Parallel Finance. Interoperability is at the core of Polkadot and opens new avenues for liquidity to flow in an ecosystem. Centrifuge aims to leverage this seamless flow of liquidity through integrations with other parachains.
The drawbacks of Tinlake
Tinlake currently runs as an Ethereum dApp, if you’ve ever executed complex smart-contracts on Ethereum you would know that they can cost a penny or two. This is a huge disincentive for ordinary users to interact with the dApp and invest in the pools on Maker or AAVE. The decision to build on Ethereum at inception made sense for the team because, at the time, Ethereum was the de-facto DeFi chain and in many regards still is. However, the team recognizes that they cannot achieve the vision of bridging trillions of dollars to DeFi using Ethereum in its current state.
The current state of Centrifuge pools
Tinlake currently has 12 pools available for investors to choose from with a TVL of $85 million. The APY for the DROP tokens in these various pools ranges from 0.59% to 10.63%. TVL has grown consistently since its inception and is set to increase as different RWAs are incorporated onto the platform. As DeFi matures and its adoption grows, these marketplaces could become highly liquid with billions of dollars in assets locked on the protocol.
The TVL and total revenue (from fees) have been consistently growing since inception and can be expected to increase as more pools are created.
The majority of TVL in Tinlake comes from the New Silver 2 pool which is financing a portfolio of real estate bridge loans. This has caused some concentration risk in the pools but will be diminished as more pools are created and different forms of RWAs are used as collateral.
Centrifuge generates revenue by originating new fixed-income securities. Whenever a new loan is financed from the pool, the protocol takes 30bps of fees. This fee is taken in DAI which is then converted into CFG on the open market, a portion of the new CFG tokens is then burned and the remainder goes to the CFG Treasury, which is controlled through governance by all CFG holders. Protocol revenue is equal to the interest paid by asset originators. Tinlake’s monthly revenue has been growing over time as more pools get added to the protocol.
The investment case for Centrifuge – The CFG token
The CFG token powers the Centrifuge chain and was created to incentivize users to use Tinlake pools, take part in on-chain governance, pay for transaction fees, and to support chain security via staking. Despite the consistent growth in TVL and revenue, CFG is currently trading at $0.28 which is below its ICO price of $0.55. There are currently over 41 000 wallets that hold CFG and this number continues to grow as more people interact with and use the Tinlake dApp. Centrifuge incentivizes adoption and usage of the Tinlake dApp by offering CFG rewards to investors who provide liquidity, this has however created some selling pressure on the token as most tokens just get sold off once people receive them.
A critique from community members has been that there is not much utility for token holders which is what ends up causing token holders to sell. The team has suggested new ways to add value and utility to the token and to reward community members:
- Origination fees: Charging borrowers protocol fees whenever new pools are created that will go into the on-chain treasury and be shared with token holders
- Staking to launch pools: Token holders can signal trustworthy pools by staking to them, this stake can serve as pool insurance in the case of defaults, but also earn part of the transaction fees of the pool it insures
- Rewards to incentivize users of the protocol: Offering community rewards
While the TVL and fundamentals of Centrifuge continue to grow, the market capitalization of CFG keeps dropping. While this is normal during market downturns, with new utility coming to the token and the awareness of the potential of RWAs in DeFi grows and becomes more accessible to investors, CFG could be a good token to pick up in the bear market if you are bullish on the prospects of the protocol.
There is a total supply of 425,000,000 CFG, which is allocated to different stakeholders as shown below. The total supply increases by 3% per annum (~12M CFG) to cover POS block rewards, DOT parachain rewards, and liquidity rewards. A portion of the transaction fees on the network get burned, as network growth slows in the long-term, the burning mechanism will eventually serve to balance the total token supply over time.
Token Vesting/unlock schedule
The core contributors’ allocation is 27% of the total supply, these tokens have a 48-month lockup with a 12-month cliff. These tokens have started being unlocked in July 2021 and will continue vesting until the start of Q3 in 2023. In addition, the ‘total backers’ allocation makes up 17.1% of the total supply and started vesting in July 2021 with a 48-month lockup. Moreover, a total of 15% of the CFG supply was allocated to bid for a parachain slot on Polkadot, 3% of this was unlocked immediately whilst the rest will vest linearly over a 96-week period.
The private sale (9.5%) is also vesting over a 2-year period, which started in July 2021 and will end in July 2023. The foundation, rewards, grants, and ecosystem tokens are also vesting at an increased rate until Q4 of 2022 when it slows down quite significantly.
It is important to take note of these token unlocks as they are likely to cause significant selling pressure on the price of CFG in the foreseeable future. It may be best to relook at entering CFG towards the end of 2022 once the token unlocks slow down.
DeFi needs to tap into the multi-trillion dollar opportunity that is RWAs and Centrifuge is leading the way in making this a reality. The innovative solution that Centrifuge has built is fulfilling the services of traditional finance in a permissionless, global and transparent way. The ability to tokenize assets through privacy-enabled NFTs creates something unique in DeFi and opens the doors for RWAs to unlock new liquidity. Centrifuge has made significant progress in bringing RWAs on-chain but will need to improve the KYC user experience, adapt to changing regulations in different jurisdictions and comply with the looming crackdown on stablecoins.