The Paradox of RWA: Why is "Semi-Chain" Doomed to Failure?
Author: long_solitude
Compiler: Daisy, Mars Finance
Does Crypto Tokenize Traditional Finance, or Does Traditional Finance Modernize Cryptocurrency?
The financial industry has been undergoing a transformation of its business model. For decades, we've seen the rise of alternative investments such as private equity, venture capital, and especially private credit. Private credit has become one of the fastest-growing sectors in the financial sector.
M&A star Ken Moelis recently lamented the decline of M&A bankers. Nowadays, alternative hybrid financing structures are more profitable than buying and selling companies.
For crypto-focused investors like us, alternative financing can fully encompass tokenized elements of on-chain structured products and capital structures. But it would be a big shame if this opportunity was eventually seized by unemployed M&A bankers instead of profitable crypto project founders.
To date, the only products that cryptocurrencies have really been accepted by the traditional financial system are stablecoins and Bitcoin. DeFi (decentralized finance) has not really taken off outside of the crypto space, and its performance is still highly tied to trading volume.
One of the ways forward is to build a fully on-chain capital structure (debt, equity, and tokenized assets in between) from the bottom up. Traditional finance loves income and structured products. Although many of us have been rewarded a thousand times in the past due to hype concepts, the future development of institutionalized on-chain finance will require us to adapt to new challenges.
We used to dismiss it
For too long, we have had a lack of interest in real world assets (RWAs). In the past, we saw it as an outdated idea of "skeuomorphism" – nothing more than a digital shell of existing off-chain assets that are still subject to a traditional judicial system that is very different from "code is law". But now, we're taking a fresh look at this seemingly unimaginative but extremely practical opportunity.
Limitations of on-chain private credit
Tokenizing private credit on-chain essentially simply opens up new financing channels for borrowers. Platforms like Maple Finance really drive this process. But in the event of a capital impairment or default, lenders can only rely solely on the existing judicial system (and platform teams such as Maple) to recover funds. To make matters worse, such debt is often issued in emerging or frontier markets where the rule of law is weak. As such, it is by no means the perfect solution advocated by its proponents (see our earlier analysis for more context).
Adverse selection dilemma
Even more alarming is the issue of adverse selection. On-chain private credit for retail crypto investors is often of poor asset quality. Those opportunities with the best risk-adjusted returns will always be monopolized by giants such as Apollo and Blackstone, and will not flow into the blockchain market at all.
The unique advantages of on-chain native business
Thankfully, there are a number of on-chain native businesses that traditional institutions have not yet set foot in (but have achieved profitability). These projects now need to be bold and innovative in their financing methods based on their on-chain revenue-generating characteristics.
As for the tokenization of US bonds? It's just a trick to add yield to DeFi strategies, or a shortcut for crypto-native users to circumvent fiat deposit and withdrawal restrictions to diversify their assets, and its substantive significance is quite limited.
The exploration and dilemma of on-chain native debt
There have been several attempts in history to issue pure on-chain debt (such as Bond Protocol and Debt DAO) secured by project tokens or future cash flows. But in the end, it didn't work, and the exact reason for this is not yet fully understood. There are several explanations:
1. Capital and user depletion in a bear market
At that time, very few projects could generate substantial revenue, and the market was severely illiquid
2. The capital-light nature of DeFi
One of the industry's most appealing traits is the ability to run multi-billion-dollar agreements with lean teams with near-zero marginal expansion costs
3. Alternative advantages of token OTC
Selling tokens over-the-counter to specific investors not only provides financing, but also social credit and status endorsement – resources that can then be translated into TVL (total lock-up) growth and price increases
4. The crushing advantage of the incentive mechanism
Compared with fancy incentives such as liquidity mining and point rewards, bond products are not competitive in terms of yield
5. Regulatory fog of debt instruments
The regulations have not been clearly defined
For these reasons, DeFi founders have been lacking the incentive to explore alternative funding channels.
Programmable Income & Embedded Finance
We firmly believe that on-chain enterprises should enjoy a lower cost of capital than traditional enterprises. By "enterprise" we mean DeFi-related projects in particular—after all, this is the only sector in the crypto space that actually generates revenue. The basis for this capital cost advantage is that all revenue is generated on-chain and is fully programmable. These programs are able to directly link future income to credit obligations.
The debt dilemma of traditional finance
In the traditional financial system, debt instruments often have covenants that bind a specific level of leverage to a company. Once the default clause is triggered, the creditor has the right to commence proceedings to take over the assets of the business. The problem is that creditors not only have to estimate the performance of the company's revenue, but also need to monitor costs at all times – because it is precisely the two variables that affect the terms and conditions that affect the terms and conditions.
A structural breakthrough in on-chain credit
Based on programmable income, on-chain credit investors can completely bypass the cost structure of the enterprise and lend directly against income. This means that businesses are able to access funding at a much lower interest rate than equity financing (based on PNL statements). Projects like Phantom, Jito, or Jupiter should have been able to secure hundreds of millions of dollars in funding from large institutional investors as collateral for their on-chain revenue.
Flexible settings through smart contracts:
- When project revenues shrink, the proportion allocated to creditors is automatically increased (reducing the risk of default)
- When the income grows rapidly, the corresponding proportion is dynamically adjusted (maintaining the agreed credit term)
This embedded financial architecture is redefining the way capital and value flow.
Practical exploration of on-chain revenue financialization
In the case of pump.fun, if it raises US$1 billion from a pension fund, the pension fund can take over the smart contract until the debt is paid off when the SGD binding rate drops (as has happened in the recent past). Although the feasibility of such radical measures is debatable, this direction is worth exploring.
Advanced applications of on-chain revenue
On-chain revenue not only fulfills the underlying credit obligations, but also enables:
- Automatic Settlement of Claims of Different Seniority in Capital Structure (Subordinated and Senior)
- Conditionally triggered repayment mechanism
- Debt auctions and refinancing
- Tranche and securitize revenue by business type
Limitations of Token Financing
Such income securitization should be a more economical financing option than selling tokens over-the-counter at a discount to hedge funds, which tend to hedge or sell at opportunistic times. Project revenue can be generated continuously, while the token supply is limited. While token sales are convenient, they are by no means sustainable for projects that aim to grow in the long term. We encourage teams that dare to be known to break new paradigms in funding, rather than sticking to the rules.
A frame of reference for traditional e-commerce
The above model is known as "merchant cash advance" or "factor rate loan" in traditional e-commerce. Payment processors such as Stripe and Shopify provide working capital to the merchants they serve through their own investment vehicles. The effective interest rate on these loans is often as high as 50-100% or more, and there is a lack of price discovery mechanisms – the merchant is firmly tied to the payment system as the price taker.
A breakthrough in on-chain embedded finance
This embedded (in-app) funding model will shine on-chain:
- Programmable payments support conditional payments, real-time money flow
- Implement more complex payment strategies (e.g., targeted customer discounts)
- Stripe, through merchant reach and the Bridge acquisition, is pioneering this algorithm-first model
- Promote the adoption of stablecoins between merchants and consumers
But the key question is: can this model open up to permissionless capital and promote competition? Payment companies are unlikely to drop their moats and allow outside institutions to lend to their merchants. This may be the entrepreneurial opportunity for on-chain native crypto commerce and permissionless capital solutions.
Weighted voting rights
If the company's equity value is derived entirely from on-chain revenue (i.e., there is no other source of revenue), then equity tokenization is the inevitable choice. In the initial stage, it may not be in the form of standard equity, but can adopt a hybrid structure between debt and equity.
Recently, Backed.fi launched a tokenized Coinbase stock to attract attention. The scheme holds the underlying shares through a Swiss custodian and can provide cash redemptions for users who have completed KYC. The token itself is an ERC-20 standard and enjoys the composability benefits of DeFi. However, this type of design only benefits secondary market participants, and Coinbase does not reap substantial benefits as an issuer – neither on-chain financing through the tool nor innovative use of equity instruments.
While equity tokenization (and other assets) has become a hot concept lately, the truly exciting case has yet to emerge. We expect this type of innovation to be driven by platforms that have a wide range of distribution channels and can benefit from blockchain settlements, such as Robinhood.
Another direction of equity tokenization is to build on-chain giants that can obtain near-unlimited financing at a very low cost with on-chain revenue, proving to the traditional market that half-baked solutions will not work - either turn all revenue on-chain into a fully on-chain organization, or remain on the NASDAQ.
In any case, equity tokenization must implement new features or change equity risk characteristics: Can fully tokenized companies reduce their cost of capital due to their real-time on-chain P&L? Can an on-chain oracle verification event trigger a conditional equity offering that changes the current Market Offering (ATM) mechanism? Can employee equity incentives be unlocked based on on-chain milestones rather than time? Can a company charge the full amount of fees incurred for trading its own shares instead of passing it on to the broker?
conclusion
We are always faced with two development paths: top-down and bottom-up. As investors, we're always looking for the latter, but more and more things in the crypto space are being made possible through the former.
Whether it's equity tokenization, credit instruments, or income-based structured products, the core question remains the same: Can new forms of capital formation be unlocked? Is it possible to create incremental functionality for financial instruments? Can these innovations reduce the cost of capital for businesses?
Just as the traditional venture capital sector arbitrages private equity versus public markets (the trend is to remain privatized rather than listed), we predict that the binary opposition between on-chain and off-chain capital will eventually disappear – and there will only be good and bad financial solutions in the future. It is likely that we were misjudged that revenue-linked on-chain credit may not necessarily reduce the cost of capital (and may even be higher), but in any case, a true price discovery mechanism has not yet been formed. To achieve this, we need to go through the maturation process of on-chain capital markets, large-scale financing practices, and the onboarding of new market participants.