As banks slash interest rates, Decentralized Finance (DeFi) is increasingly becoming a favorite for savers. Emerging as a game-changer, DeFi protocols may enable stablecoin holders to make profits in more ways than just speculating.
At the same time, despite noteworthy improvements, the financial systems have major shortcomings: lack of universal access to financial services to a significant portion of the globe, inefficient cross-border transactions and lack of interoperability with blockchain protocols. This hinders stablecoin holders from earning interests from tokenized assets around the world.
Thanks to distributed ledger technology, legacy finance entities, and stablecoins can provide speed and convenience in accessing and settling payments in the global market. As well, stablecoin-holders can now earn interest via tokenized assets from legacy finance.
How can Stablecoin-Holders earn Interest from Legacy Finance?
Stablecoin holders can earn interests from legal finance through securitization and tokenization of assets.
What’s Securitization? Securitization is the process of converting,through financial engineering, an illiquid asset or group of assets into a security.
What’s tokenization? Tokenization is the process of issuing blockchain tokens (particularly, security tokens) that represents, digitally, the value of a tradable asset.
With secularization and tokenization, legacy financial organizations can use Security Tokens (STOs) to create digital representations of their assets. That is legacy finance can offer STOs to represent a share in a company, participation in an investment fund, or a piece of the organization’s assets. Such STOs can be sold in the exchange market as interest-bearing assets.
With tokens being exchanged at a predetermined ratio to popular stablecoins, stablecoin-holders can acquire STOs and earn interest, therein.
What challenges affect stablecoins’ ability to earn interest from legacy Finance?
Despite the opportunities, stablecoins and DeFi protocols have the potential to introduce a host of challenges and risks from an oversight, regulatory and public policy perspective.
Fundamentally, stablecoins and DeFi protocols are not similar. Thus, the opportunities and risks they introduce are dependent on the structure and design underlying each arrangement.
#1. Fair competition in financial markets
Regarding fair competition in financial markets, Global Stable Coins (GSC) arrangements have the potential to promote market concentration thus go against competition and antitrust policies. Due to strong networks that spur their adoption, GSC arrangements can achieve market dominance in a significantly short period.
In the event that GSC systems are built on proprietary systems, they’ll prohibit entry or increase barriers to entry to such systems. This may be the case where enterprises that govern the stablecoin arrangements control the key channels that consumers and businesses use to access a range of services.
Increased barriers of entry may adversely affect interest rates earned by stablecoin holders as GSCs that hold dominance can offer relatively low-interest rates. Conversely, with robust competition frameworks, GSCs will compete by providing better interest rate terms. This will benefit digital transformation while safeguarding consumer trust in the financial system.
#2. Financial stability implications
With GSCs and their ecosystems, fragilities like credit risk, operational risks, and maturity and liquidity mismatches may introduce challenges in earning interest rates for stablecoin holders.
Notably, GSCs whose reference assets include bank deposits can be exposed to liquidity risks and credit risks in the underlying bank. Elaborately, defaults or liquidity problems in a holding bank may limit GSC’s abilities to meet stablecoin and interest redemption requests.
At the same time, GSCs holding a wide range of assets may be exposed to liquidity and market risks associated with those assets and issuers’ credit risk. A fall in the reserve asset’s value, triggered by overall market conditions or by an idiosyncratic change in the fundamental value of the asset, can reduce the value of the GSC. This can adversely affect interests earned by stablecoin holders.
As such, stablecoins holding a wide range of assets should have liquidity arrangements to ensure they have adequate funds to meet redemptions requests. That’s even when stablecoins experienced significant selling pressure.
#3. Legal, regulatory and oversight challenges
A clear and transparent legal framework is a core element of payment, clearing and settlement arrangements. Stablecoins should be underpinned by clear legal guidelines that specify, with certainty and predictability, material aspects of how parties utilize a coin’s underlying technical arrangements.
Stablecoins and their underlying technical and contractual arrangements vary considerably. Their legal regime depends on a stablecoin’s design. Therefore, it is important for stablecoin issuers and holders, and DeFi protocols to be transparent to avoid the following legal, regulatory and oversight issues that may affect stablecoin returns.
#4. Market integrity challenges
With stablecoins, there are fewer opportunities for price manipulation, as they try to reduce price volatility relative to fiat currencies. However, different stablecoins have unique pricing criteria. In some stablecoin arrangements, designated market-makers can have significant market power and the ability to influence stablecoin prices. This introduces the potential for market abuse and possibilities for manipulating stablecoin holders’ returns.
As well, stablecoin issuers can intentionally (or unintentionally) mislead stablecoin holders on critical functions like the management of collateral assets. These forms of manipulation can lead to mispricing and dysfunction in stablecoin markets. Notably, a single party can play the roles of market-maker, trading platform and custodial wallet within a stablecoin ecosystem. As a consequence, market misconduct can have amplified and adverse effects on stablecoin returns.
Can DeFi be the way forward?
There being opportunities and challenges towards stablecoin-holders earning interest from legacy Finance, one major question lingers: Can DeFi or DeFi protocols be the way forward?
Truthfully, the DeFi protocol has the potential to exploit opportunities and remedy challenges associated with stablecoins earning interest rates from traditional financial institutions.
To comprehend how DeFi protocols can enhance the possibility of stablecoins earning interest rates from traditional financial institutions, studying TradeFinex as a possible solution is important.
TradeFinex is a Distributed protocol for sustainable finance that’s built over the XinFin Network XDC Protocol. The decentralized peer to peer global Trade & Infrastructure Finance platform enables special purpose vehicles from Fintechs or banks to Distribute their trade finance assets to stablecoin token holders to generate interest
Powered by XinFin’s enterprise-ready blockchain protocol, the peer-to-peer platform has some important features. They include decentralized platforms, asset tokenization, smart contracting, integrated wallets, regulatory sandbox environments, and global payments and settlements.
How does TradeFinex work?
Leveraging the XinFin’s Hybrid Blockchain technology, TradeFinex automates and streamlines infrastructure project finance.
Through the XDC Protocol, TradeFinex digitizes and tokenizes legacy trade instruments into DLT-token-based smart contracts. These smart contracts are fully regulated under the Abu Dhabi Global Market (ADGM).
As well, Banks and Fintechs, through the TradeFinex network, tokenize the Trade Finance Document after Securitization of the Assets Document and pay Distribution fees in XDC coins.
How can TradeFinex exploit opportunities offered by stablecoins?
TradeFinex can enhance financial inclusion through its globally-acceptable and accessible peer-to-peer payment system. Specifically, through XinFin’s XDC fueled tokenization scheme, the TradeFinex system can facilitate global trade and financing by eliminating the funding gap associated with disparate currencies around the world.
With XinFin’s common world token, Tradefinex can allow 1.7 billion adults on the globe who don’t have access to transaction accounts to access lending. That’s because investors or banks in developed economies, through XinFin’s XDC fueled tokenization scheme, have a way to overcome currency depreciation risks for any cross border investment or debt.
The TradeFinex platform offers real-time cross border payments and settlements via the XDC network. At the same time, the TradeFinex platform gives users incentives to form
XDC tokens for commerce. These features enable TradeFinex to exploit opportunities associated with stablecoins. Some of the opportunities include transferring funds via DLTs, providing more liquidity to markets, and reducing credit risk during cross-border transfers.
How does Tradefinex solve challenges that affect stablecoins’ ability to earn interest from Legacy Finance?
Regulated under the ADGM, Tradefinex overcomes challenges posed by stablecoins’ inadequacies and their implications on returns from Legacy Finance institutions.
With the UAE’s antitrust and competition laws, the focus is placed on a number of features. These include curbing monopolistic business practices, restricting economic concentration that may affect competition, and prohibiting restrictive agreements and practices that may enable firms to exploit their dominant position.
As a consequence, UAE’s antitrust and competition laws ensure that TradeFinex offers interest rates that are devoid of manipulation or that exploit their dominance in the market. This benefits digital transformation while safeguarding consumer trust in the financial system.
TradeFinex’s operations using stablecoins are regulated under the ADGM’s Financial Services and Markets Regulations 2015 (FSMR). As such, TradeFinex’s operations are licensed and regulated as Providing Money Services. Thus, digitization and tokenization of legacy trade instruments into token-based smart contracts are regulated under the FSMR to avert malpractices. This guarantees stablecoin holders suitable returns.
As well, under its crypto-asset framework, the Financial Services Regulatory Authority (FSRA) regulates TradeFinex businesses. That is all services that relate to crypto-asset exchanges, intermediaries and custodians.
With ADGM’s robust framework, the full range of risks associated with Tradefinex activities is checked. To the stablecoin holder, this means Tradefinex is adequately regulated to reduce risks associated with Legal, regulatory and oversight challenges.
How can different stakeholders participate?
#1.Stable coin holders
Stablecoin holders can participate in two ways: set up their nodes or join the TradeFinex network through their regulated custodian exchanges.
With pilot transactions set to begin in the first quarter of 2020, Tradefinex expects to start distribution with USD 100 Million in Tokenized trade Instruments. This value will later be scaled to the billions.
Notably, cryptocurrencies provide an alternative investment class. But, the legacy finance world hasn’t actively connected to crypto-asset holders. TradeFinex network, however, bridges this gap. Specifically, through TradeFinex’s open API platform that’s compatible with legacy systems and ISO20022, users can tokenize trade finance assets or securitize assets to alternative asset investors.
Through the XDC token that’s paired against major cryptocurrencies, stablecoin holders can invest in tokenized trade finance assets or securitized assets. This would enable stablecoin holders to earn interest from previously unreachable legacy finance entities around the globe.
As well, the XDC token can be traded with the Ethereum token called XDCE at a ratio of 1:1. This gives token holders the flexibility to hold tokens in either form for utility. At the same time, XDC can be swapped with the ERC-20 at a ratio of 1:1. This swap can be facilitated on the AlphaEx exchange, which is compatible with all decentralized exchanges and is present in liquidity markets. This would ensure coins holders can redeem their holdings without challenges.
#2. Regulated Digital/Crypto Asset Exchanges
Regulated digital or crypto-asset exchanges, through the Tradefinex network, can participate by offering interest-earning options for their users. Through the XDC protocol,crypto-asset exchanges can allow their users to trade in a variety of assets, thus earning some returns.
#3. Blockchain Platforms/Networks
Existing blockchain networks can easily interoperate with XDC Chains. Through atomic swaps, different blockchain-token holders can access trade finance assets. These would permit such holders to invest in trade finance assets.
#4. Regulated Digital/Crypto Asset Custodians
Through the Tradefinex network, Regulated Digital/Crypto Asset Custodians can offer interest-earning assets to their users. Specifically, through XinFin’s XDC trading pairs crypto-asset custodians can permit users to invest in a variety of previously unreached and interest-bearing assets.
5. Fintech Originators
With the TradeFinex network, Non-Bank Loan Asset originators or Trade Securitization SPVs can connect to TradeFinex Network via the XDC Protocol. This permits Fintech originators to securitize their assets and distribute them to alternative asset funders in the peer to peer TradeFinex Network.
Banks can participate by distributing their Trade finance assets or securitizing their assets to alternative asset investors through digital/tokenization routes. This ensures banks Tokenize and Trade Cross border Trade Finance assets ensuring greater and highly-competitive liquidity
#7. DeFi Protocols
Notably, DeFi protocols can code on XinFin [XDC] Network and generate interest on their stablecoins.
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