Tokenizing Real World Assets the FinNexus Way: Part 3 — What We Do
By: Ryan Tian
Tags: Decentralized, Finance, Tokenization, Blockchain, Protocol

This is part 3 of a 3-part series that outlines the FinNexus way of tokenizing real world assets. Part 1 described the reasons for and necessity of tokenization. Part 2 described the different types of assets that are currently being tokenized. In this Part 3, I will introduce the FinNexus Way of Tokenization. Special thanks to Nicholas Krapels and Noah Maizels for advice on the series.

This post brings to a conclusion my three-part series on tokenization. Previously, I talked about the Why? and the What? in regards to this exciting new process of turning real world assets into digital tokens. In this post, I will discuss the How? FinNexus will have a robust process to select and transform real world assets into digital ones so that they can be easily incorporated into any crypto investment portfolio.

The FinNexus Way of Tokenization

FinNexus is a general protocol suite that aims at providing financial services to cryptocurrency users. Asset owners, service providers, and investors may get connected to public blockchains and to each other through FinNexus in a convenient and efficient manner. By using the FinNexus interface, they will be able to develop and use various digital financial applications, assets, and instruments in different scenarios.

FinNexus endeavors to provide many varieties of products to its platform so that cryptocurrency enthusiasts can properly diversify their digital asset portfolio to better suit their own individual risk/return profile. By incorporating tokenized real world assets within their unique portfolio, blockchain investors can protect themselves from the extreme volatility of Bitcoin and Ethereum that most tokens are highly correlated with.

FinNexus Infrastructure

FinNexus will not be operating the underlying assets of the products by itself. It will be working as an open finance gateway or hub, connecting these assets with FinNexus platform users, as well as various intermediaries and other service providers.

It is this series of connections that gives us the latter half of the FinNexus’ name. The first half, obviously, refers to finance. In Latin, the word nexus means “a binding together.” Together, the term FinNexus means “a binding together of finance.”

When Kain Warwick, founder of Synthetix, discussed the future of DeFi in Ryan Sean Adams’ Bankless newsletter, he mentioned that

“I believe that it will ultimately replace most financial coordination games, or at the very least force them to evolve into a new hybrid form that leverages the best aspects of DeFi and CeFi.”

Boris Yang, my friend, co-founder and CEO of FinNexus, takes a similar stance when he talks about our project:

“Our team is aware of the centralized nature of real world assets, especially in aspects of ownership registration, management, pricing, supervision, etc. Therefore, our tokenization method will be a combination of or balance between centralized and decentralized means.”

In our conception of this issue, we attempt to position FinNexus as a robust middleware layer between various types of financial product providers and the assets themselves, either native to crypto or more traditional in nature. One of the most difficult problems to solve in the digital asset industry is developing a robust mechanism to tie the digital token to its counterpart in the real world. How do you know that the tokens in your crypto wallet actually represent a piece of equity or cash flow in the real world? Well, if that asset was created with the FinNexus protocol suite, we want you to be confident that the bearer of the token is indeed entitled to a piece of the ownership of the asset that that token represents.

FinNexus protocol clusters serve as a flexible mesh fabric between both crypto and traditional assets and those intermediaries wishing to tokenize them into financial products.

Our first product to be released will be the tokenization of consumer loan assets in Southeast Asia. These tokenized products shall serve as an example to demonstrate exactly how FinNexus protocols can be used to convert real world assets with real world cash flows into tokens.

For detailed information about these tokens and their underlying assets, please check the FinNexus website for the offering circular.

In the rest of this post, the process of tokenization in the FinNexus ecosystem is described in detail.

1. Examine the characteristics of the underlying assets/rights.

Each real world asset exhibits a variety of characteristics, particularly in the rights associated with them. Firstly and most importantly, we must analyze the aspects of assets as thoroughly as possible. Due diligence of the industry, region, business model, ownership structure, source of revenue, income distribution structure, counter-parties, and other considerations must be conducted in order to determine whether they are necessary and economically feasible to be tokenized.

The FinNexus team has conducted research of various real world application scenarios. At present, it seems that the most efficient marriage is in the fields of stable coins, credit markets, supply chain financing, real estate, and copyrights.

The underlying asset is targeting the growing credit market in Indonesia. They provide short-term consumer loans to borrowers with a license from the regulatory authority OJK (Otoritas Jasa Keuangan). Their portfolio benefits from the rapid growth of the Indonesian credit market.

Consumer credit in Indonesia is experiencing tremendous growth that shows no signs of stopping its steady increases. In November 2019, the total market was 2,525,754 billion IDR.

The underlying asset for the first FinNexus tokenized product is a package of consumer loans that enjoys steady and frequent cash inflows and outflows. The loan is taken in Indonesian Rupiah (IDR), while the source of funds can be in USD.

The entity running the underlying assets is mainly getting customers from their mobile app as well as an an internet interface. They are benefitting greatly from the rapid growth of the market and the rich internet operating and marketing experience that Cheetah Mobile brings to the table. Loans are given without collateral to individuals in a relatively small amount, with a range from 30 USD to 300 USD.

The credit nature of the business is straightforward and steady, with clear and simple counterparty legal relations. The pool of assets is easily defined, collected and supervised by a centralized entity. The exchange risks between the stable coins transacted during subscription to the product and distribution of that product, as well as the exchange risks of the fiat currencies used in real world operations to support the tokenized products, are limited. The beneficiary rights of the potential investors of the products are clear and can be subdivided into proportions. These qualifications make the credit business a quality source of underlying assets for tokenization.

2. Define the token structure best suited to the underlying assets.

Token models are largely flexible and can be designed into various forms according to the essence of the underlying assets or rights. The technological language of tokens may share some common points in the same categories of assets, but the financial models need to be very detailed and tailored according to the specific application scenarios.

The underlying assets are typical financial credit operations. One party is on the lender side, and a large pool of borrowers make up the other side. The flows of funds are in fiat currencies and in relatively small amounts with high transaction frequency, managed by a legit party while settled in the local banks. Due to the nature of the business, it is clear that centralization cannot be totally removed in the tokenization process.

Also, there is a clear discrepancy between the crypto unit of accounting used in the subscription and distribution phase, and the fiat currencies transacted during the underlying asset operations. In this particular case, the currency exchange is inevitable and can only be done with a centralized entity or mechanism.

Thirdly, the possible forms of tokens can represent common shares, preferred shares, debentures, shares in a pool of designated assets, beneficiary rights of certain future cash flows, or even a stable coin with a deflating nature mirroring the gains from the credit operations. But they all share a clear financial nature.

One of the goals of introducing real world assets to the blockchain is to provide DeFi investors with more choices, to expand the richness of products bearing different levels or characteristics of risks, and to facilitate the effective diversification of investments. Therefore, the FinNexus way of tokenization mainly considers the following aspects:

the needs and requirements of the asset owner; whether the risks and returns of the underlying assets or rights can be effectively transferred into the token model while limiting the risks correlated with traditional cryptocurrencies; that tokens be as decentralized as they can be while minimizing the risks from centralization, whether it should be a relatively low-risk model with fixed expected returns, or a high-risk model with undetermined returns; to consider the acceptability of the token model from the combination of perspectives both from our traditional finance experience and typical investor behavior in the crypto ecosystem; to make full disclosure of the asset owners, underlying assets and risks.

With the considerations above, FinNexus plans to package the UM assets into a hierarchical model with tokens representing the beneficiary rights in different risk and return tranches.

3. Ensure a smooth tokenization process.

After we have clarified the token definition in the models, the tokenization process will combine the efforts of the FinNexus product team and the technical team. Our goal is to carefully minimize the risks related to the centralized nature of the real world underlying assets and make proper information disclosure to investors.

Similarly, we take the UM asset as an example.

The risks and returns embedded in the underlying assets are oriented from the credit activities, regarding which, we already have some mature models of financial instruments in traditional finance that our token models may learn from. The overall model will be a kind of asset-backed token, representing the beneficiary rights of future cash flows. A predetermined and clear expected rate of return will be easier to demonstrate and better accepted by the DeFi investors nowadays. The pool of assets will be collected with the targeted subscription amount, and the cash inflow from the pool will continue to invest into the credit assets in the duration with predetermined qualifications, which we call the cyclical purchasing procedure, in order to keep the funds actively earning in the best interest of the investors.

Also, to increase the credit enhancement for the investors, the token model applies a hierarchical structure, which makes the tokens into two tranches, naming the senior and equity tranches, representing tokens with different risks and expected returns. Subordinate (equity tranche) investors provide credit enhancement for senior investors based on the priority of repayment of various levels of principal and interest arranged by the project. Moreover, external credit enhancement measures, as deficiency payment commitment and other guarantees will provide additional protection to the senior tranche token holders.

The basic transaction structure for UM-series products

FinNexus will create the tokens and act as the underwriter, financial advisor and supervisor, as well as the transaction platform. Technically, the first phase of products is planning to be issued on the Wanchain mainnet, but future phases have the potential to be more flexible, with full functionality to interact with others. According to our roadmap 2020, future tokenized products will be built on Wanchain and the XRP Ledger this year. We also aim to utilize these networks and more to create a Protocol Cluster for Assets Payments (PCAP) that would connect different digital currencies including WAN, XRP and others.

Also, during our first phase of tokenized product issuance, FinNexus proposes an innovative way of token issuance, called ICTO, which grants investors conversion rights during a certain time period. Investors may either hold their FNX tokens to participate in the future development of the platform or convert to an asset-backed token, called UM1S, to enjoy a fixed rate of return from this FinNexus product.

Our Path Forward

We’re incredibly excited to use these assets as an example to show how we are Tokenizing Real World Assets the FinNexus Way. If you’ve read this far into our three part series, thank you for your interest and please contact us at our socials below! In the future, the FinNexus team endeavors to look for all types of tokenizable real world assets all around the globe that can positively contribute to the long-term health of the DeFi ecosystem.

Stay tuned.

About FinNexus

FinNexus is the open finance protocol built on the Wanchain blockchain. It is a hub for connecting different decentralized ledgers to each other and users, and also for connecting with traditional finance applications. The first iteration of FinNexus will be a marketplace for hybrid decentralized/traditional financial products.

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