The Lifeblood of DeFi: Commodity-backed Stablecoins

Overview

In this 3rd blog in our series covering the basics of stablecoins, we introduce commodity-backed stablecoins by briefly looking at a couple of specific examples. The first wave of commodity-backed stablecoins are digital representations of traditional commodities that live on blockchains. Tokenized precious metals, such as gold and silver, are good examples of physical assets represented on-chain. Another example of a commonplace asset is real estate. An individual can participate in home mortgage loan lending since the tax lien can be separated from the financial lending and repayment aspect. Both of these examples will be explored in this article.

If you are unfamiliar with what a stablecoin is or want a refresher, start with the first article in this series that provides a basic overview.

If you are curious about how the most popular stablecoins are backed, then jump to the second article in the series on fiat-backed stablecoins.

Commodity-backed Non-fiat Stablecoins

Precious Metal Stablecoin

Commodity-backed stablecoins combine a focused investment vehicle with the transactional efficiency supported by blockchain technology. For example, PAX Gold (PAXG) is a gold-backed stablecoin that has a physical, 400-ounce gold bar stored in a vault for each PAXG token that is issued on the ERC-20 blockchain. There are numerous benefits to investors with the most obvious being ease of purchase/sell, ease of transferability, and divisibility that are inherent to the digitization and storage of assets on a blockchain. Other advantages relative to alternative methods of investing in gold are captured by Paxos in the table below.

As blockchain technologies continue to evolve, other assets outside of traditional commodities are beginning to be put on blockchains, which allows retail investors to participate in asset classes historically accessible only to banks and institutions. One example is home mortgage lending.

Mortgage-backed Stablecoin

Another interesting example of an commodity-backed stablecoin is Bacon Protocol’s bHome token which is backed by home mortgages. The bHome token is purchased with USDC, and the USDC is added to a pool of funds that are lent to homeowners seeking a loan. Then, using an NFT that represents a lien against their home, a homeowner deposits the NFT into a smart contract which allows the borrower to withdraw USDC from the lending pool. Details of the home and the loan amount are part of the NFT’s attributes and can be transparently verified by inspecting the blockchain. This allows an investor (lender) to view the collateral used by the borrower, the repayment amount and other terms of the loan captured by the NFT.

Traditionally, banks fund home loan issuance by rehypothecating cash received from retail deposits. Then the bank receives the bulk of loan interest payments from the borrower, leaving the retail depositor with a small slice of the revenue generated from their initial deposit. Using the power of a blockchain, holders of the bHome coin collect the interest payment, and pay a small fee to the protocol and human loan origination team that files liens with the county. Technically, the payments are received by the smart contract but those are flowed back to the token holder when they redeem their bHome token for USDC.

Wrapup

As blockchain development continues, there will be a huge range of stablecoins backed by physical assets that will live on on-chain, and this evolution will allow retail investors to participate in asset classes historically guarded by banks and institutional investment firms. Additionally, efficiencies will be gained by removing human intermediaries which should result in higher returns to the investor and/or lower costs within the financial ecosystem. When assessing an commodity-backed stablecoin, the quality of the underlying reserve asset should be assessed to determine investment risk.

Our 4-part blog series on stablecoins includes:

Lifeblood of DeFi: Stablecoin Overview

Lifeblood of DeFi: Fiat-backed Stablecoins

Lifeblood of DeFi: Commodity-backed Stablecoins

Lifeblood of DeFi: Algorithmic Stablecoins (coming soon)