Author: long_solitude

Translation: Daisy, Mars Finance

Will Cryptocurrency Tokenize Traditional Finance, or Will Traditional Finance Normalize Cryptocurrency?

The financial industry has been undergoing a transformation in its business models. For decades, we have witnessed 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 finance.

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 investors like us who focus on cryptocurrency, alternative financing can certainly include on-chain structured products and tokenized elements of capital structure. However, it would be a great pity if this opportunity is ultimately seized by unemployed M&A bankers rather than the founders of unprofitable crypto projects.

So far, the only products that have truly been accepted by the traditional financial system are stablecoins and Bitcoin. DeFi (decentralized finance) has yet to really take off outside the crypto space, and its performance remains highly tied to trading volume.

One potential direction for future development is a bottom-up approach, building a fully on-chain capital structure (debt, equity, and tokenized assets in between). Traditional finance loves yield and structured products. While many of us have previously achieved thousand-fold returns from speculative concepts, the future development of institutional on-chain finance will require us to adapt to new challenges.

We Once Looked Down on This

For a long time, we have been indifferent to Real World Assets (RWA). In the past, we viewed them as a form of "reification" — merely giving existing off-chain assets a digital shell, while these assets remained subject to a traditional judicial system that is fundamentally different from "code is law." But now, we are re-examining this seemingly unimaginative yet highly practical opportunity.

Limitations of On-Chain Private Credit

Tokenizing private credit on-chain essentially just opens up new financing channels for borrowers. Platforms like Maple Finance have indeed pushed this process forward. However, once capital impairment or default occurs, lenders can only rely entirely on the existing judicial system (and platform teams like Maple) to recover funds. More troubling is that such debt is often issued in emerging or frontier markets with weak rule of law. Therefore, it is by no means the perfect solution that its advocates claim (for more background, please refer to our earlier analysis).

Adverse Selection Dilemma

More concerning is the issue of adverse selection. On-chain private credit aimed at crypto retail investors often has questionable asset quality. The best risk-adjusted opportunities will always be monopolized by giants like Apollo and Blackstone, and will never flow into the blockchain market.

Unique Advantages of On-Chain Native Businesses

Fortunately, there are indeed a number of traditional institutions that have not yet entered (but are already profitable) on-chain native businesses. These projects now need to boldly innovate their financing methods based on their on-chain revenue characteristics.

As for the tokenization of U.S. Treasury bonds? It is merely a trick to add yield seasoning to DeFi strategies or a shortcut for crypto-native users to diversify their assets while avoiding fiat deposit and withdrawal restrictions, with limited substantive significance.

Exploration and Dilemmas of On-Chain Native Debt

Historically, there have been several attempts to issue purely on-chain debt (such as Bond Protocol and Debt DAO), with these debts secured by project tokens or future cash flows. However, none have ultimately succeeded, and we have yet to fully clarify the specific reasons. Currently, the following explanations exist:

1. Capital and User Exhaustion in Bear Markets

At that time, very few projects could generate substantial revenue, and market liquidity was severely lacking.

2. The Light Capital Nature of DeFi

One of the most attractive characteristics of this industry is its ability to operate protocols worth hundreds of millions with streamlined teams, with marginal expansion costs nearly zero.

3. The Alternative Advantage of Token OTC

Selling tokens over-the-counter to specific investors not only raises funds but also garners social credit and status endorsement — these resources can then be converted into TVL (Total Value Locked) growth and price appreciation.

4. The Crushing Advantage of Incentive Mechanisms

Compared to liquidity mining, point rewards, and other fancy incentives, bond products have no competitive edge in terms of yield.

5. The Regulatory Fog Surrounding Debt Instruments

Relevant regulations have never provided clear definitions.

It is precisely for these reasons that DeFi founders have consistently lacked the motivation to explore alternative financing channels.

Programmable Income and Embedded Finance

We firmly believe that on-chain enterprises should enjoy lower capital costs than traditional enterprises. Here, "enterprises" specifically refer to DeFi-related projects — after all, this is the only sector in the crypto space that truly generates revenue. The existence of this capital cost advantage is based on the fact that all income is generated on-chain and is fully programmable. These projects can directly link future income to credit obligations.

The Debt Dilemma in Traditional Finance

In the traditional financial system, debt instruments typically have clauses that constrain specific leverage levels of enterprises (covenants). Once a default clause is triggered, creditors have the right to initiate procedures to take over the enterprise's assets. But the problem is: creditors not only need to estimate the enterprise's revenue performance but also must constantly monitor cost expenditures — because the variables affecting the clause indicators are precisely revenue and cost.

Structural Breakthroughs in On-Chain Credit

Based on programmable income, on-chain credit investors can completely bypass the enterprise's cost structure and lend directly against income. This means that enterprises can obtain funding at rates far below equity financing (based on PNL statements). Projects like Phantom, Jito, or Jupiter should be able to secure hundreds of millions in financing from large institutional investors using their on-chain income as collateral.

Through flexible settings of smart contracts:

• When project income shrinks, the proportion allocated to creditors automatically increases (reducing default risk).
• When income grows rapidly, the corresponding proportion dynamically decreases (maintaining the agreed credit term).

This embedded financial architecture is redefining the flow of capital and value.

Practical Exploration of On-Chain Income Financialization

Take pump.fun as an example: if it raises $1 billion from a pension fund, when the new coin binding rate declines (as seen recently), the pension fund can take over the smart contract until the debt is repaid. Although the feasibility of such radical measures remains controversial, this direction is worth exploring.

Advanced Applications of On-Chain Income

On-chain income can not only fulfill basic credit obligations but also achieve:

• Automatic repayment of different priority debts in the capital structure (subordinated and senior debt).
• Condition-triggered repayment mechanisms.
• Debt auctions and refinancing.
• Income segmentation and securitization by business type.

Limitations of Token Financing

Compared to selling tokens at a discount over-the-counter to hedge funds (which often hedge or sell at opportune times), the aforementioned income securitization should be a more economical financing solution. Project income can continuously generate, while token supply is limited. Token sales may be convenient, but they are not a sustainable path for projects aiming for long-term development. We encourage bold teams to explore new financing paradigms rather than sticking to conventions.

Reference from Traditional E-commerce

The above model is known in traditional e-commerce as "merchant cash advance" or "factor rate loans." Payment processors like Stripe and Shopify provide operational funding to the merchants they serve through their own investment tools. The actual interest rates on these loans can reach as high as 50-100% or even higher, and they lack a price discovery mechanism — merchants, as price takers, are firmly bound within the payment system.

Breakthroughs in On-Chain Embedded Finance

This embedded (in-app) financing model will shine on-chain:

1. Programmable payments support conditional payments and real-time cash flow.
2. Achieve more complex payment strategies (such as targeted customer discounts).
3. Stripe is pioneering this algorithm-first model through merchant coverage and Bridge acquisitions.
4. Promote the use 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 give up their moats and allow external institutions to lend to their merchants. This may be the entrepreneurial opportunity for on-chain native crypto businesses and permissionless capital solutions.

Different Rights for the Same Shares

If a company's equity value is entirely derived from on-chain income (i.e., no other sources of income), then equity tokenization is an inevitable choice. Initially, it may not adopt a standard equity form but can use a hybrid structure between debt and equity.

Recently, Backed.fi's launch of tokenized Coinbase stock has attracted attention. This scheme holds the underlying stock through a Swiss custodian, allowing cash redemption for users who complete KYC. The token itself is an ERC-20 standard, enjoying the composability advantages of DeFi. However, this design only benefits secondary market participants, and Coinbase, as the issuer, has not gained substantial benefits — it cannot use this tool for on-chain financing nor achieve innovative applications of equity instruments.

Although equity tokenization (and other assets) has recently become a hot concept, truly exciting cases have yet to emerge. We anticipate that such innovations will be driven by platforms with extensive distribution channels that can benefit from blockchain settlement, such as Robinhood.

Another direction for equity tokenization is to create on-chain giants that can obtain nearly unlimited financing at extremely low costs based on on-chain income, proving to the traditional market that half-baked solutions are unworkable — either fully on-chain all income to become a completely on-chain organization or remain on NASDAQ.

In any case, equity tokenization must achieve new functions or change the risk characteristics of equity: can a fully tokenized company reduce its capital costs due to its real-time on-chain profit and loss statement? Can event-triggered equity issuance be verified through on-chain oracles, changing the current market issuance (ATM) mechanism? Can employee equity incentives be unlocked based on on-chain milestones rather than time? Can the company collect all transaction fees generated from its own stock trading instead of ceding them to brokers?

Conclusion

We always face two development paths: top-down and bottom-up. As investors, we always pursue the latter, but more and more things in the crypto space are being realized through the former.

Whether it is equity tokenization, credit instruments, or income-based structured products, the core question remains the same: can new ways of capital formation be opened? Can incremental functions be created for financial instruments? Can these innovations lower the capital costs for enterprises?

Just as the traditional venture capital field arbitrages between private and public markets (the trend is to remain private rather than go public), we predict that the binary opposition between on-chain and off-chain capital will eventually disappear — in the future, there will only be distinctions between good and bad financial solutions. It is very likely that we are mistaken, and on-chain credit linked to income may not necessarily lower capital costs (and may even be higher), but in any case, a true price discovery mechanism has yet to form. To achieve this goal, we need to undergo the maturation process of on-chain capital markets, require large-scale financing practices, and need the participation of new market players.

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