Understanding Fixed Income Products

By Michael Lukasevicz, Growth Marketing @ Centrifuge

With increasing interest in bringing fixed income onchain, it’s more important than ever to understand the ecosystem of finance’s credit products. Tokenizing these products offers enhanced transparency, liquidity, and efficiency through overcoming the constraints of traditional financial systems.

Likewise, an understanding of these products is important in constructing an RWA investment portfolio. The Centrifuge Credit Group, a decentralized group of credit professionals, has provided asset primers on all major categories of the fixed income market.

Keep reading for an a summary of these asset primers and an overview of the different types of fixed income products!

US Treasuries

Over $1B in Treasury notes have been tokenized on public blockchains (CoinDesk). This volume in onchain allocation raises the question: how does this market work?

Treasuries are backed by the United States government, which gives them a low-risk credit profile. Treasuries have a $25 trillion market cap—about 20% of the global fixed-income market—and are considered virtually risk-free, serving as a benchmark for other institutional credit assets.

Treasury yields move inverse to their prices and offer a glimpse into future economic expectations. The yield curve, formed by yields across different maturities of Treasuries, typically slopes upward. Conversely, an inverted curve suggests potential economic downturns. As you can see below, the yield curve is currently inverted.

Bringing high-profile, low-risk assets like Treasuries onchain highlights the stability and security that blockchain technology can offer to the financial sector. This democratizes access to Treasuries and introduces an unprecedented level of liquidity and accessibility. To learn more about US Treasuries, check out this asset primer by the Centrifuge Credit Group.

US Corporate Bonds

Corporate Bonds are debt securities issued by corporations to raise capital. Investors favor corporate bonds because they offer higher returns than Treasuries, reflecting the increased risk of a corporation defaulting on its debt.

Credit ratings, provided by agencies such as S&P, Moody’s, and Fitch, gauge the risk associated with corporate bonds. These ratings are based on an analysis of the company’s financial health and ability to repay debt.

Corporate Credit Ratings (Investopedia)
Corporate Credit Ratings (Investopedia)

Investment Grade

Investment Grade (IG) Corporate Bonds represent a large portion of the Corporate Bond market, providing investors with a safer investment alternative than non-investment grade bonds. IG bonds hold ratings of BBB- or higher, indicating a relatively low default risk and higher credit quality.

Due to their lower risk profile, IG bonds yield less than their non-investment grade counterparts, but more than Treasuries. Investors gain exposure to these bonds for the ratio of security and returns they provide, especially during economic uncertainty.

From a DeFi perspective, IG bonds offer an opportunity for onchain asset managers to add stable collateral to their portfolio with higher yields than Treasuries. Tokenizing these bonds streamlines historically cumbersome processes while introducing a new level of efficiency and security. To learn more about investment grade corporate bonds, check out this asset primer by the Centrifuge Credit Group.

Non-Investment Grade

Non-Investment Grade (NIG) Corporate Bonds, often labeled as high-yield, speculative, and junk bonds, represent a high-risk, high-reward segment of the bond market. These bonds are issued by companies rated below BBB-, reflecting the increased risk corresponding with higher yield prospects. For companies that are not eligible for investment-grade ratings, due to weaker credit metrics or undergoing restructuring, NIG bonds are essential for securing capital.

NIG bonds represent an opportunity for a higher return (albeit higher risk) credit assets onchain. Tokenizing these high-yielding assets can democratize access while enhancing transparency and efficiency through smart contract automation. To learn more about non-investment grade corporate bonds, check out this asset primer by the Centrifuge Credit Group.

Asset-Backed Securities

Asset-Backed Securities (ABS) encompass a variety of asset types including (but not limited to) auto loans, aircraft leases, credit card receivables, business loans, and mortgages. These assets are pooled and securitized, allowing them to be traded on financial markets. ABS are popular because of the diversity of asset pools, loss prevention (tranching), and high liquidity.

Mortgage-Backed Securities

Mortgage-Backed Securities (MBS) are the largest type of ABS. They are made up of securitized pools of mortgages that allow investors (often institutional) to access these diversified income-generating assets.

The MBS market is split between Agency and Non-Agency categories. Agency MBS are issued by government-sponsored enterprises with a government guarantee, reducing the risk of credit losses. Non-agency MBS are issued by private entities, bearing a higher risk while potentially offering higher returns.

MBS are among the most liquid institutional credit investments due to their standardization and large market size. Generally, they provide a yield premium over US Treasuries, which compensates for prepayment risks and market volatility.

Bringing MBS onchain can enhance their TradFi benefits while offering the increased transparency and efficiency that tokenization provides. To learn more about mortgage-backed securities, check out this asset primer by the Centrifuge Credit Group.

Final Thoughts

The integration of fixed income chain presents an opportunity to transform the traditional financial system. Through tokenization, traditionally cumbersome processes become streamlined while introducing unprecedented levels of transparency and accessibility, creating a more efficient financial system for both issuers and investors.

The market for tokenized fixed income products is positioned for growth, with investors projected to allocate between 7% and 9% of their portfolios to tokenized assets by 2027 (current allocations are between 1% and 4%). This growing appeal is driven by high net worth (HNW) and smaller institutional investors looking to access traditionally exclusive asset classes with greater ease and lower minimums. As for what fixed-income products these investors are looking to invest in, approximately 70% of all investors prefer tokenized non-investment grade corporate bonds, reflecting a higher risk appetite (EY Parthenon).

We imagine credit funds operating onchain–like BlockTower—using Centrifuge to bring all fixed income products onchain and create a more efficient, accessible, and user-friendly decentralized financial system.

Learn more about the Centrifuge Credit Group and read all the Asset Primers here.

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