Overview of the Real-World Asset Digitalization Sphere
RWA stands for Real-World Assets, which are assets from the physical world that have been tokenized. Tokenization involves the creation of tokens that represent these assets, whether they are tangible or intangible. The value and other characteristics of RWA can be determined by external sources.
For instance, the Ondo Short-Term US Government Bond Fund (OUSG) serves as an example of RWA. It is an ERC-20 token that is backed by short-term US Treasury bonds. Specifically, it represents the shares of the iShares Short Treasury Bond ETF, which holds these bonds.
Numerous blockchain platforms provide the necessary infrastructure for tokenizing and trading RWA. According to data from DeFiLlama, this sector encompasses 25 protocols with a combined Total Value Locked (TVL) of $1.6 billion.
Tokenization enables the integration of traditional assets into the DeFi ecosystem, enhancing their accessibility and trading efficiency through the utilization of automated market makers and other blockchain solutions.
RWA acts as a bridge between Traditional Finance (TradFi) and DeFi, potentially reshaping the cryptocurrency market by introducing new sources of capital, liquidity, and profitability.
It is important to note that tokenized assets should not be mistaken for synthetic assets like EUR-PERP from Synthetix. Synthetic assets, although they track the value of real-world assets, are typically presented as unsecured derivatives.
Primary Categories of RWA
In principle, any asset that can be formalized and encoded is eligible for tokenization. These assets encompass both tangible items like precious metals and intangible assets like copyrights.
The following asset types are potentially well-suited for tokenization:
However, practical considerations, including regulatory requirements and asset-specific characteristics, influence the ease of tokenization and the level of adoption.
For instance, participants in the cryptocurrency market have been utilizing RWA tied to the US dollar for eight years, represented by tokens such as USDT, as well as other stablecoins backed by fiat currencies. Conversely, the tokenization of stocks only emerged in 2018.
Nevertheless, the advancement of blockchain technology and the growing interest from market participants in new asset classes have contributed to the rise of specific types of RWA in 2023, including:
- Stocks and government bonds.
- Real estate.
- Credit obligations.
- Collectible items.
Developers are also exploring the tokenization of carbon credits (Solid World) and precious metals (CACHE Gold).
According to the Boston Consulting Group, the overall capitalization of RWA could reach $16 trillion by 2030, encompassing stocks, government bonds, real estate, and investment fund assets.
How Does the Process Work?
Experts have identified three primary stages involved in tokenizing traditional assets, whether they are stocks, credit obligations, or real estate.
Stage 1: Off-chain Formalization
This initial stage entails establishing ownership rights and capturing the economic value of the asset. The asset must undergo an expert evaluation of its condition or monetary worth, comply with the regulatory requirements of the relevant jurisdiction, and be owned by the RWA issuer.
For instance, to tokenize a real estate property, an entrepreneur establishes a legal entity. The entity then acquires a hotel, for example, and based on the monetary valuation of the property, issues a specific number of shares at a predetermined cost. Each share represents ownership in the acquired hotel.
Stage 2: Information Transfer
Once the asset is formally established in the physical world, its information needs to be transferred to the blockchain. Smart contracts and tokens of various standards are utilized for this purpose, depending on the nature of the asset.
During this stage, developers create a smart contract that contains relevant data about the real asset, forming the foundation for issuing the RWA. Issuers often entrust a third party to handle the information transfer process.
For example, a hotel-owning company collaborates with a tokenization platform, providing documentation that verifies ownership rights, asset valuation, and the number of issued shares. The platform’s developers then create a smart contract and issue tokens equivalent to the company’s shares.
Stage 3: Development and Maintenance of RWA
This stage involves the ongoing management of the tokenized asset, ensuring its liquidity, and providing the necessary technical infrastructure for trading and redeeming the RWA. Typically, the tokenization platform assumes most of these responsibilities, making adjustments to the smart contract and regulating token circulation.
To accomplish this, the platform maintains constant communication with the issuer, verifies legal information, and supplies accurate quotes for the real asset. Servicing the RWA also requires the involvement of price oracles and off-chain specialists, which helps offset the relatively lower costs associated with blockchain infrastructure.
Why Is Tokenization Gaining Traction?
The concept of tokenizing real-world assets (RWA) gained attention from various projects in the early stages of the industry. While the first RWAs emerged in 2018, it was only in the latter half of 2022 that the segment began to be acknowledged as a promising and enduring market development trend.
In 2023, Brian Armstrong even included RWAs in the list of projects he would prioritize, signaling the industry’s potential and prospects.
So, what prompted developers and investors to revive this well-known technology only now? There are several reasons, with the primary one being the prolonged bearish trend in the cryptocurrency market.
According to Coinmarketcap, the total market capitalization of cryptocurrencies in September 2023 amounted to $1.05 trillion. This is three times lower than the peak values observed at the end of 2021. The market cap has hovered between $0.8-1.2 trillion for over a year, and the daily trading volumes in September 2023 were even lower than those following the Terra collapse.
Additionally, the following factors can be considered:
- A notable decline in trading volumes on decentralized exchanges (DEX) – $67 billion in November 2021 compared to $7 billion in early September 2023.
- Funds flowing out of decentralized finance (DeFi) – the total value locked (TVL) decreased from $178 billion at its peak in November 2021 to $37 billion in early September 2023.
- Decrease in the capitalization of stablecoins (used as a liquidity marker) – $187 billion in March 2022 compared to $124 billion in September 2023.
The crypto market has been experiencing losses for over a year. DeFi platforms require new sources of liquidity, which they find in traditional finance (TradFi) through RWA.
Simultaneously, the yield on traditional financial instruments, particularly U.S. Treasury bonds, is increasing. The rise in the key interest rate, as part of the Federal Reserve’s strategy to combat post-COVID inflation, has led to annual yields on these assets reaching 4.1-5.3%, the highest level in the past 15 years.
In comparison, stablecoins from the top 20 pools can only offer similar annual yields through MakerDAO and JustLend. However, investments in DAI and USDD carry more potential risks than purchasing U.S. Treasury bonds.
Given comparable returns, investors prefer more reliable instruments with transparent regulation and guaranteed payments by the U.S. government, avoiding protocol hacks, issues related to storing private keys, and issuer bankruptcies.
RWA partially offsets the outflow of investments from the crypto market into treasury bonds by integrating them into the ecosystem. RWA represents the largest category of tokenized traditional assets, with a total market capitalization of $630 million.
The adoption of blockchain in the banking and financial sectors in recent years has also contributed to the development of RWA.
In August 2023, SWIFT conducted tests on transferring tokenized assets between blockchains, Visa introduced a solution for on-chain fee payments in fiat, and PayPal launched a stablecoin. Simultaneously, blockchain platforms like Stellar and Ripple are becoming the technical foundation for tokenizing securities, launching central bank digital currencies, and facilitating interbank transactions.
The crypto industry has progressed beyond its early development stage, characterized by opposing traditional markets. Most projects now prefer to position themselves as partners of TradFi or providers of more efficient infrastructure. Calls for “deconstructing” the financial system have been replaced by narratives of its “modernization” and “transformation” using blockchain technology. RWA aligns perfectly with this trend.
RWA Ecosystem
The RWA (Real-World Assets) sector comprises several project categories, as highlighted by Binance:
- Infrastructure: Projects that establish the technological foundation for asset issuance and compliance. This encompasses specialized blockchains, technical stacks, and legal support for RWA.
- Asset Providers: Platforms that tokenize assets directly and develop infrastructure for their servicing and distribution. Asset providers are classified based on the type of RWA and the tools they offer.
The primary market sectors include:
Real Estate: Tokenizing and trading ownership rights for residential or commercial properties, along with earning rental income proportional to the ownership stake. This sector actively employs both fungible tokens and NFTs. Examples of platforms in this category include Tangible, RealT, and Lofty.
Lending Platforms: These platforms enable users to borrow cryptocurrencies against RWA collateral or lend tokenized assets, using real-world securities as collateral. Some projects, like Maple, even facilitate uncollateralized loans. Examples of lending platforms include Maple, Goldfinch, and Centrifuge.
Public Debt (Government Securities): Tokenized public debt grants access to government bonds on the blockchain. Users can trade or hold RWA backed by these securities and receive payouts in the form of established interest rates. Examples of platforms in this category include Ondo, BondBlox, and Backed.
While these are the most capitalized RWA categories, the ecosystem also encompasses other areas such as agriculture, regenerative finance (ReFi), insurance, various financial instruments, and specific physical assets.
Prominent Projects
Centrifuge: A comprehensive RWA platform that enables the tokenization of traditional assets, borrowing against them, or using them as collateral to obtain cryptocurrency loans. Centrifuge integrates with several crypto lending platforms, including Aave and MakerDAO, facilitating interaction between RWA and DeFi.
MakerDAO: Widely recognized as a lending protocol offering loans in the stablecoin DAI, backed by cryptocurrency collateral. In November 2020, MakerDAO integrated tokenized assets as an additional collateral source. By September 2023, the total volume of RWA held by MakerDAO exceeded $2 billion, with these assets comprising 14% of DAI reserves. As the Federal Reserve’s key interest rate increased, tokenized assets became a significant revenue source, accounting for 56% of the platform’s total profits.
Ondo Finance: A platform for trading US government bonds and money market assets. It offers various tokens linked to real assets and its own stablecoin USDY, backed by US Treasury bonds. Ondo utilizes exchange-traded funds from different providers for tokenization. The service caters to both retail and institutional investors, requiring a minimum purchase amount of $100,000, and wallet interaction necessitates prior approval from the Ondo team.
RealT: A comprehensive service catering to the real estate sector of RWA. It provides tokenization services, facilitates trading of digitized real estate, and even supports DeFi farming using RWA. Token holders automatically receive rental income. Users must register and undergo verification to access the platform.
These examples represent a fraction of the projects within the RWA ecosystem, showcasing the diverse opportunities and offerings in this emerging field.
What Are the Advantages of Asset Tokenization?
The integration of traditional and decentralized finance is the primary driving force behind the development of Real World Assets (RWA). While this integration is currently one-sided at the technical and economic levels, it has the potential to bring benefits to both markets.
In the DeFi sector, asset tokenization provides a new source of capital and yield, along with the introduction of new asset classes. These tokenized assets allow for the compensation of cryptocurrency volatility and the hedging of related risks, all within the industry itself. On the other hand, traditional finance (TradFi) can explore new markets and deploy economic activity in DeFi. The availability of unlocked liquidity opens up new earning opportunities. For example, holders of tokenized treasury bonds can receive a fixed income and utilize their RWA as collateral to borrow ETH and invest it in a liquid staking protocol.
Moreover, asset tokenization brings traditional assets into a new realm of digitization through the use of blockchain and smart contracts. This lays the foundation for the further development of trading platforms, enabling 24/7 trading, secure data storage, and the resolution of various issues faced by centralized exchanges and markets.
One of the key advantages of integrating RWA with blockchain technology is the increased inclusivity of financial instruments. Blockchain eliminates intermediaries in the trading process, while fractionalization reduces the entry barrier in industries that were previously inaccessible to retail investors.
By eliminating intermediaries and transitioning to an efficient blockchain infrastructure, operational costs that are typically factored into the final asset price can be reduced.
According to research conducted by the International Monetary Fund (IMF), DeFi platforms charge fees that are significantly lower than those of banks in both developed and emerging markets. This allows RWA issuers to offer better prices without compromising their own margins.
However, there are several challenges associated with tokenizing and transferring traditional assets onto the blockchain. These challenges include establishing a proper legal framework, addressing technical limitations, and ensuring the security of storage.
Regulating RWA is generally more defined compared to cryptocurrencies, as the underlying assets are already integrated into the regulatory frameworks of specific jurisdictions. However, tokenized versions of assets create a new market, posing greater challenges for regulation. To protect investor rights, a regulated process for issuance, redemption, and circulation of RWA is necessary, but such rules are not yet established in all key jurisdictions. Legislative requirements create technical problems due to existing token standards, smart contract functions, and underlying blockchain principles that do not fully allow for control over tokenized assets.
To overcome these technical shortcomings, some platforms are seeking compromises. For instance, platforms like Ondo require users to undergo a KYC procedure, after which their wallets are manually authorized to interact with the platform’s services.
In the future, the emergence of new L1 blockchains better suited to the needs of RWA is expected. These networks may be more centralized and less confidential but will provide the required technical and legal standards for tokenization.
The technical synchronization between traditional assets and their tokenized versions is currently low, and there is a lack of clear rules for regulating the circulation of RWA tokens, raising security concerns. Key issues include preventing double spending of the underlying asset (e.g., simultaneous use of shares or commodities as collateral in both DeFi and TradFi) and protecting against unauthorized sale of the underlying asset by the RWA issuer, which could lead to the creation of unsecured tokens. Additionally, ensuring timely fulfillment of obligations by the token issuer, particularly the redemption of tokenized obligations, is crucial.
Efforts are being made to introduce protocols that mitigate the risks associated with unscrupulous RWA issuers. However, these solutions require additional expenses and off-chain interactions, which can reduce the efficiency of tokenization. The development of qualified services that provide storage for underlying assets could help address this challenge.
As transparent regulatory requirements are established and technical compatibility between DeFi and TradFi improves, the benefits of asset tokenization will become more significant. Nevertheless, the overall concept of interaction between the crypto market and real assets remains uncertain. Possible scenarios include merging decentralized and traditional finance into a unified hybrid market, facilitating interactions between markets through established and regulated platforms, or utilizing blockchain solely as a technical foundation for TradFi without incorporating cryptocurrencies and DeFi.
Each of these approaches transforms the infrastructure and ecosystem of both markets while distributing financial and technical benefits differently.
Prospects for the Future Development of the Real World Assets Sector
According to a recent study conducted by Galaxy Research, the total value of tokenized real-world assets has reached a record high of $3.1 billion in August. Viktor DeFi, a decentralized finance analyst, predicts that the RWA market will surpass $10 billion by 2024. Among the various asset types, gold and precious metals make up approximately 37% of the total volume, followed by securities at around 23% and treasury obligations at 20%.
The growth of the RWA sector can be attributed to leading industry players who are actively exploring the integration of real assets with blockchain technology. To facilitate this expansion, industry companies are forming alliances and coalitions. For instance, the Tokenized Assets Coalition (TAC), composed of Circle, Coinbase, Aave, Credix, and Goldfinch, was announced on September 7th.
A recent report by 21.co, a company specializing in digital asset management, suggests that the market for tokenized assets could potentially reach $10 trillion within this decade. This forecast takes into account the increasing adoption of blockchain technology by traditional financial institutions. According to the report published on October 18th, the convergence of cryptocurrencies and traditional asset classes, including fiat currencies, stocks, government bonds, and real estate, is experiencing unprecedented growth. The authors estimate that the market value of tokenized assets could range from $3.5 trillion in a “bearish” scenario to $10 trillion in a “bullish” scenario by 2030.
These projections are in line with other reports and statements highlighting the immense potential of RWA tokenization. As more individuals, major market players, and investors recognize the significant technological and financial advantages associated with tokenized real-world assets, it will be intriguing to observe the development and expansion of this emerging market.