From Physical to Digital: The Evolution of Real-World Assets (RWAs) Tokenization
Introduction:
In the rapidly evolving world of blockchain technology, an innovative concept transforms how we perceive and interact with traditional assets — The Tokenization of Real-World Assets. This article delves into the fascinating realm of this groundbreaking approach, exploring how blockchain enables the representation of real-world assets as digital tokens. We will examine the benefits, challenges, and potential impact of tokenizing properties, revolutionizing the financial landscape, and offering unprecedented investment opportunities.
What are Real World Assets (RWAs)?
RWAs encompass a wide range of assets with well-defined monetary value, including Tangible Assets like gold and real estate and Intangible Assets like government bonds and carbon credits.
Types of Real-World Assets:
What is Asset Tokenization?
Asset tokenization involves creating digital tokens on a blockchain representing Real-World Assets (RWAs). By leveraging tokenization, ownership rights of assets like fine art or company shares can be transformed into digital tokens. These tokens represent the underlying assets, facilitating seamless tracking and transfer of ownership within the blockchain ecosystem.
At times, as a token holder, you have the opportunity for profit sharing but do not possess ownership rights to the underlying asset.
Tokenization Process:
Token Standards:
During the Off-Chain Formalization phase, the gathered information is translated into code, then represented as metadata within a digital token. Accessible through the blockchain, this metadata ensures complete transparency regarding the asset’s economic value and ownership. This process is known as “Tokenization.” Several proposals have been introduced to establish a DeFi standard for asset tokenization, as depicted below.
RWA Markets:
Within the RWA (Real World Assets) space, Equity and Real Asset markets remain relatively small, with only a few protocols currently operating in this area. One possible reason for this limited presence is the heavy regulation surrounding Equities and Real assets commonly traded in public markets. On the other hand, fixed-income markets dominate the RWA space, as they are more vibrant in the transaction flow, offer a wider range of opportunities, and attract diverse participants.
Private Credit based RWAs offerings are abundant within DeFi. They have over US$4B in total loan value across 1,650 loans.
Why is the On-Chain Tokenization of RWAs gaining importance?
The DeFi industry has experienced tremendous growth in recent years, reaching a peak of $257 billion on 09 Nov 2021. However, unforeseen events, such as the fall of Luna and FTX, have resulted in a significant drop in Total Value Locked (TVL). The inflationary pressure and poor Tokenomics of many tokens have led to a drastic decline in token values, with some dropping by over 90%. Moreover, DeFi yields have also decreased significantly, marking the end of the easy DeFi yield era.
A significant portion of the world’s wealth is tied up in illiquid assets due to various factors. These include the high ticket size, which makes them less affordable for the mass investor, the challenges in fractionalizing these assets, regulatory obstacles, and complex user journeys that hinder easy access for investors.
On-chain asset tokenization offers a promising solution to overcome the barriers of asset illiquidity and the complexities associated with traditional fractionalization. By tokenizing assets on the blockchain, it revolutionizes the entire process of connecting investors with investment opportunities, streamlining the end-to-end process. Additionally, it opens up new possibilities in the secondary market for assets once investments have been made.
Advantages of Tokenization:
- Access to Illiquid Assets: A significant portion of the world’s wealth is tied up in illiquid assets, which generally trade at a discount compared to liquid assets. Illiquid assets have a high stock-to-flow ratio, lower trading volumes, and imperfect price discovery compared to liquid assets. However, we can provide global investors with widespread access to these illiquid assets on a mass scale through Tokenization.
- Diversification of Investment Portfolio: By enabling tokenization, investors can expand their access to a diverse array of asset classes and sectors, promoting portfolio diversification and enhanced risk management
- Access to Global Markets: Tokenization eliminates geographical barriers and unlocks global investment opportunities. Investors worldwide access tokenized assets through blockchain platforms, facilitating cross-border investments and portfolio diversification.
- Transparent and Secure Transactions: Asset ownership and transactions become transparent through tokenization. Blockchain’s immutable and publicly accessible records enable investors to verify asset history and authenticity, mitigating fraud risk.
- Cost-Saving Investment Options: Asset tokenization substantially reduces transaction costs by streamlining asset transfers and eliminating intermediaries. This cost-effectiveness benefits investors and asset owners, as it reduces fees and administrative expenses associated with investing in tokenized assets.
- Enhanced Liquidity: Tokenization facilitates fractional ownership, empowering investors to purchase and trade smaller portions of assets. This democratization of investment opportunities enhances liquidity, creating a seamless marketplace where asset owners and buyers can readily connect.
Challenges in Tokenization:
- Regulatory Complexity: The intricate landscape of global and regional regulations can be overwhelming, particularly with tokenized assets falling under the jurisdiction of multiple regulatory bodies. It is imperative to prioritize compliance with securities, tax, data privacy/protection, and anti-money laundering laws.
- Asset Valuation: Accurate and dependable asset valuation is crucial to tokenization. Nevertheless, evaluating real-world assets, especially illiquid or unique ones, can be complex.
- Integration with TradFi: Connecting the blockchain ecosystem with existing financial systems may pose technical and operational challenges.
- Lack of Awareness/Adoption: One of the primary challenges lies in the lack of public awareness, coupled with concerns regarding the risks associated with platforms, smart contracts, etc., contributing to the slow growth rate
Market Outlook:
Regulatory Landscape:
As mentioned above, Regulatory Complexity remains the foremost concern. The following summarization chart will offer an overview of the current status of Asset Tokenization from the perspective of each country.
Use cases:
- Ryzer:
Ryzer is an investment platform utilizing blockchain tokenization, simplifying investing in real-world assets and diversifying investment portfolios, similar to investing in stocks or mutual funds. With a minimum investment of Rs. 10,000, first-time investors can start building their real estate investment portfolio. Leveraging blockchain technology, Ryzer offers access to high-growth assets, including open land, residential, commercial properties, and ongoing development projects from its platform.
How does it work?
- Maple:
Maple Finance is a decentralized corporate credit market built on-chain to enable institutional borrowers to access undercollateralized loans through its lending pools managed by accredited pool delegates. With Maple, institutional borrowers get access to undercollateralized loans while empowering lenders with sustainable yields for their assets.
How does it work?
Liquidity Providers (LPs) deposit funds into a Liquidity Pool to fund loans and earn yield. In return, they receive an LP token representing their pool share.
Pool Delegates are responsible for managing each pool. They perform due diligence and agree on terms with Borrowers using smart contracts. Pool Delegates must stake a specified reserve amount (decided and continuously updated by the protocol Governor) into their Pool to cover defaults, aligning their incentives with Liquidity Providers.
Borrowers request capital from the platform by creating a Loan (which holds collateral and receives funding) and inputting requested loan terms. Once these terms are agreed on with a Pool Delegate, Borrowers can withdraw the requested funds for a fixed term, at a fixed rate, and at a fixed collateralization level.
Conclusion:
The Tokenization of Real-World Assets represents a monumental shift in the financial paradigm, providing unparalleled opportunities for investors and industries.
While RWA markets hold promise for improved yield opportunities, it is essential for investors to thoroughly assess the track record of existing DeFi protocols that incorporate RWAs. It is crucial to inquire about any historical defaults they may have experienced and thoroughly understand their underwriting and due diligence processes for risk management. As of today, notable platforms like Centrifuge, Maple, and TrueFi have reported approximately $65 million worth of defaults.
Several counter-initiatives have been implemented by the protocols to address these challenges. For instance, the introduction of Maple 2.0 by Maple and Goldfinch now involves Auditors to approve Borrowers. TrueFi has also introduced Portfolio Managers as part of their efforts to mitigate risks and enhance the system’s overall performance.
In my assessment, RWA lending presents significant growth potential. Currently, there are only a few protocols operating in this space. However, as yields on crypto-to-crypto lending remain relatively low, more protocols are expected to enter the RWA lending market in the future, ultimately driving higher yields in the DeFi ecosystem.
Additional Resources:
- https://research.binance.com/en/analysis/real-world-assets
- https://web-assets.bcg.com/1e/a2/5b5f2b7e42dfad2cb3113a291222/on-chain-asset-tokenization.pdf
- https://www.rohasnagpal.com/docs/Tokenization_Playbook.pdf
- https://www.youtube.com/live/imAxY0pEGCs?feature=share
- https://maplefinance.gitbook.io/maple/technical-resources/protocol-overview/background
- https://www.ryzer.app/2023/07/25/you-wont-believe-how-asset-tokenization-works-a-comprehensive-analysis/
- https://app.rwa.xyz/#protocols
- https://twitter.com/DefiIgnas/status/1617800006332973057
Acknowledgment:
I am delighted to share this article, which I crafted while participating in the DeFi Talents Program. The program, hosted by Web3 Talents (https://web3-talents.io/defi-talents), is an 18-week mentoring initiative designed to empower individuals for leadership roles in the Decentralized Finance arena.
