Unpacking RWAs

Classifications, market dynamics, and strategic insights

tldr

• RWAs are the tokenized representation of anything with value that exists outside of the blockchain, including physical and digital assets.
• Tokenization leverages blockchains for improved trade and management, enhancing liquidity, global reach, and transparency while reducing intermediary costs.
• Right now, the most dominant RWA is by far USD stablecoins (~97%), followed by securities (~1.5%, primary US T-bills), and commodities (~1%, primarily gold).
• Stablecoins hold a unique position in bridging the adoption gap between crypto enthusiasts and ordinary people with their use case extending beyond diversification to hedging against currency debasement and cross-border payments.
• Global interest in tokenized US treasuries skyrocketed in 2023 as investors worldwide were attracted to increasing yield.
• There are a number of emerging RWA categories that are intriguing but also highly speculative, including art and collectibles, IP rights, infrastructure financing, impact claims, insurance policies, and agricultural assets.
• Market projections have one thing in common: RWAs will become a huge industry this decade — estimates range from $3.5 trillion in the bear-case scenario to $16 trillion in the bull-case.
• There are a bunch of challenges to realizing these projections — regulatory obstacles, first, and foremost, but also technical and operational risks, valuation challenges, uncertainties around market readiness, economic and social barriers to entry, and category-specific challenges around each RWA category.
• We propose a heuristic guide for identifying investable projects given these risks and challenges that takes into account unlockable liquidity, global demand, yield opportunities, and regulatory clarity.

To start, let’s define RWAs and “real-world assets” so we know what we are talking about here and what we are not. Real-world assets are assets that have value and exist outside of the blockchain. They can be physical, digital, or data-based and derive their value from their existence in the “real world” — meaning, outside the blockchain. These assets include, but are not limited to, fiat currencies, treasuries, commodities, real estate, equities, bonds, high-value collectibles, and even intellectual property. “RWAs,” in the context of crypto, refers to the tokenized form of these real-world assets. RWAs, then, have two defining characteristics:

1. They represent something offchain that has value
2. They are managed and recorded on a blockchain, instead of a different ledger

Tokenizing real-world assets and bringing them onto the blockchain is not primarily about bringing liquidity from cryptocurrency markets to traditional finance. The primary motivation is about leveraging blockchains to improve the way we trade and manage real-world assets:

1. Unlocking liquidity for illiquid assets: Illiquidity is a major capital efficiency issue in traditional finance. According to academic research, the illiquidity discount can amount to as much as 30% of the value of an asset. Tokenization allows typically illiquid assets (e.g., real estate, private equity, art) to be fractionalized into smaller, more affordable units — thus, lowering barriers to entry and creating more liquid markets.
2. Global reach: Blockchains open the doors to a borderless and permissionless ledger, operated under strict global consensus. Tokenization thus exposes real-world assets to the massive internet-first market. Investors from various countries or jurisdictions can invest in assets more seamlessly and at lower costs than in traditional markets.
3. Transparency and security: A public blockchain’s strict global consensus, immutability, and transparency ensures that all transactions are recorded securely and can be audited by anyone. Compare this to traditional markets, where transactions often require validation by intermediaries and audit trails are opaque, privatized, costly, and time-consuming.
4. Cost reduction and efficiency: Traditional asset transactions can be cumbersome and resource-intensive. Blockchains streamline this process by enabling peer-to-peer transactions with smart contracts that automate and secure the whole process. If the code is solid, we can expect potentially better security without the costs of expensive and manual human intermediaries. Fewer intermediaries, fewer intermediary costs.

Typical chain of financial intermediaries required for an IPO.

Financial innovation: Tokenization facilitates the creation of new types of financial products and services that may combine various asset classes or offer structured returns , providing more options for portfolio diversification. For example, tokenization technology would enable the creation of a single token representing a mix of stocks, bonds, and commodities offering structured returns based on the performance of the underlying assets — and even automate prioritization of bond exposure when stock volatility is high, or growth stocks during risk-on bull markets.

RWA Types: Current and Future

What sort of RWAs are currently on the market and what might we see over the coming years?

Per 21.co’s tokenization Dune dashboard, we see 8 types of RWAs currently onchain. Ranked in terms of market share:

1. Fiat-collateralized stablecoins (96.69% market share): Digital tokens backed by fiat currency reserves (e.g., USD, Euro). Doesn’t include crypto-backed and algorithmic stablecoins.
2. Government securities (1.40%): Tokenized forms of government-issued debt instruments (e.g., treasuries, bonds).
3. Commodities (1.17%): Digital representations of basic, fungible physical goods (e.g., gold, oil, agricultural products).
4. Asset-based finance (0.47%): Tokens representing financial assets that are backed by physical or other tangible assets (e.g., asset-backed securities and loans).
5. Real estate (0.24%): Tokenization of property assets which are typically highly illiquid, allowing for fractional ownership and lowering barriers to entry (e.g., high costs). See Villcaso’s presentation from Alliance’s ALL12 Demo Day.
6. Private equities (0.03%): Tokens representing ownership in companies that aren’t publicly traded, democratizing access to private equity investments.
7. Private funds (0.01%): Tokens associated with shares of private investment funds (e.g., hedge funds, private equity).
8. Equities (<0.01%): Tokenized stocks of publicly traded companies; enabling 24/7 global access to stocks, and easier access by people in less developed areas.

Note: This table excludes a one-year $64 million bond tokenized on Polygon by Siemens last year, which could be separated into a “corporate bond” type. It also excludes crypto-backed and algorithmic stablecoins.

One way to interpret the above table is that only stablecoins have found strong PMF and taken off. To add some color here, stablecoin volume has gone from virtually zero to near parity with Visa in the last six years, with some expecting volumes to surpass Visa this quarter (Q2’24) (caveat: a large % of that stablecoin volume can be attributed to trading and bots.)

Stablecoin volumes settled onchain annually set to surpass $10 trillion this year, on par with Visa and within an order of magnitude of ACH. Source: Nic Carter, Castle Island Ventures

Before jumping to the conclusion that only stablecoins can compete with major players, let’s not forget about the timelines here. USDT, the first fiat-backed stablecoin, was first issued by Tether in October 2014. It wasn’t until five years later that Paxos issued tokenized gold, the first commodity RWA, and over six years later that Franklin Templeton issued the first government security RWA.

To give some perspective, both commodities and securities RWAs — dominated by underlying gold and treasuries, respectively — have reached >$1 billion market caps faster than stablecoins, which took nearly five years. In particular, securities took off since early 2023 owing to attractively high interest rates on US treasuries.

With this in mind, it is tempting to ask:

Some hopium: If commodities and securities RWAs reach the same sort of crypto-agnostic adoption that we’re seeing recently with stablecoins. Note: Includes crypto-backed and algorithmic stablecoins. Source: The Block.

Looking at MakerDAO’s balance sheet, we also see rapid growth of securities that make up most of their RWA portfolio, starting from just ~10% to over 50% of their assets in 2023. By mid-year, securities topped even stablecoins and crypto loans as their largest asset class. At peak, MakerDAO’s securities holdings reached nearly $3 billion.

From TradFi to “Everything”

Now that we have a sense of what is onchain and their relative maturity, let’s take a look at what’s not onchain (or just starting to come onchain). As RWAs could technically represent any asset outside the blockchain, this list is not meant to be exhaustive but rather highlight some interesting nascent categories. We can only speculate on these category developments based on extrapolation and evidence of early developments:

1. Fine art: While natively digital art on the blockchain as NFTs has entered the mainstream, there is an open question of whether “real-world” art will do the same. Tokenization and fractional ownership could provide better liquidity for high-value artworks and collectibles, making these assets accessible to more people. See Maecenas.
2. Other luxury collectibles: Luxury goods like watches and wine also could benefit from tokenization as markets for these goods are well-capitalized but generally illiquid. The upside here would be opening up these markets to a wider audience. However, given their precious qualities, physical storage, maintenance, and insurance will be major obstacles. That said, we’ve heard some discussions around using various luxury collectible RWAs as collateral in DeFi, somewhat mirroring the use of NFTs — another high-value illiquid asset class for loans (see NFTFi and Blur’s Blend).
3. IP rights: Intellectual property — including patents, copyrights, and trademarks — make up a significant asset class that could be tokenized. Tokenizing IP rights could streamline licensing processes, enhance transparency regarding ownership, and open up new funding opportunities for creators. See IPwe.
4. Infrastructure financing: Large-scale infrastructure projects (e.g., energy financing, transportation networks, public utilities) could be tokenized to allow for fractional investment and easier management of investor stakes. Tokenization here may address three key challenges facing infrastructure projects: financing initiatives, democratizing infrastructure, and increasing efficiency of infrastructure management. See The World Bank’s research on tokenizing infrastructure.
5. Impact claims: Tokenizing impact claims like emission reductions is an interesting direction for RWAs. If done right, it would allow investors to more easily and accurately track the impact of their investments and improve capital efficiency in impact-related markets (e.g., carbon markets). See ixo.
6. Insurance policies: Tokenizing insurance policies could increase the efficiency of insurance markets by enabling fractional policies (e.g., easy partial coverage), risk diversification (e.g., selling risk more broadly), and potentially even automated claims processing through smart contracts. See Etherisc.
7. Agricultural assets: Tokenization of agricultural assets, including farmland and produce, could facilitate better risk diversification for investors and improve transparency and efficiency. See Agridigital.

While it is worth keeping track of these developments, it could take a while to see significant traction in any of these areas. All of the areas above are very much in the crypto-native phase, and as such, their main use case for now is diversification into uncorrelated sources of returns (see below).

Illustration of two-phase adoption curve with example RWAs and their use cases

Market Projections

The general consensus is that the RWA market is going to experience significant growth in coming years. But how much will it grow?

The RWA market is already substantial and growing. Currently, we see over $6 billion locked in the smart contracts of RWA protocols (excluding stablecoins), 33x since around the same time two years ago, and over a fivefold increase since last year.

A BCG report estimated real estate tokenization alone to be valued at $2.7 billion in 2022, and the total size of illiquid asset tokenization globally at $16 trillion by 2030.

Their projections take into account that a large chunk of the world’s wealth is held in illiquid assets, including real estate (including home equity), natural resources, land, commodities, public infrastructure, fine art, computing infrastructure, private equity, and various other asset classes only accessible to select wealthy investors/institutions due to constraints on ticket size (e.g., pre-IPO stocks, hedge funds, infrastructure projects, commodities and alternative investment instruments, and private credit).

Even in the bear-case scenario that only 2% of these assets make it on chain by 2030, we can extrapolate a $3.2 trillion RWA market. In other words, RWAs in 2030 would make up a larger market than all cryptocurrencies today.

Another projection by 21.co in their RWA report estimates that the market will be between $3.5 trillion in the bear-case scenario and $10 trillion in the bull case by the end of the decade, assuming a CAGR ~61% to ~87%. Recently, Jeremy Allaire, founder of USDC, stated he “feels comfortable” saying total stablecoin value will reach $3 trillion by 2030.

We can take away that there’s a non-negligible chance that RWAs are going to become a much bigger market this decade. The underlying assumption is that crypto will keep maturing and more traditional institutions will use blockchains and build products on top of them (see Appendix for a list of major TradFi organizations entering the space).

Challenges

While we are bullish about the future of RWAs and see at least conservative projections realized, we aren’t so sure about the timeline. Numerous risks and challenges, particularly regulatory uncertainties, could slow progress. As the market grows, so will scrutiny over it, and the regulatory challenges may become more significant.

Regulatory Risks

Regulatory compliance and lack of standardized processes are significant barriers to entry. Most jurisdictions still lack clear regulatory frameworks for tokenized assets, which increases risk for institutions on the sidelines and could slow down adoption and innovation.

Deloitte states that risks associated with regulatory compliance are “likely the largest obstacle to adoption of asset tokenization by regulated institutions.” A major issue here is that many regulatory authorities are involved in shaping the rules. Whether an RWA protocol is compliant or not is not an easy answer to the question and currently most fall in a gray zone. To compound this obstacle, the timeline for establishing any clear regulations is uncertain.

Delloite’s framework for risk assessment of digital assets

Technical and Operational Risks

The integration of tokenization with existing financial systems presents various technical challenges. Hurdles to be addressed include (a) ensuring interoperability between different blockchains; (b) establishing robust governance structures; and © managing cybersecurity risks.

The complexity and costs of implementing and tokenization systems could be prohibitive for some institutions. Some institutions may find it too onerous to keep up with the continuous technological upgrades we see in this space and the management of smart contract vulnerabilities.

Fortunately, there are some notable projects like Chainlink, Avalanche, Centrifuge, Nexera, and Plume building RWA infrastructure to address these challenges. And a bunch more entering the scene to keep an eye on:

Correct Valuations

Assets with volatile values or those requiring regular appraisal pose significant challenges to the tokenization process. Real-time oracle valuations must be integrated to reflect current market conditions accurately, ensuring token values align with their real-world counterparts. This is especially critical for assets like commodities, art, or collectibles, where value fluctuations are common and can be influenced by extrinsic factors beyond pure market demand (e.g., regulatory, cultural, environmental).

Ongoing management involves ensuring token integrity and accuracy, particularly as the underlying asset changes in value, undergoes physical changes, or is subject to different regulations over time.

Market Readiness

The market’s readiness to adopt tokenized assets on a large scale is uncertain. Take stablecoins as an example, while they make up over 96% of the RWA market onchain today, they saw a major downturn following the collapse of Terra/UST and during bearish market sentiment, with stablecoin supply falling over 25% from ~$162 to ~$120 billion during a 1.5 year period from April 2022 to September 2023.

However, there has been some retrace since then, both indicating market readiness to adopt this class of RWAs (again) but also the volatility and immaturity of this market.

So while there are signs of significant interest at least in the stablecoin class, the actual widespread adoption of tokenization across various newer RWA classes like government bonds and real estate may take longer than expected. If (or when) crypto markets are hit by black swan events in the future, we can expect further delay.

Economic and Social Barriers

Socioeconomic factors such as low internet penetration in some regions pose an obstacle to accessing tokenized assets. Additionally, to see market growth in a big way we obviously need not only significant capital deployment, but also to foster understanding and trust in tokenization in both institutional and retail investors alike. Without this prologue, there won’t be enough liquidity in secondary markets to realize the benefits of tokenization in the first place.

Diverse Asset Categories

We should remember that not all RWAs are alike, and each presents unique challenges in terms of ensuring authenticity, maintaining condition of the underlying asset, and handling storage and preservation needs. These factors will vary greatly depending on whether we’re talking about fiat currencies vs. real estate vs. artwork vs. luxury goods. To compound this, each real-world asset class can come with its own rules governing their tokenization, sale, and transfer — varying across different jurisdictions.

Investing in RWA Projects

Given all that was discussed so far, we can use a two-axis chart as a heuristic for identifying investable projects in the RWA space, where the horizontal axis spans from “core TradFi” to “everything else” and the vertical axis represents decreasing feasibility given technical and regulatory challenges.

Investable areas in RWAs, projects toward top and left are generally more ready and attractive in the short to medium term

For the near term, we would bet on projects falling more towards the top-left of this triangle chart, where there is some combination of:

1. Large unlockable liquidity
2. Global demand
3. Yield/DeFi opportunities
4. More regulatory clarity

Tokenize eVerYThInG?

Not a good idea. To the disappointment of crypto fanatics and permabulls, some things simply should not be tokenized. These include highly-regulated substances (e.g., drugs, hazardous materials, etc), custom goods made for specific buyers, perishable goods, low-value items (e.g., ordinary clothing, household items). Tokenization of these would be impractical for one or another reason — compliance challenges, market size, storage requirements, low liquidity, non-global interest, etc. — and there’s little or no benefit to outweigh the costs of implementing tokenization and blockchain technologies.

Conclusion

RWAs present a transformative potential for the crypto industry to go from niche to mainstream — first evidenced by the adoption of stablecoins for practical uses such as hedging against currency debasement and making cross-border payments. There are some indications that we may see other RWAs bridge the adoption gap from niche crypto to normies. The involvement of major TradFi institutions like BlackRock and Franklin Templeton in issuing tokenized treasuries, alongside major DeFi protocols like MakerDAO and Ondo Finance rapidly growing their assets in tokenized treasuries last year, underscores a developing opportunity for on-chain diversification and yield.

But, the journey towards widespread acceptance and utilization of tokenized RWAs is not without major technical and regulatory challenges. Users need time to get comfortable with these new products and build trust in their reliability and security — similar to the gradual acceptance of stablecoins over the past decade. Despite these challenges, we see these obstacles being overcome through continued innovation and regulatory engagement.

Looking ahead, the future of tokenization is promising, offering numerous benefits such as liquidity, borderless and permissionless accessibility, and transactional efficiency. As market readiness increases through testing and time, institutions that proactively engage with these innovations, adapt to emerging regulatory frameworks, and contribute to technological advancements in this space are likely to profit. The progressive integration of tokenization holds promise for a more inclusive, efficient, and transparent financial ecosystem where the lines between DeFi and TradFi are increasingly blurred, as is the divide between crypto enthusiasts and the general public.

If you’re building in these spaces or this post resonates with you, hit me up!

Appendix

Some major TradFi organizations actively exploring and implementing tokenization projects:

1. BlackRock (launched March 2024): BlackRock’s first tokenized asset fund BUIDL, created with Securitize, has captured almost 30% of the $1.3 billion tokenized Treasury market in just six weeks with ~$380 million in tokenized treasuries, taking the top spot from Franklin Templeton.
2. Franklin Templeton (launched April 2021): Franklin Templeton issued a U.S. government money fund (BENJI token) on the Stellar blockchain. Currently ~$370 million in tokenized treasuries.
3. JPMorgan Chase (launched October 2020): JPMorgan’s Onyx platform is a blockchain-based system designed to facilitate intraday repo transactions. It has successfully handled over $300 billion in transactions.
4. Goldman Sachs (launched November 2022): Goldman Sachs launched its digital asset tokenization platform, GS DAP, with the issuance of a €100 million ($104m) digital bond for the European Investment Bank (EIB) on the private GS blockchain.
5. HSBC Orion (launched November 2022): HSBC has been involved in the issuance of tokenized bonds, aiming to streamline processes and reduce the time from issuance to market.
6. UOB (launched April 2022): ​​UOB also issues tokenized bonds.
7. Singapore Central Bank (launched October 2022): Launched Project Guardian, a collaborative initiative with policymakers and the financial industry that seeks to test the feasibility of applications in asset tokenization and DeFi.
8. State Street (launched May 2023): Has expressed interest in tokenizing ETFs and private assets.
9. Santander (launched May 2022): Santander launched loans backed by tokenized commodities such as soy and corn.
10. Siemens (launched February 2023): Launched first digital bond (€60 million; maturity of 1 year) on a public blockchain (Polygon) in accordance with Germany’s Electronic Securities Act (eWpG).

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Disclaimer: This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice, or investment recommendations. This post reflects the current opinions of the authors and does not necessarily reflect the opinions of Inception Capital, its affiliates, or individuals associated with Inception Capital. The opinions reflected herein are subject to change without being updated.