Real World Assets: The Emerging Paradigm For Web3
The following is the research piece produced by some of the core members of OccamDAO which explores the current state of tokenization, its potential for the web3 industry at large and challenges it faces. Research also contains a use-case which describes the tokenization stack of Galactica Network.
This use case was co-authored with the team of Galactica.com.
Potential
Real World Assets (RWAs) are tangible assets that exist outside of the blockchain ecosystem. Specialists tokenize and incorporate these assets into the blockchain, which enables them to serve as a source of yield within the Decentralized Finance (DeFi) sector. RWAs include a diverse range of traditional assets, including commercial real estate, bonds, vehicles, and other articles of value, all of which can be effectively tokenized and accounted for.
The integration of RWAs is a pivotal step forward for DeFi. It opens up opportunities for participants in the space to tap into the extensive reservoir of liquidity, opportunities, and value inherent in the traditional, non-digital asset domain. To put this into perspective, while the digital asset space is estimated to be worth around US$1 trillion, traditional financial systems persistently hold assets exceeding US$600 trillion [1]. Therefore, in order for DeFi to profoundly transform global financial practices, it is essential to fully tokenize and integrate access to RWAs.
Alongside DeFi protocols, traditional finance (TradFi) sectors are increasingly recognizing the potential impact of RWA integration. Over the past few years, several institutions have started to explore the development of proprietary blockchain systems for tokenizing assets.
Case in practice, blue-chip institutions like Goldman Sachs and J.P. Morgan have taken to experimenting with tokenized RWA offerings to achieve cost savings and efficiencies. J.P. Morgan’s Onyx Digital Assets team, in collaboration with Apollo Global Management, announced as recently as November 2023 that it intends to develop a proof-of-concept system under Project Guardian to enable fund managers to tokenize funds [2].
Goldman Sachs, through its Digital Asset Platform (GS DAP), has similarly achieved significant savings in digital bond issuances [3]. Broadridge, Equilend, Intain, Vanguard, and Liquid Mortgage are also notable for their developments in leveraging blockchain for asset tokenization and achieving efficiencies in various financial processes, according to reporting by Coindesk [4].
With this trend gaining momentum, it is anticipated that traditional exchanges will eventually support the secondary trading of tokenized real-world assets. As the industry matures, regulatory developments will likely be a key catalyst in driving widespread acceptance and adoption of these practices.
Integrating traditional assets into blockchain platforms presents a variety of benefits for conventional investors, such as:
- Liquidity: Simplified architecture for liquidity provision and end-user access.
- Accessibility: Tokenization on blockchain platforms makes traditional assets globally accessible, broadening investor reach.
- Transparency: Blockchain ensures a tamper-proof, publicly accessible record of ownership, giving stakeholders clear insight into how tokenized assets are managed and governed.
- Settlement efficiency: Faster settlements and lower operational and intermediary costs work to streamline transaction processes.
- Composability: Tokenized assets offer versatility, usable across various services within the same blockchain network. For example, a tokenized security can serve as collateral in a lending market, or provide liquidity in a decentralized exchange.
- Interoperability: Seamless transfer of assets and data across different blockchains if, for example, two banks decide to use distinct blockchains, for example, Ethereum and Polygon respectively.
According to a Boston Consulting Group report, the market for tokenized assets is projected to reach $16 trillion by 2030 [6]. This includes tokenizing assets already on the blockchain and fractionalizing traditional assets like exchange-traded funds (ETFs) and real estate investment trusts.
Even with the impressive projection of $16 trillion, tokenized assets will still only constitute a small fraction — less than 1.8% — of the global asset value, estimated at $900 trillion. This calculation doesn’t factor in the potential growth of the global asset value. However, it’s arguable that the actual addressable market is the entire global asset market, considering the potential for any tokenizable item to be represented as RWAs on-chain.
DeFi users have demonstrated significant interest in tokenization and RWAs, as evidenced by the surge in activity at the beginning of 2023.
According to 21co’s Tokenization Report, the market value for tokenized assets is estimated to vary from $3.5 trillion in a conservative bear-case scenario to as much as $10 trillion in an optimistic bull-case scenario by 2030 [8].
Current State of the Market
The following table illustrates the evolving landscape of asset tokenization. While fiat-backed stablecoins were the initial and most successful application of this financial innovation, its use cases have expanded significantly. A notable development in this expansion is the European Investment Bank’s issuance of bonds on a private distributed ledger technology (DLT) platform.
Although significant progress has been made in integrating RWAs on-chain, the current market across public blockchains like Ethereum, Arbitrum, Avalanche, Optimism, and Base is still largely dominated by stablecoins, which make up 97% of the market share. As a result, other asset classes like commodities, corporate bonds, and government securities are significantly less represented in the market.
Even with the substantial growth in the tokenization of government securities this year and evident interest from both retail and institutional investors, these assets currently represent only 1% of the market. This limited market share is attributed to the lack of regulatory clarity and the absence of a compliance layer, which impedes the full integration of RWAs into the Web3 ecosystem. The Web3 space, evolving alongside a Regulatory Trinity (AML/CFTC, Market Structure, Securities Regulation), often encounters regulations specific to jurisdictions like the EU and the US [10]. Addressing these regulatory challenges is essential for the further development of RWAs in the Web3 space.
Challenges
Five key challenges currently confront the tokenization of assets:
- Legal and regulatory compliance: Establishing a legal framework is crucial to ensure that transferring a token equates to transferring ownership of the underlying asset.
- Valuations and audit implications: Implementing a robust price discovery mechanism is necessary so that tokens trade at values close to their intrinsic or nominal worth.
- Standardized laws and regulations: How can tokenized securities spanning across multiple jurisdictions operate in a globally compliant manner?
- Security and scalability: Public blockchains must demonstrate resilience against cyber-security attacks and scale to the demands of the global financial system.
- Collaboration between the multiple key stakeholders: Creating a standard process for on-chain asset integration is vital to minimize human intervention and enhance scalability.
Tokenization on Galactica Network
When it comes to integrating traditional finance with DeFi, one of the most significant barriers is the lack of a regulatory compliance layer within blockchain protocols. This deficiency is particularly problematic for transferring institutional assets to blockchain platforms. The absence of a compliance framework creates a misalignment between blockchain operations and existing financial regulations, hindering traditional financial institutions from fully adopting DeFi practices.
The most promising solution at present involves the application of ZK technology. This technology facilitates the secure and private exchange of personal and financial data while maintaining privacy and establishing a linkage between ownership and real-world identity. ZK technology streamlines processes such as Know Your Customer (KYC) and Anti-Money Laundering (AML), offering a robust framework for identity management. It uniquely meets both the privacy requirements of public blockchains and the stringent demands of regulatory compliance.
The increasing recognition and adoption of ZK technology by both Web3 and traditional institutions highlight its potential as a key enabler in shaping the future of finance.
Galactica Network is a protocol tailored to streamline the integration of RWAs onto the blockchain. It provides an effective compliance layer, while ensuring the secure handling of user data in this process.
Before delving into the benefits of tokenization on the Galactica Network, it is pertinent to understand its advantages over Permissioned blockchains. Often viewed by traditional investors and regulators as a more secure option compared to permissionless networks, Permissioned blockchains have a number of distinct differences. The following table highlights these key differences.
Galactica Network is committed to creating a blockchain platform that emphasizes regulatory technology (RegTech), catering to the new wave of Web3 regulations. This mission involves not only complying with these emerging standards, but also enhancing the platform’s functionality with programmable features, all while upholding the fundamental Web3 values of decentralization and privacy protection.
Let’s outline key features that make this possible:
- ZkKYC: Linked to the concept of Galactica Network Citizenship, this feature verifies that users are over 18 and not from sanctioned countries, addressing compliance while protecting privacy and personal data security. It expands users’ Web3 Footprint and Persistent Identities, enhancing Sybil resistance.
- Contingent Transactions: This feature, effectively a dynamic whitelisting mechanism, ensures dApps comply with defined regulations. It effectively tailors user/liquidity compliance profiles within dApps. For instance, a zkCertificate (zkKYC issued on-chain) could be used to confirm a user’s age and accredited investor status within the U.S., allowing for specific dApp interactions without revealing sensitive information.
Further details on these concepts are available in the respective sections of the Galactica Network Whitepaper.
The accompanying illustration demonstrates how these features could be operationalized, using the example of a Gated Liquidity Pool deployed on the network.
These technological concepts make possible:
- Security tokens issued by licensed entities. Primary and Secondary spot markets for:
— Real World Physical Assets
— Financial Assets
— Hybrid Assets
- Merge of Web3 efficiency and TradFi asset diversity, regulation and liquidity.
- Automated compliance proofs for on-chain transactions reducing compliance costs.
- Privacy pools and other forms of compliant financial privacy.
- Establishment of CeDeFi, blending the centralized finance experience with the decentralized mechanisms of DeFi.
References:
[1] The Tie Research (2023), Real World Assets: Finance’s Bridge to Crypto.
[2] Business Wire (2023), Onyx by J.P. Morgan and Apollo Explore Tokenization in Investment Portfolios Across Blockchains as Part of Project Guardian.
[3] Business Wire (2023), Goldman Sachs’ Tokenization Platform GS DAP™, Leveraging Daml, Goes Live.
[4] Coindesk (2023), Tokenization and Real-World Assets Take Center Stage.
[5] Binance Research (2023), Examining the State of Real-World Assets.
[6] Boston Consulting Group (2022), Relevance of on-chain asset tokenization in ‘crypto winter’
[7] Federal Reserve Board of Governors (2023), Tokenization: Overview and Financial Stability Implications.
[8] 21.co (2023), The State of Tokenization.
[9] Dune Dashboard (2023), Summary Table of Tokenization: By Type of Asset.
[10] Galactica Network (2023), Regulatory Trinity.
[11] Binance (2023), Real World Assets: State of the Market.
[12] a16z (2023), State of Crypto Index.
