Crypto’s Next Chapter; The Tokenization of Real World Assets

From its inception, cryptocurrency has suffered from the lack of an established connection to the traditional financial industry. While freedom from regulation brought its own unique merits, the unintended consequences of this isolation have resulted in a constrained design space for applications, limited vectors for the generation of real yield, detachment from stability, and a strong dependency on anonymous fair actors. DeFi in particular has been stuck in a closed loop of self-reflexive money cycling. Real World Assets are about to change this in a very big way.

An introduction to Tokenizing Real World Assets

Acting as a bridge between the decentralized world of crypto and the legacy financial system, the term Real World Assets (RWAs) originates from within the crypto industry and refers to the tokenization of traditional financial instruments of value such as stocks, precious metals and credit. RWAs are a key building block for crypto’s long term vision of “the tokenization of everything”.

Since the arrival of smart contracts in the public domain, blockchain platforms have become a trusted source for the issuance, storage, and management of tokens. At its most basic, a token is a unit of account that asserts ownership over any abstract object and tokenization is the process of issuing digital assets on a distributed ledger. As simple as this technology might seem on the surface, its implications are profound. The marriage of decentralized systems with legacy finance provides the best of both worlds to create the most robust and efficient economic infrastructure in human history. Where TradFi lacked, DeFi blossomed and vice versa. The rigorous standards of legacy finance have provided strong accountability guarantees to consumers (not including banks), while the anonymity of DeFi has resulted in, well, the financial madness that still runs rampant in the crypto market.

Applying tokenization to RWAs means that traditional assets will be put on-chain via tokenized representations. Citigroup believes this innovation to be a $4 trillion and 1 billion users opportunity in the short term, and a $250 trillion+ opportunity over the next decades. Why? Because DeFi is a significantly more efficient infrastructure for finance than what we're currently working with.

The perks of RWAs vs the traditional financial system

The market efficiency benefits of RWAs are synonymous with the generalized efficiency benefits of blockchain technology:

- Accessibility

Due to the nature of distributed cloud servers (aka blockchains) being operational 24/7, RWA’s will allow market participants around-the-clock access to trading/investing in assets. This is in stark contrast to the traditional financial industry which is closed after working hours and during weekends and holidays.

- Settlement

TradFi settlement can be as long as three days, meanwhile, depending on chain design, settlement of trades will become near-instant, which in turn reduces any uncertainty. You can also directly own the assets in your own wallet.

- Disintermediation

Blockchain servers and protocols automate and provide a full stack of necessary functionality that has traditionally required a multitude of 3rd parties to service. By rendering those third parties obsolete, the fees associated with their services will disappear.

- Fractionalization

The programmability of tokenization extends the granularity of traditional assets. This fractionalization unlocks liquidity for many different assets, lowers the barriers to entry and allows for enhanced accuracy of ownership.

- Composability

As the financial landscape continues to evolve at the speed of human innovation and new protocols are built, there will be unified infrastructure for collaborative development. As the RWA system evolves, new financial and digital innovations will be built around these assets.

- Interoperability

Legacy asset classes will now be able to interact with decentralized primitives (AMMs, liquidity pools, bridges, etc.) and fulfill the promise of a superfluid financial ecosystem. At some point in the not too-distant future, you will be able to trade any asset against each other.

- Transparency

The mantra of decentralization is “Don't trust, Verify”. By having the data associated with RWA recorded in a distributed ledger, previously opaque information (such as the flow of money) will become openly available.

Different Types of RWA’s

Tangible and intangible, liquid and illiquid, the spectrum of Real world Assets is immense.

Tangible - physical products.

Currency
The largest and most liquid markets in the world, FX (foreign exchange) markets are already prominent in the crypto ecosystem in the form of stablecoins. However, with the RWA narrative being accepted/embraced by regulators the size of this market segment will grow exponentially.

Real Estate
With a global market value north of >$3.9 Trillion USD, real estate is one of the ripest markets for tokenization. Notorious for its cumbersome, slow, and fee-ridden processes of settlement, it comes as no surprise that Real Estate RWA has been a segment under research and development since the advent of smart contracts.

Precious Metals (Gold, Silver, Platinum, Copper, etc.)
For the last 100 years, precious metals have transitioned their trading patterns from physical coin exchange to paper settlements, after all, trading physical blocks of gold requires immense logistic expense and is very inefficient. Paper settlements brought an exponential increase in market participants, tokenization will further improve the efficiency of this ancient commodity.

Art

Long considered to be a market of the ultra-wealthy elites, the art market has been one of private valuations and speculative prices. After the empowerment of digital art via NFTs, this once-unreachable market has slowly begun evolving into a publicly accessible one.

Intangible - non-physical or informational products.

Equities

Shares of companies, commonly referred to as stocks, are highly desirable products with a well-developed market infrastructure already existing. However, the equities markets have historically been geographically concentrated. Through tokenization, these markets will be able to deepen their liquidity and garner global interest across borders.

Bonds

Be it a corporation or a government, bonds are the most common form of fixed-income debt products on the market. Considered to be among the most reliable of sources for “real yield” the arrival of this asset segment on the blockchain re-invents potential credit leverage.

Carbon Credits

The youngest of all other markets discussed here, carbon credits are still an untapped source of capital efficiencies with environmental purposes. Somewhere between debt and equity, these exotic instruments have a very unique value proposition as they carry no inherent value until they are “claimed”. Not something retail market participants have access to as this is only used by big businesses as a means to offset carbon production. By introducing retail to this sector a radically new and fair-market pricing model will arise.

Leading Projects in the Space

Projects have been building in this space long before it was called RWA. Since the introduction of ICO (circa 2017), thousands of startups have been attempting to develop tokenized assets (mainly in real estate). Some called it securities, others called it utilities and all of them tried to tokenize everything under the umbrella of the ERC-20 standard. The vast majority of them did not live past the hype cycles.

Some six years of development later, an array of new token standards came to the foray (ERC-721, ERC-3643, ERC-2222 & ERC-4626) that have empowered a new wave of robust projects that are pioneering the RWA revolution:

MakerDAO

Creator of the first widely recognized and used decentralized stablecoin, DAI, MakerDAO is the oldest standing project in the space. Having proven a degree of sustainability with a combination of dedicated vaults and an over-collateralized crypto-based model, it has carried this success over to its RWA operations. Supporting over $700 million USD in on-chain RWA-backed loans, MakerDAO is leading in terms of volume. An interesting design element worth noting is the MakerDAO protocol actually issues its own Dai stablecoins whenever a loan is taken.

Goldfinch

A decentralized credit protocol focused on helping emerging market businesses obtain loans. Goldfinch requires RWA collateral from potential borrowers. With a strict policy around the assets that can be used for pledging as collateral, USDC only, Goldfinch is a rare case study that has created a resilient “counter-cyclical” business model. As a progressively decentralizing DAO project, Goldfinch has an emission rewards model for its GFI token based on platform contribution. In order to earn GFI users must contribute to lending pools. Users that hold the native GFI tokens become DAO members and contribute to the platform's operations by vetting the creditworthiness of prospective borrowers and underwriting loans.

Maple Finance

A credit market that is designed to service existing corporates and enterprises with a radical approach to its collateralization for the provision of credit. Closer to a permissioned model with a few touch decentralized touchpoints, Maple is the first of its kind to offer uncollateralized on-chain loans. Maple Finance integrated the legacy underwriting system for risk analysis via “delegates”.

Backed

An issuer of asset-backed tokens, namely company stocks. Backed acts as a custodian that owns the RWAs and issues tokens that represent ownership rights to the underlying assets at a 1:1 ratio (1 token = 1 stock). While the tokens can be traded on-chain seamlessly, in order to convert the tokens to claim their underlying asset, users must go through an identity verification process and comply with jurisdictional regulations.

Centrifuge

A novel lending protocol focused on providing credit to businesses that would have otherwise not been able to get it in traditional markets. Decentralized in its structure, the protocol leverages a pooled liquidity model to aggregate capital from investors for the provision of loans. The providers are able to earn a yield based on real world financial activity rather than speculation. Centrifuge abides

More fundamentals make you never leave the blockchain

Many of the world's premier financial institutions have been striding gallantly into RWA’s. Well-known enterprises such as Goldman Sachs, Siemens, Hamilton Lane, and Boston Consulting Group have already begun to execute their operations on-chain, going so far as actually building out their own platforms and protocols. Even governments have already dipped their portfolios into the distributed ledger ecosystem with Hong Kong issuing a $100 million USD bond on the Goldman Sachs platform.

Managing an eye-watering ~$10 Trillion USD and growing, the dominant multinational megacorp, Blackrock, has plunged into the world of tokenization of real world assets. Going as far as claiming that the “tokenization of securities is the future of all markets”, CEO Larry Fink likens the coming evolution of tokenization to the evolution of legacy markets on the arrival of ETF’s. To put some context around this, after the first ETF was introduced in January of 1993, the growth rate of the markets accelerated to historical levels and rallied for 6 years straight.

This transformation has only just begun. With a tremendous amount of work ahead for startup ups, regulators, and institutions, it seems as though the wisdom of crypto OG’s reigns true even today, we’re still very early.