Tokenizing Real-World Assets: An Exploration

Tokenizing real-world assets has become a revolutionary force in the financial landscape. This transformative process of tokenization represents real-world assets (RWA) in digital form on a programmable and automated blockchain, encompassing tangible and intangible assets such as real estate, precious metals, art, collectibles, company shares, carbon credits, patents or bonds. The advantages of this approach are multifaceted, ranging from cost reduction to increased liquidity and transparency. In this blog, we’ll delve into the intricacies of real-world asset tokenization (also been termed OCA (off-chain asset) tokenization), explore current trends, and envision its future impact.

Understanding Real-World Asset Tokenization

Real-world asset tokenization leverages blockchain technology to create virtual investment vehicles representing assets. This method allows for direct trading or fractional ownership, making assets more accessible. Instead of relying on physical documents, ownership details are securely recorded on the blockchain.

The real-world attributes of the assets, such as their performance and valuation, are tracked, deriving them from sources outside the blockchain. Similar to other crypto tokens, real world asset tokens can be programmed to include features like lockup periods and specific requirements for investors.

Advantages of Tokenizing Real-World Assets (not MECE*)

1. Cost Reduction, Eliminating Middlemen & Efficiency: The elimination of intermediaries like lawyers and brokers significantly reduces transaction costs, making investment in real-world assets more affordable, much faster to transact and settle.
2. 24/7 Trading: Blockchain enables continuous, 24/7 trading, enhancing liquidity and market efficiency beyond traditional working hours.
3. Lower Entry Barriers: Fractional ownership capabilities reduce the barrier to entry, enabling a broader range of individuals to participate in investments that were once exclusive.
4. Increased Transparency: All transactions are recorded on the blockchain, providing an immutable and transparent record of ownership, fostering trust among traders.
5. Less Volatility: The benefits of tokenizing asstes for the crypto economy include new sources of less volatile collateral and less volatile yield for DeFi protocols — reducing the risk exposure to highly volatile, often correlated, cryptocurrencies.
6. Unlocking of Illiquid Assets: A significant portion of global wealth is locked in illiquid assets, all else equal, illiquid assets usually trade at a discount and have limited trading volumes, and thus have inefficient price discovery mechanisms, relative to liquid assets. Tokenisation can reverse this and users can even use a tokenized illiquid asset as collateral in a lending marketplace, or e.g., provide liquidity on a decentralized exchange.
7. Financial Inclusion: Tokenization has the potential to address the financial inclusion gap, providing access to investments for the 1.7 billion people without financial services. By breaking down barriers and fractionalizing assets, tokenization makes traditionally illiquid investments accessible without (or with much less) borders.

Challenges of Tokenizing Real-World Assets (not MECE*)

1. Legal and Regulatory Compliance: Tokenization requires a legal framework governing ownership transfers. Essentially, the challenge lies in guaranteeing that the transfer of a token signifies the transfer of ownership of the underlying asset. Market participants holding or exchanging tokens must comply with anti-money laundering (AML) and know your customer (KYC) regulations, verifying the identity of their clients. The potential solution lies in leveraging Zero-Knowledge (ZK) technology, which has the capability to automate the secure exchange of personal and financial information, maintaining privacy, and establishing a connection between ownership and a genuine identity.
2. Standardized Laws and Regulations (Cross-border): There are no clear regulatory frameworks in place and the clarity of exisiting frameworks varies immensely across different jurisdictions. It is not evident at this stage how tokenized securities can be compliant across multiple jurisdictions.
3. Valuation and Audit Implications: Enforcing an effective price discovery mechanism is crucial to facilitating the token’s trading in proximity to the “intrinsic” or nominal value of various tokenized assets. Additionally, ensuring rigorous collateralization standards becomes imperative, especially in instances where institutions hold cryptocurrencies.
4. Security, Scalability & Collaboration Amongst Multiple Stakeholders: Public blockchains must demonstrate resilience against cyber-security attacks and scale to the demands of the global financial system. There is a need for a standard for bringing assets on-chain to minimize human intervention and make things as scalable as possible. Potentially, Artificial Intelligence (AI) models can be used to analyze historical data for identifying patterns of vulnerability, combined with regulated sandbox environments that allow for experimentation with novel securitized implementations.

A Multi-Trillion Dollar Market Opportunity

In 2023, there are about 431 million crypto users or about ~5.36% of the world population. The level of crypto adoption today is equivalent to internet adoption in 2000 when the number of internet users amounted to 361 million or 5.91% of the world population at the time. The countries with the highest percentage of crypto ownership tend to have a high internet and banking penetration rate. Today, holders of tokenized assets account for a little more than 10% of the estimated 431 million crypto owners, or roughly 47 million people.

Accordding to the research by 21.co, the value of tokenized assets across public blockchains amounts to about $118.57 billion as of October 2023. Digital dollars or USD stablecoins are the first successful tokenization implementation, representing ~10% of crypto’s total market value and ~97% of all tokenized assets. Ethereum remains the digital asset industry’s financial hub, with over 50% of stablecoins deployed on the network.

Other asset classes, including U.S. treasuries, have seen significant growth this year (>450%) on the back of decades-high interest rates. The valuation of tokenized U.S. Treasurys has surged to $685 million. Furthermore, real estate has experienced a 102% growth in on-chain values between Q1 and Q3 2023. However, outside USD stablecoins, most of the tokenization solutions today are still not globally accessible due to regulatory restrictions and socioeconomic circumstances.

Tokenization by Types of Assets across Selected Blockchains (Ethereum, Avalanche, Stellar, Arbitrum, Base, Polygon, Gnosis, Optimism)

Based on the same study, the market value for tokenized assets will be between $3.5 trillion in the bear-case scenario and $10 trillion in the bull case by 2030, which would be a 40-fold increase from 2022. The market value is derived from the estimated penetration rate of the total addressable market across various asset classes, including non-financial corporate debt, real estate funds, private equity, securities collateral, trade finance, and public debt securities.

The Growing Landscape and Institutional Interest

Institutional investors, comprising 91% of respondents in a joint Celent and BNY Mellon survey, express keen interest in tokenized assets, clearly showing that traditional finance institutions are recognizing the potential of this alternative asset class.

Franklin Templeton’s launch of the Franklin OnChain U.S. Government Money Fund in 2021 and its subsequent expansion highlights the shift towards blockchain for processing transactions.

In Q3 2023, blue-chip institutions such as Goldman Sachs and J.P. Morgan are exploring digital asset offerings for cost savings and efficiencies. Key themes include the adoption of end-to-end digital systems, resulting in significant savings. Examples include Goldman Sachs achieving 15 basis points in savings for a €100M digital bond issuance and J.P. Morgan projecting $20 million in savings on a $1 trillion tokenized repo volume. Various companies, such as Broadridge, Equilend, Intain, Vanguard, and Liquid Mortgage, showcase notable efficiency gains through blockchain solutions. The Bank of America sees RWA tokenization as a key driver of digital asset adoption.

Money markets and treasuries are focal points for familiarizing asset managers and issuers with tokenization workflows, generating yields on-chain. While alternative product strategies are in development, money markets yielded approximately 5% annually, accumulating nearly $700 million in on-chain capital by the end of Q3 2023.

Institutions are moving beyond operational uses and savings, placing tokenized products with their client bases. Citi offers digital corporate bonds through BondbloX to Southeast Asia private banking and wealth management clients. UBS extends its digital offerings, with an Ethereum-based money market fund in Singapore. As blue-chip institutions expand their digital suites, their private banking, wealth, and asset management teams are becoming distribution channels, accessing capital that retail broker-dealers may struggle to reach.

Examples of Companies Tokenizing RWAs

1. Centrifuge: facilitates decentralized financing of liquid capital markets. By harnessing the power of blockchain technology, the protocol is bringing the entire structured credit market on-chain to provide DeFi users with a stable source of collateralized yield. Centrifuge uses the $CFG token.
2. Maple: is another protocol that provides an innovative protocol for credit specialists to establish on-chain lending businesses. This integration of industry-standard compliance and smart contracts results in a versatile platform for financial institutions, pool delegates, and companies alike. $MPL is the governance token of the Maple Protocol.
3. Pax Gold (Paxos): offers investors a way to own investment-grade physical gold on the blockchain. Each $PAXG token is backed by one fine troy ounce of gold that is stored in LBMA vaults in London.
4. Ondo: a project that has managed to tokenize US Treasury Bonds on-chain. Tokenized US Treasury Bonds, called OUSG, can be used as collateral on platforms like Flux Finance, allowing their holders to unlock more liquidity that can be used for leverage, or deployed elsewhere to farm and earn more yield. For example the Ondo US Dollar Yield Token, or $USDY is a tokenized note which takes innovation from stablecoins and is secured by short-term US treasuries and bank deposits.

Tokenization examples by issuer, asset type, and platform (non-exhaustive list)

Future Outlook

The market for tokenized assets is poised for substantial growth. Forecasts underscore the transformative potential of tokenizing real-world assets. Financial assets and real estate are expected to dominate, given their size and widespread use cases.

RWA Market Cap and Share Change, Source: Overview of On-Chain RWAs and the Forces Propelling their Growth, October 5,2023, Galaxy

Tokenization may represent a breakthrough in financial innovation comparable to the introduction of mutual funds in the 1970s and ETFs in the 1990s. However, given there will be proper regulatory frameworks, its impact will be much more ubiquitous as it allows any asset to be represented digitally on the blockchain. As investors seek sustainable yields and transparent investment sources, tokenized real-world assets are poised to play a pivotal role in shaping the future of finance.

To conclude, the journey of tokenizing real-world assets is unfolding in real-time, and its impact is reverberating across industries. Whether it’s the democratization of investments, the disruption of traditional financial frameworks, or the enhancement of transparency and liquidity, the tokenization of real-world assets is not just a glimpse into the future — it is the evolution of the financial ecosystem happening now.

While use cases like stablecoins illustrate the potential of tokenization, we are still in the experimental phase of this innovation. As the digital asset space matures, it will converge with the traditional financial system and become more present in our lives, analogous to how the Internet has increasingly become an essential part of our daily lives over the past 30 years. Today, holders of tokenized assets already represent more than 10% of the crypto owners.

I expect crypto to integrate with existing financial software and build bridges into the physical world, enabling tokenization to grow into a multi-trillion-dollar industry impacting billions of people worldwide.

We are at a turning point — RWA tokenization is an application of the blockchain infrastruture that has been built so far. We have years to go but value creation is on its way.

Cycle of Technological Innovation

*MECE — The MECE principle, is a grouping principle for separating a set of items into subsets that are mutually exclusive and collectively exhaustive

Sources:

• CoinDesk: Tokenized Real Estate
• World Bank: Financial Inclusion Overview
• Boston Consulting Group: Tokenization of Assets
• Dune Analytics: https://dune.com/21co/tokenization-overview
• Tokenization Report by 21.co Research Team
• Warp Capital: RWA Report Bonds and Treasuries November 2023
• The Block: Tokenisation of Off-Chain Assets
• CoinDesk: Tokenization and Real World Assets Take Centre Stage