Introduction 

Real-world asset (RWA) tokenization has gained huge momentum over the past few years and has an estimated market worth trillions of dollars. This surge in popularity can be attributed to the growth of DeFi protocols and the burgeoning interest from financial institutions and governments in bringing financial instruments on-chain. 

Through tokenization and blockchain technology, virtual counterparts of physical assets such as property, art, treasuries, and even luxury items like watches and jewelry can be created. This transformative process, known as asset tokenization or digitization, entails converting rights to assets into digital tokens. These tokens can be securely and reliably bought, sold, and traded using blockchain technology, effectively increasing liquidity as well as lowering costs and transaction times across markets. 

In this primer, we will delve into the mechanics of real-world asset tokenization, exploring its use cases, advantages, and challenges. Additionally, we will provide an overview of the key participants driving innovation and encouraging institutional adoption in this burgeoning asset class.

While Real-World Asset tokenization has yet to fully integrate into financial markets, Boston Consulting Group has predicted that asset tokenization could reach $16 trillion by 2030. There is no doubt that tokenization is poised to reshape the landscape of traditional investment practices.

How does RWA tokenization work?

Through tokenization, real-world assets become digital tokens that symbolize ownership of physical assets, such as gold, or digital entities like protocols. The digitization of these assets introduces an immutable and transparent record on a blockchain, providing a secure means to verify ownership, sales, and transfers. The representation of an asset encompasses the essential and specific properties of an asset, such as measurements, expiration date, underlying price, entitlements, reserves, physical and transfer conditions, rights, and more. 

Tokenized assets can take two primary forms: "off-chain", representing ownership of a physical asset, or a native "on-chain" token, solely existing within the digital realm. This distinction allows for a flexible and diverse range of tokenized asset structures.

RWA tokenization Infrastructure 

The tokenization process for real-world assets.

RWA infrastructure refers to the underlying technological and organizational framework that supports the tokenization and management of real-world assets. This infrastructure includes:

Blockchain Technology

The choice of blockchain platform is critical. Ethereum Virtual Machine (EVM) networks are most commonly used for RWA tokenization because of their versatility and large developer community.

Smart Contracts

Smart contracts are self-executing software programs that automate the actions required in an agreement and run when predetermined conditions are met. They play a crucial role in automating and enforcing the rules and agreements associated with RWA tokenization.

Legal and Regulatory Frameworks

Well-defined legal structures and compliance with regulatory requirements are integral to RWA infrastructure. Legal frameworks must ensure that tokenization adheres to existing laws and regulations.

Security and Identification

Secure and reliable identity verification processes are implemented to ensure the legitimacy of participants in the tokenization process. This may include processes like Know-Your-Customer (KYC) and Anti-Money Laundering (AML). 

Blockchain Network Data

Tracking wallets, transfers, mints, balances, and overall activity is critical for users of RWA protocols and investors.

Oracles

Oracles provide external data to smart contracts, facilitating the integration of real-world information (such as asset valuations) into blockchain-based systems.

Technology and Token Standards

While ERC-20 for fungible assets and ERC-721 for non-fungible assets have been around since the dawn of DeFi, a new set of ERC specifications have been introduced to help with the representation of on-chain financial instruments:

ERC-3643: Designed to enable the issuance, management, and transfer of security tokens in compliance with regulations, ERC-3643 ensures secure and compliant transactions for all parties involved in the token exchange.” According to digital asset company Tokeny, $28 billion worth of assets have already been tokenized using this specification.

ERC-3525: To solve the drawback of commonly used ERC standards, this specification allows the creation of a “semi-fungible token that has the quantitative features of ERC-20 and qualitative attributes of ERC-721.” It has been used so far to issue convertibles/vouchers online.

ERC-2222: This is a “standard interface for distributing payments such as dividends, loan repayments, fee or revenue shares among token holders.” This standard was created to handle claims on the future cash flow of tokenized assets like debt positions, loans, derivatives and bonds. For example, Maple Finance uses this standard for the profit re-distribution of USDC from the Maple Treasury.

ERC-4626: This specification is “a standard to optimize and unify the technical parameters of yield-bearing vaults. It provides a standard API for tokenized yield-bearing vaults that represent shares of a single underlying ERC-20 token…offering basic functionality for depositing, withdrawing tokens and reading balances.” Since its creation in May 2023, over 50 tokenized vaults have been deployed across EVM-compatible chains.

Tokenization Process

The tokenization process involves four primary steps:

• Identification and Valuation

The first step is to identify the asset(s) that will be tokenized, such as real estate, art, commodities, or even revenue streams like music publishing rights. Tokenizable assets can be transferred or sold with a set or variable price. To determine prices and worth, assets are appraised or valued.

• Legal Structuring and Compliance

Legal agreements must be established to define the terms of the tokenization, including ownership rights, revenue sharing, and any other contractual obligations. These agreements can be encoded into self-executing smart contracts, ensuring automated and transparent enforcement of the agreed-upon rules. Compliance with relevant regulations is also crucial, and depending on the jurisdiction and the nature of the asset, there may be specific legal requirements to meet, such as Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures.

• Token and Smart Contract Creation

Smart contracts underlying the digital tokens representing ownership are created on the blockchain. 

• Distribution and Trading

The created RWA tokens are distributed to investors or participants who can then trade them on secondary markets like decentralized exchanges or DeFi platforms. This introduces liquidity to traditionally illiquid assets, allowing for easier transfer of ownership. Ongoing management of the tokenized assets is often facilitated through blockchain-based governance mechanisms, and token holders may participate in decision-making processes through voting mechanisms encoded in smart contracts.

Use Cases

The uses of tokenized real-world assets can be divided into two main categories: fungible tokens and non-fungible tokens (NFTs).

Fungible Tokens

Fungible tokens, usually used for transactions, are interchangeable and are powered by Ethereum token standards like ERC-20. For example, cryptocurrencies like BTC and ETH are fungible tokens - one Bitcoin is indistinguishable from another Bitcoin and has the same value. Examples include:

Stablecoins

Stablecoins are a commonly used form of RWA. Fiat-backed stablecoins such as USDC or USDT are backed by the value of a currency such as the US dollar or treasuries in a reserve or liquid collateral. Stablecoins are valuable for cross-border transactions and efficient trading and settlements. 

Commodities

Commodities like gold, silver, or oil are frequently tokenized and represented on the blockchain. Tokens like PAX Gold (PAXG) and Tether Gold (AUT) and platforms like Rush Gold leverage blockchain technology for users while collateralizing each token with real commodities. In 2023, Bank of America reported that the tokenized gold market has already captured over $1 billion in investment. Tokenization allows for a secure and transparent way to invest in fractions of commodities while hedging against inflation. 

Treasuries and Bonds

Tokenizing treasury securities like government bonds can generate yield with few risks, diversify portfolios, and hedge against the depegging risks of stablecoins.   According to data compiled by CoinDesk, the market capitalization of tokenized money market funds was nearing $500 million in 2023.

Source: Tokenized Markets Using Blockchain Technology: Exploring Recent Developments and Opportunities

Non-Fungible Tokens

NFTs are smart contracts powered by Ethereum token standard ERC-721 that represent unique assets that are not readily interchangeable with other tokens. Morgan Stanley has explored projects related to tokenizing real estate, art, and private equity investments, and has said that "Non-fungible tokens are disrupting the traditional art market, creating new communities of collectors and giving artists more access to their fans and buyers.” Examples of RWA NFTs include: 

Art and Collectibles

Art is perhaps the most discussed form of NFTs. Traditional artworks like paintings and sculptures or digital artwork can be transformed into tokens on a blockchain, each serving as a digital certificate of authenticity and ownership. With RWA and blockchain technology, traditional artworks are transformed into digital tokens, creating a transparent and accessible ecosystem for art ownership and investments. By tokenizing art, artists can monetize their work and bring liquidity and investors to the market.  

Real Estate

Traditionally, real estate investments involve large funds, intermediaries like brokers and lawyers, and transactions that can take weeks. When real estate is tokenized, investors can buy, sell, and transfer fractional ownership of properties across the world instantaneously.

Intellectual Property (IP) and Royalties

Copyright NFTs within the RWA framework leverage blockchain technology to tokenize and trade ownership of music publishing rights, patents, and other forms of intellectual property. The transparent and immutable nature of blockchains ensures a clear and traceable record of ownership for royalties and allows for automated payments to ensure fair compensation to creators. 

Luxury Assets

High-value luxury items, like yachts, vintage cars, or rare jewelry, can be tokenized, allowing investors to own a share of these assets. Tokenization enhances liquidity and provides an avenue for diversification in luxury asset portfolios

“The next generation for markets, the next generation for securities, will be tokenization of securities.” - BlackRock CEO Larry Fink

Benefits and Challenges of Tokenization

Advantages

Tokenizing real-world assets creates opportunities for both asset managers and investors by offering cost savings, expediting transaction processes, and creating a more equitable market.

Efficient Transactions

Transactions across traditional markets require multiple approval processes and usually have a 72-hour settlement time. Using blockchain technology to prove ownership and pay for investments allows assets to be traded and settled instantaneously at any hour of any day, since protocols are not limited by working or market hours.

Greater Liquidity

Fractional ownership also contributes to providing more liquidity to traditionally illiquid assets. By tokenizing an asset into fungible tokens, ownership is now available to a wider audience of investors with fewer funds and financial primitives can be settled at a much faster pace.

“Tokenized stocks and bonds can improve liquidity and inclusivity, thereby increasing market participation and transparency, and in turn reducing risk.”

Lowered Costs

A more efficient investment system also lowers costs across the investment process. Cutting out the costs of middlemen like lawyers, banks, and brokers enables the seller and buyer to trade directly and pay minimal gas fees to transfer the asset. The Financial Times has estimated that using blockchain driven market infrastructures for the buying and selling of funds may save asset managers up to $2.7 billion a year. 

Transparent Environment

In addition to simplifying ownership, automating end-to-end functions using blockchain technology gives investors a single source of truth. Transacting and recording events on-chain allows participants access to information not available in traditional financial markets. The transparency gained by using the immutable ledger of blockchain technology protects against fraud and promotes investors' trust with accountability. It also reduces overall systemic risks and errors and enables the development of better financial models, which leads to a better framework for understanding the risks inherent to these new financial markets.

New Financial Products

By leveraging smart contracts and other new technologies, DeFi protocols are creating new financial instruments that were not possible in traditional markets. Innovative financial primitives with different incentive mechanisms are being created, tested, and validated at a faster pace than was previously possible.

Challenges

While the potential for tokenized real-world assets is immense, there are a few challenges to implementing them in financial systems.

Regulatory Obstacles

Regulations differ by jurisdiction and location and are both intricate and constantly changing. Tokenized projects must avoid legal concerns and ensure compliance with local laws. Certain tokenized asset classes like luxury cars or watches may avoid this obstacle.

Asset Security

Security and volatility are concerns surrounding all of digital assets, and the token economy is no exception. Digital assets are prone to hacking, and secure and reliable custody of assets is crucial to stop attacks, fraud, or improper use.

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