In this article, we'll explain what real-world asset tokenization is, and how it allows anyone to secure a digital proof of asset ownership, facilitating a more efficient, inclusive and secure global asset marketplace.
We'll also explore the potential advantages and disadvantages of tokenization, its future prospects, and give you concrete examples of real-world asset tokenization today.
What are Real-World Assets?
Real-world assets (RWAs) typically refer to physical and other traditional financial assets in the traditional global economy. Example of real-world assets include:
- Real Estate: Buildings, land, and property.
- Bonds: Private debt, public debt, mortgages etc.
- Stocks and Shares: Apple shares, stock options, NASDAQ, S&P etc.
- Commodities: Physical goods like oil, gold, silver, and agricultural products.
- Art and Collectibles: Paintings, sculptures, rare collectibles, and antiques.
- Currencies: US dollar, Chinese Yuan, Euro etc.
- Consumer Goods: Physical products like electronics, furniture, and clothing.
- Other: Carbon credits, futures contracts etc.
RWAs are often contrasted with digital or virtual assets, most commonly found in crypto. They are usually characterized by their intrinsic financial value, deriving worth from their utility, rarity, or desirability.
In the context of finance and investment, RWAs can be used as collateral, sold for profit, or held for value appreciation or income generation (e.g. rental properties/dividends/interest).
What Is Real-World Asset Tokenization?
Tokenization refers to the digitilization of asset ownership, into digital tokens that can be securely stored, transferred, and traded on a blockchain.
Each token represents a direct ownership stake in the underlying asset, with digital tokens allowing for the division of these assets into ever smaller, more easily tradable units in a process known as asset fractionalization.
By reducing the barriers to entry of asset ownership, and reducing the costs of asset exchanges, tokenization can make it easier for smaller investors to purchase and trade various assets.
For example, given the soaring property prices across the world, fractionalized real estate this could give smaller investors a more accessible way to get a foothold in the real estate market.
Tokenization can be implemented in almost any real-world market today, including commodities, debt, real estate, collectibles, shares, funds, or even services. The exact asset tokenization process for various assets will be different on the type of asset and protocol being used. For example, fungible vs non-fungible, or digital vs physical.
Why use Blockchain to Tokenize Real-World Assets?
Blockchain, a form of distributed ledger technology, is the technological foundation behind asset tokenization. At its most basic level, blockchain uses a mix of complex cryptography and decentralization to ensure the integrity of digital data - in this case, basically a tokenized record of who owns what (asset ownership).
This allows parties to settle various financial transactions directly without having to trust a third party, such as a bank, to process transactions and verify ownership.
It also offers extra security, transparency, and efficiency, all of which can provide significant advantages in global asset markets today.
Once tokenized on a blockchain, assets can also be fractionalized into ever smaller units. By allowing for smaller units of trade, tokenization can unlock liquidity for otherwise illiquid assets. For example, fine art or real estate.
Once you throw smart contracts into the mix, which leverage blockchain to perform complex transactions and enforce financial agreements on-chain, then you have all the ingredients you need for tokenization to revolutionize financial markets as we known them today.
How does Tokenization work?
Tokenization platforms handle the conversion of real-world assets into their digital representations, ensuring each digital token accurately reflects ownership, and providing a platform to trade and settle tokens.
But these platforms go beyond mere technology; they are critical in maintaining legal and regulatory compliance.
In the digital realm, ownership requires secure, legally recognized foundations provided by "legal wrappers." Embedded into the blockchain, these legal instruments define the rights tied to each token, detailing the specific asset it represents (like an apartment in a tokenized building), and its associated rights, privileges, and legal implications (such as trading rights or asset access).
More than just confirming ownership, legal wrappers offer protection against technical glitches or legal uncertainties. They also document procedures for technical issues and preserve the integrity and rights of digital assets. Essentially, they act as legal insurance for digital investments in the physical world.
Top Examples of Real-World Asset Tokenization in 2024
#1: PAXG (Paxos Gold) | Previous Metals
PAX Gold (PAXG) is a digital token backed by physical gold, offering a cost-effective and secure way to invest in investment-grade gold. Each PAXG token represents one fine troy ounce of gold, stored in London's LBMA vaults. It's a regulated product, overseen by the New York State Department of Financial Services, ensuring security and transparency.
PAXG allows fractional ownership, is instantly redeemable for physical gold or cash, and aims to combine the benefits of physical gold with the efficiency of digital assets.
Other examples of tokenized commodities include Tether Gold ($XAUt) and Kinesis silver ($KAG).
#2: USDY (Ondo US Dollar Yield Token) | Treasury Bonds
The Ondo US Dollar Yield token (USDY) is a unique financial product offered by Ondo Finance, giving international investors the opportunity to invest in US Treasury bonds on-chain.
USDY is essentially a tokenized promissory note secured by short-term US Treasuries and bank demand deposits. This makes it an attractive option for non-US individual and institutional investors, as it combines the ease of access found in stablecoins with the benefit of high-quality, US dollar-denominated yield.
Other examples of tokenized Public Bonds include USTY from Tradeteq, and OpenEden's TBILL tokens.
#3: PayPal USD | Fiat Stablecoins
PayPal USD (PYUSD) is a stablecoin issued by Paxos Trust Company, designed specifically for use in PayPal's payment system. It's an ERC-20 tokenized digital dollar, offering stability and the benefits of blockchain technology. PYUSD ensures a 1:1 backing with the U.S. dollar, with reserves held in cash and cash equivalents.
Regulated by the New York State Department of Financial Services, it aims to provide a secure and efficient way for digital transactions, combining the stability of fiat currency with the flexibility of crypto assets.
Other notable fiat-denominated stablecoins include USDC and EURC by Circle, as well as USDT by Tether.
#4: Centrifuge | Private Credit
Accounting for around 50% of the tokenized private credit market, Centrifuge is a L1 tokenization blockchain that enables small-to-medium businesses to raise credit financing by using their inventory and other physical items as collateral.
Through the use of legal wrappers, these assets are tokenized into non-fungible tokens (NFTs) and then used to secure loans from decentralized finance (DeFi) investors.
Other notable projects working in private credit include Maple Finance, and Creditcoin.
What Are The Advantages of Tokenization in 2024?
#1: Increased Liquidity
Asset tokenization can help unlock historically illiquid assets such as art or real estate. For example, it is much easier for smaller investors to buy 1% of a rental property, than to buy a whole property. Lower transaction and settlement costs also encourage the freer flow of capital increasing market liquidity for real-world assets.
#2: Accessibility and Inclusion
Tokenization can help to democratize investment in various asset classes. By leveraging fractional ownership, these asset markets can enjoy lower barriers to entry, making it possible for smaller retail investors to diversify their portfolios and invest in a wide range of exciting industries. Equally, as tokenized assets exist digitally, they can be traded from anywhere by anyone regardless of national boundaries—potentially protecting yourself from financial meltdown.
#3: Enhanced Transparency
Most blockchains utilize distributed ledgers to create transaction transparency. This transparency can help to minimize fraud and ensure equal market information for all market participants.
#4: Lower Settlement Costs
Blockchain allows for direct peer-to-peer settlements, reducing the significant overhead costs associated with most real-world asset trading platforms today. Indeed, tokenized assets can be bought and sold for fees as low as $0.01.
#5: Smart Contracts
Tokenized assets can interact with various smart contracts and DeFi protocols, helping to create entirely novel financial platforms, services, and products. Smart contracts can also be used to create a completely trustless asset management solution for asset owners, letting users trade without counterparty risks.
What Challenges Are There For Asset Tokenization?
#1: Regulatory Challenges
Although blockchain networks are globally accessible and decentralized, this can often clash with local regulations. Indeed, the regulatory landscape surrounding asset tokenization is still rapidly evolving, with major discrepancies and uncertainties across different national jurisdictions.
Nevertheless, several jurisdictions, such as Luxembourg, the EU, and Nigeria are actively improving regulatory clarity for digital assets to foster innovation.
#2: Scalability and Interoperability
Blockchain technology, while powerful, still faces several scalability and interoperability challenges. In particular, limited cross-chain interoperability can inhibit the liquidity and accessibility benefits of tokenization by restricting certain asset markets to a single chain.
If you are not sure what's the difference between cross-chain and multi-chain, click here to read our in-depth explanation.
#3: Security Concerns
While blockchain technology provides robust security features, it is not immune to cyber threats. Hacking attempts, vulnerabilities in smart contracts, and digital wallet breaches all pose risks to tokenized assets and investor holdings, especially on decentralized ledgers.
Continuous advancements in security measures are necessary to mitigate such risks.
#4: Limited Investor Rights and Control
Whilst asset-backed tokens can democratize ownership, they can also pose significant challenges to investor control and decision-making.
Depending on the underlying governance structures, token holders might have limited decision-making power or face challenges in exercising their ownership rights.
#5: Last Mile Problems
Although tokenization can unlock significant market benefits, one major challenge is ensuring that a digital asset is correctly backed by its underlying asset.
For non-digital assets, this necessitates the use of various off-chain verification tools, regulatory frameworks, and enforcement mechanisms which carry centralization risks and cost overheads.
This means that asset classes which are already highly digitized, such as bonds, stocks and shares, are all much easier to tokenize than assets such as commodities or real estate.
Main Obstacles to Real-World Asset Tokenization in 2024
The biggest obstacle today is regulatory uncertainty. Governments must do more to provide clear regulatory frameworks for asset tokenization, for example, how to comply with existing laws such as anti-money laundering (AML) and know-your-customer (KYC) regulations or creating legal frameworks for the asset tokenization process.
New regulations should be designed to protect market participants, ensuring that tokenized assets are properly backed, managed, and legally protected. In addition, to unlock the full potential of this burgeoning technology, global regulators should work together to achieve a common international framework for how to both trade and tokenize assets.
The exact difficulty, both legally and technically, of tokenizing different asset classes depends on the industry itself. Industries where last mile problems are difficult to solve, for example, commodities, where token holder rights are difficult to navigate, for example, real estate, or where the legal status of investment is already heavily regulated, for example, venture capital markets, are less likely to benefit from all of the advantages which tokenization can offer. At least in the short-term.
In contrast, fungible assets, and especially, digitised assets, such as bonds or shares, are much easier to tokenize.
Creating the proper frameworks for asset tokenization will take time. Nevertheless, as more and more countries continue to embrace the efficiencies offered by digital assets, the coming reality of asset tokenization is a question of when, not if.
Whilst new opportunities are emerging every day, this industry remains a work in progress. Until the technology matures, proper regulation is implemented, and more mainstream financial institutions and industries start incorporating asset tokenization, that will remain the case.
Nevertheless, the underlying technology is already helping a variety of real-world industries. Particularly in finance where regulations are clearest and the assets are easiest to tokenize. One great example is USDC, a tokenized dollar (aka stablecoin) backed 1:1 by USD, allowing the US dollar to benefit from all of the accessibility, transparency, and low-cost transactions that blockchain has to offer.
Indeed, various platforms such as Creditcoin are already using the advantages of distributed ledger technologies to increase the accessibility and transparency of real-world asset markets.
As the asset tokenization industry continues to mature, digital tokens are set to radically transform the nature of ownership, trading, and liquidity. But don't be surprised if it takes a few years.
Updated: January 9th, 2024 by Joshua Yap.