The Future of Real-World Asset Tokenization Explained
You have been seeing the terms 'RWA' and 'Real World Asset' being shared around, but what do they mean? Read this article to learn all about RWA.
Introduction
In recent years, blockchain technology has brought forth innovative solutions to long-standing challenges in various industries. One such breakthrough is the tokenization of real-world assets, a process that involves representing various physical assets as digital tokens on a blockchain.
Once tokenized on a digital ledger, these asset markets can benefit from increased transparency, efficiency and liquidity compared to their traditional counterparts.
This article aims to shed light on what exactly tokenization means, how it relates to blockchain technology, explore the potential advantages and disadvantages of tokenization and it's future prospects, and finally, provide examples of real-world industries which being tokenized today.
What Is Tokenization?
Tokenization refers to the conversion of real-world assets, such as real estate, artwork, commodities, or even intellectual property, 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 tokenization allowing for the division of these assets into smaller, more easily tradable units.
For example, as a seller, a houseowner could tokenize ownership shares in their house and sell a portion of them in order to raise liquidity, making historically illiquid asset highly liquid instead. As a buyer, it also becomes much easier to make smaller investments and become an asset-owner. Given the soaring property prices across the world, this could give smaller investors a more accessible way to enter the real estate market.
Tokenization can be implemented in almost any real-world market today, including commodities, fine art, 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-native vs off-chain.
Why Blockchain?
Blockchain, a form of distributed ledger technology, is the technological building block of asset tokenization. At its most basic level, blockchain uses complex cryptography to ensure the integrity of digital data - basically, 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.
In short, this allows for secure, transparent and efficient transactions, all of which can offer significant benefits for real world asset markets.
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 on-chain, then you have all the ingredients you need for a tokenization revolution in real world asset markets.
What Are The Advantages of Tokenization?
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.
Accessibility and Inclusion
Tokenization can help to democratize investment in various asset classes that were previously restricted to institutional or high-net-worth investors. 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—also protecting yourself from financial meltdown.
Enhanced Transparency
Most blockchain's utilize distributed ledgers to create transaction transparency. This transparency can help to minimize fraud and ensures equal market information for all market participants.
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.
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?
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 in an effort to foster innovation.
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.
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 tokenised assets and investor holdings, especially on decentralized ledgers. Continuous advancements in security measures are necessary to mitigate such risks.
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.
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 with them various centralization risks.
Why Aren't Real World Assets Tokenized Already?
Tokenization is poised to radically transform asset management as we know it, democratizing market access, unlocking liquidity and making global finance more inclusive.
Regulatory Uncertainty
The biggest obstacle today is regulatory uncertainty. Governments must do more to provide a 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 for 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.
Technical Challenges
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 near future.
In contrast, fungible assets, and especially, intangible assets, such as internet-based goods/services, are much easier to tokenize.
Creating the proper frameworks for asset tokenization will take time to mature. 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.
Tokenized Asset Industries
Despite the ongoing regulatory challenges, many industries are actively developing new products using asset tokenization. We've provided a number of real-world examples to help you understand the potential of this exciting new industry.
Real Estate
Traditional real estate investment has been characterized by high entry barriers, cumbersome processes, and limited liquidity. Tokenization of real estate assets can potentially change this by making real estate investment more accessible, affordable, and liquid.
By tokenizing real estate, investors can purchase fractions of properties, making it possible for more people to gain a foothold on the property ladder. Moreover, tokenisation allows for a much more liquid market. Nevertheless, fractionalized real estate also raises several legal challenges over governance procedures, ownership and more.
Fine Art and Collectibles
By dividing ownership of art pieces or collectibles into multiple shares, tokenization enables a broader range of investors to participate in the art market, providing more access to real-world opportunities for real yield. This could make it possible for more people to invest in this niche investment market. It could also help artists and collectors monetize their assets more effectively.
Intellectual Property and Patents
Tokenization of intellectual property (IP) and patents can transform the way IP rights are managed, transferred, and monetized. Tokenized IP can provide inventors and owners with new revenue streams, making IP investment more accessible to a wider audience, and creating new opportunities for lending and borrowing IP assets as collateral.
This could lead to a more efficient and transparent IP market, making it easier for inventors to monetize their ideas and for investors to invest in promising innovations. It could also help foster innovation by making it easier for inventors to raise funds for their projects.
Commodities, Stocks and Debt
Many markets in more traditional assets are also open to disruption, where low-cost transparent settlements can help to facilitate more liquid global capital markets. Moreover, tokenized assets can be used to interact with smart contracts to enable new kinds of complex trustless transactions.
Nevertheless, tokenizing some assets, such as precious metals, presents unique challenges, requiring more real-world verification mechanisms when compared with markets which are more easy to digitize, for example, bonds or company shares.
In essence, tokenization makes it easy to transfer a certificate of ownership, but some kind of framework is needed to ensure that a token is truly backed by its underlying asset. This requires forms of off-chain enforcement, making tokenization more challenging and costly for physical assets.
Conclusion
The truth is that tokenization isn't a panacea. Whilst the potential is vast, this emerging industry is currently 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 tokenise. 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 which blockchain has to offer.
Indeed, various platforms are already using the advantages of distributed ledger technologies to increase the accessibility of real-world asset markets. Gluwa Invest, for example, uses USDC to increase the accessibility of its global investment platform, harnessing the benefits of low-cost transactions and leveraging blockchain to provide clear investment transparency through the Creditcoin protocol.
As the asset tokenization industry continues to mature over the coming years, new interoperability solutions are introduced, and proper legal frameworks are put in place, digital tokens will be set to radically transform the nature of ownership, trading and liquidity. But don't be surprised if it takes a few years.
Tae Oh
Benedict Clark