Real World Assets (RWA) in Crypto

Real World Assets (RWA) refer to physical assets or financial instruments that are tokenized and represented on a blockchain. Some examples of RWAs include real estate, commodities, debt instruments, equity, invoice financing, music royalties, and more. The tokenization of real world assets allows them to be fractionalized and traded more easily on blockchain networks. RWAs bring new liquidity, transparency, and accessibility to traditionally illiquid markets.

Tokenizing real world assets provides several potential benefits:

Increased Liquidity

By representing real assets on a blockchain, their liquidity is significantly increased. Investors can more easily buy and sell tokenized assets 24/7 through decentralized exchanges. Liquidity pools and market makers can provide continuous pricing and exchangeability.

Fractional Ownership

RWAs can be divided into small fractional tokens, allowing smaller investors to gain exposure. A $1 million property can be fractionally owned by thousands of distributed owners.

Transparency

On-chain data provides transparency into the performance of the underlying real world assets. Ownership records and transaction histories are publicly verifiable.

Improved Accessibility

Blockchain tokens allow anyone to invest in assets that were previously difficult to access, like private equity, venture capital, and hedge funds. Geographic restrictions are minimized.

Programmability

Smart contracts enable automated compliance, decomposed cash flows, and built-in business logic tailored to the needs of the asset.

While promising, there are still challenges around regulation, tokenization standards, and institutional-grade custody solutions that need to be worked out as RWAs in crypto mature. Overall, RWAs have the potential to greatly expand the breadth of digital asset investment opportunities.

Categories of Real World Assets

There are several major categories of real world assets that are being tokenized:

Real Estate

This includes residential or commercial properties like apartment buildings, hotels, offices, retail centers, and vacant land. The properties generate cash flows from activities like rent and can appreciate in value over time. Real estate tokens represent fractional ownership in the properties.

Commodities

Commodities like gold, silver, oil, or agricultural goods can be tokenized to allow fractional ownership and easy transferability. Commodity-backed stablecoins are a popular example.

Debt Instruments

Loans, bonds, and other debt/credit instruments can be on-chained. This provides an immutable record of obligations and payments while allowing the debt to be traded.

Equity

Tokens can represent shares in a company, fund, or other enterprise. Equity tokens allow 24/7 trading compared to limited exchange hours for traditional stocks.

Invoice Financing

Tokenized invoices and receivables enable quick monetization of outstanding payments for small businesses. Invoice NFTs represent claims on future cash flows.

Music Royalties

Music copyrights and royalty streams from publishing/performance can be tokenized for fractional ownership and transparent tracking.

Sports Contracts

Athlete contracts, sponsorship rights, and media licensing deals can be tokenized to allow fan engagement and investment.

Intellectual Property

Patents, trademarks, and other IP like software licenses can be tokenized to simplify licensing, transfer, and fractional ownership.

The list continues growing as more real assets are ported to blockchain formats. While the assets themselves don't change, their utility and accessibility is enhanced through tokenization.

Benefits for Asset Owners

Tokenizing real world assets unlocks a number of benefits specifically for the current owners of those assets:

New Capital and Liquidity

Existing owners can raise new capital by selling tokenized equity or debt. Assets can be refinanced or borrowers can take new loans against their collateral. Ongoing liquidity also opens up new opportunities like portfolio rebalancing.

Operational Efficiency

Manual paperwork and processes can be replaced with automated smart contracts for tasks like payments, compliance, and record-keeping. This reduces costs and human errors.

Product Innovation

With programmable tokens, new financial products can be designed like shares in rental income from a property or dividends from a music catalog. Current owners can earn yield in new ways.

Reach New Investors

Tokenization provides exposure to a wider global pool of investors, expanding fundraising possibilities beyond local networks. Small minimums allow smaller investors.

Improve Investor Relations

On-chain transparency into asset performance allows for real-time, granular disclosures to build trust with investors. Automated reporting streamlines information sharing.

Portfolio Consolidation

Disparate assets like real estate properties or royalty streams can be consolidated into standardized tokens for simplified oversight and tracking.

While relinquishing some control, tokenization can help owners unlock value, capital, and efficiency from assets they already have. The benefits arguably outweigh the drawbacks in many cases.

Challenges with Tokenized Assets

Despite the advantages, there are still meaningful challenges around RWAs in crypto:

Immature Regulation

Most financial regulations do not address crypto asset treatment, leaving uncertainty around compliance. Evolving guidance from regulators makes it difficult for projects to proceed.

Fragmented Standards

A lack of consistency in token standards results in tokenized assets that are not interchangeable. Better standardization is needed around areas like compliance coding.

Technical Barriers

Non-technical asset owners face barriers in creating and managing smart contracts, wallets, and integrations required to tokenize assets. Better tools and services can lower barriers.

Network Effects & Liquidity

Trading activity and liquidity for new RWA tokens is limited until a critical mass of investors/exchanges participates. This presents a chicken and egg problem in early stages.

Insurance & Custody

Institutional-grade solutions for custody, asset servicing, insurance and compliance do not yet exist. This restricts participation from large regulated entities.

While rapidly evolving, the RWA ecosystem still has maturation required on multiple fronts to reach mass adoption. Nonetheless, current challenges are likely temporary and solvable.

Tokenization Process

The lifecycle for tokenizing real world assets involves several key steps:

Asset Evaluation

The first step is evaluating assets for candidacy. Relevant factors include asset type, potential for cash flows, geographic location, and legal/regulatory considerations. Assets with predictable, fungible value streams are better candidates.

Entity Creation

Typically a special purpose entity or vehicle (SPE/SPV) is created to hold legal title to the asset. The SPE issues tokens to investors who gain economic exposure. The SPE maintains linkage between the tokens and the underlying asset.

Token Design

Next, the token itself is designed including its standards, functions, issuance model, governance mechanisms, and parameters. Decisions balance attractiveness to investors and flexibility for the asset owner.

Smart Contracts

Smart contracts code the logic and rules governing the tokens like transfer restrictions, ownership models, cash flow distributions, voting rights, etc. Proper security audits validate contract fidelity.

Offering Launch

Once legal, tax, and regulatory factors are addressed, the asset owner can proceed with a token offering. This represents a capital raise event similar to traditional IPOs or debt offerings.

Exchange Listing

Listing tokens on secondary exchanges provides ongoing liquidity and price discovery once the initial offering concludes. This supports future trading activity.

The process requires cross-disciplinary expertise across blockchain, finance, law, and asset management. When done properly, the result is a compliant asset-backed token aligned with investor interests.

Real Estate Tokenization

Real estate is one of the most popular and practical assets to tokenize to date given its tangible value, predictable cash flows, and fragmented nature. Some details on real estate tokenization:

Commercial vs Residential

Commercial properties like offices and retail centers are more commonly tokenized given larger deal sizes and potential for more stable cash flows. Residential can be challenging with many individual tenants.

Equity vs Debt

Real estate can be tokenized through equity tokens representing fractional ownership or via debt tokens that provide loan exposure. Debt tokens offer lower risk/return than equity.

Property Tokens vs REITs

Property tokens represent individual properties while Real Estate Investment Trusts (REITs) contain a portfolio of properties to provide diversification.

Cash Flow Distribution

Smart contracts can encode rental payment distributions proportionally to token holders. Tokens can also confer voting rights for property management decisions.

Secondary Trading

Real estate tokens provide 24/7 liquidity for investors who want to exit their position before the property is sold or transferred. Geographic ties are removed.

As a tangible asset, real estate has been at the forefront of RWA innovation and adoption, providing a blueprint for other assets to follow.

Commodity Tokenization

Commodities like precious metals, oil, and agricultural products present another opportunity for tokenization and digitization. Some characteristics of commodity tokenization include:

Supply Verification

Token issuers must prove they have sufficient reserves of the underlying commodity to back the tokens 1:1. Third party attestations provide confidence.

Redeemability

While less common, some commodity-backed tokens commit to direct redeemability meaning holders can exchange their tokens for actual delivery of the commodity.

Use of Proceeds

Funds from the token sale must be provably allocated to acquire more of the commodity. This maintains adequate backing.

Price Stability

Commodity tokens are often used to build "stablecoins" whose value is tied to the commodity price rather than speculative market swings.

Yield Generation

By lending out commodities like gold, issuers can generate yield which they share with token holders through programs like staking rewards.

Commodity tokenization provides a more efficient means to gain exposure and earn yield on raw materials without direct custody and ownership of the physical assets.

Security Token Offerings (STOs)

When tokenized assets qualify as a "security" under regulations, their issuance is considered a security token offering (STO) and has more legal requirements compared to utility tokens. Some tips for STOs include:

Know Your Customer (KYC)

Like traditional securities, STO issuers must vet token buyers and verify their identity/accreditation status to comply with Anti-Money Laundering (AML) and Know Your Customer (KYC) rules.

Restricted Access

STOs must restrict purchase access only to verified, eligible participants. General public access would violate securities laws around regulated offerings.

Disclosure Requirements

PROJECT NAME ###### STOs mandate disclosures around the asset, token economics, smart contract functions, risk factors, and conflicts of interest to inform buyers.

Accredited Only

For offerings to retail buyers in many jurisdictions, participation is limited only to investors who qualify as accredited based on income, net worth, or sophistication.

Ongoing Reporting

Periodic updated disclosures must be made available around company performance, operational metrics, token economics changes, etc. These disclosures hold issuers accountable.

While more constrained than utility token sales, STOs enable regulatory-compliant issuance of tokenized securities and investment assets.

Marketplaces for Tokenized Assets

Specialized marketplaces focused on RWAs are emerging to drive adoption and liquidity:

Tokenization Platforms

End-to-end tokenization platforms help owners seamlessly convert PRIA assets into tokenized formats and handle compliance requirements.

RWA Exchanges

Centralized exchanges developed specifically for trading real asset backed-tokens continue to launch. This provides organized liquidity pools.

Over-the-Counter (OTC) Desks

For larger institutional trades, OTC desks provide personalized service to source buyers/sellers and negotiate pricing for RWA tokens.

Data/Research Providers

As the market matures, more data and analytics tools are covering the RWA sector to inform investment processes and valuations.

Indexes and Benchmarking

Indices that aggregate and benchmark performance of RWAs are starting to emerge to allow passive investing in a basket of assets.

Advisory Firms

Consultants and advisors with expertise in real asset tokenization guide clients on strategy, implementation, and maximizing benefits.

The ecosystem infrastructure improving liquidity, data, and services for tokenized assets should lead to a positive feedback loop and compounding growth.

Benefits for Investors

For prospective investors, tokenized real world assets open up new possibilities:

Portfolio Diversification

RWAs represent an entirely new asset class for diversification away from volatility of crypto tokens and correlations with traditional stocks/bonds.

Hedging and Inflation Protection

The tangible value of real assets can provide hedging against inflation and economic downturns compared to speculative digital assets.

Yield Generation

Real assets that generate predictable cash flows like real estate or royalties allow investors to gain exposure to stable yield streams.

Collateralized Lending

Tokenized assets can be used as collateral for decentralized lending or traditional lending through partnerships with banks/institutions.

Small Minimums

Whereas investing directly in real estate or private equity requires large minimums, tokens provide exposure in small increments.

Around the Clock Trading

Tokenized assets trade 24/7 avoiding limitations of business hours or manual processes. This provides flexibility and responsiveness.

While still early, RWAs present a new future of diversified, globalized, 24/7 investing in alternative assets beyond stocks and bonds.

Criticisms and Rebuttals

Some common criticisms of real world asset tokenization include:

"It's too complex and expensive."

Rebuttal: Any new technology has learning curves. Standards and best practices are emerging to streamline tokenization. Declining transaction costs also improve feasibility.

"Illiquidity will be a problem."

Rebuttal: Yes, initially. But dedicated RWA exchanges are already facilitating liquidity and activity. As the market grows, so will trading volumes and liquidity pools.

"Regulatory uncertainty is too great."

Rebuttal: Valid concern, but regulators are gradually providing more guidance given interest in the asset class. Jurisdictions like Wyoming have passed crypto-friendly laws to attract innovators.

"Smart contracts have too much risk."

Rebuttal: Rigorous smart contract audits, testing, and formal verification are mandatory best practices to identify vulnerabilities before deployment. Fail-safes and upgrades provide protection.

"The technology is too new."

Rebuttal: Blockchain principles have been around for over a decade. Highly vetted open source stacks like Ethereum are reliable and production-ready. Companies that build on established foundations mitigate technology risks.

Like any new innovation, marketplace evolution and proven implementations over time will dispel skepticism.

Future Outlook

In the coming years, real world asset tokenization is positioned for significant growth as blockchain capabilities advance and mainstream adoption accelerates. Several trends to expect:

Decentralized Finance Integration

Closer bridges to DeFi will create new opportunities for things like borrowing against tokenized collateral or algorithmic trading of token baskets.

IoT Measurement

Internet of Things sensors can transmit performance data for tokenized assets to on-chain smart contracts, enabling dynamic automated management.

Interoperability Scaling

Interoperability solutions and Layer 2 rollup technology will allow RWAs to inherit scalability gains happening across blockchain ecosystems.

Institutional Participation

Custody, insurance, regulatory clarity and professional-grade infrastructure will pave the way for tokenized real asset exposure to institutional portfolios.

Automated Compliance

Advances in zero-knowledge proofs, confidential computing and selective disclosure will programmatically enforce compliance while optimizing user experience.

As tokenized markets deepen, real world assets on the blockchain will transition from novelty to norm—unlocking a multi-trillion dollar addressable market for investors and asset owners alike.

Real world asset tokenization is transforming traditionally illiquid, inaccessible markets like real estate, private equity, and commodities by introducing properties of digital assets like around-the-clock liquidity, fractional ownership, transparency and programmability. Despite meaningful challenges still to overcome around technical readiness, user experience, and regulatory clarity, the trajectory is clearly pointed towards a future where all assets reside on interoperable blockchain networks. Incumbents who embrace tokenization early will have an opportunity to help shape the technology in a way that benefits their interests. With diligent cross-disciplinary execution across blockchain, finance, law and asset management, real world asset tokenization can usher in an era of new financial inclusion and interconnectedness.