May 17, 2023 - 7 min read
Blockchains can supercharge global liquidity by providing greater access to financial markets, a transparent and immutable ledger, and faster settlement times.
Real-world asset tokenization is all about transforming rights to a tangible or intangible asset into a digital token which is to be held on a blockchain ledger. Subsequently, the real-world asset is transferable to others users with compatible digital wallets. Think of tokenizing a rental home, which could then be fractionalized further to allow for multiple investors to share ownership.
This lowers barriers to entry like the high upfront costs and risk of taking on excessive leverage, which are typical of real estate purchases. It also reduces friction as it pertains to the asset’s transferability since the process can essentially be automated and settled relatively quickly via smart contracts. The productivity gains from reducing such overhead means supercharging a global real estate market already valued at a staggering $10 billion dollars.
Of course, there are many more markets which could be brought on-chain via tokenization. We’re talking about any asset which would benefit from the liquidity, availability, and settlement times that Web3 boasts. This could be anything from gold bullion bars, government treasuries, fine art, limited-edition sneakers, autographed memorabilia, patents, copyrights, and more.
This article will discuss a few of the benefits to tokenizing real-world assets, some of the speedbumps which have slowed adoption, some hopeful cases where RWA tokenization is gaining traction, and some parting thoughts on the role Oracles will play in the mainstream adoption and rollout of this technology.
Naturally, a lot of real-world assets are illiquid, meaning they cannot be easily bought or sold easily. To sell an illiquid asset quickly often means taking a substantial loss on the investment. Tokenization increases liquidity by representing them on blockchains. In addition to the efficiency and speed afforded to trading RWAs using smart contracts, assets can be fractionalized into more affordable units, broadening the pool of potential investors.
Furthermore, RWA tokenization increases access to investing, meaning that people with internet access around the world can leverage the power of financial markets. Anyone that has undergone a simple KYC check can invest in tokenized assets of any kind, regardless of their location in the world.
This reduced barrier to entry fosters financial inclusion which should increase overall prosperity. Compounding this over a few generations makes us even more bullish on the prospects of mainstream adoption. It is difficult to understate the upside here; we have but to unlock the potential of currently untapped human ingenuity.
Tokenized assets living on blockchain ledgers means that there is always a transparent, immutable record upon which we can rely, and transferring ownership of assets is relatively easy. This reduces administrative overhead and cases of fraud. It also provides clear proof of ownership, and a reliable history of ownership. Settlement times will also be faster compared with legacy financial systems and products.
Though tokenization holds immense potential to turbocharge global finance, there are still hurdles to overcome. As regulatory frameworks mature, technology becomes more user-friendly, and asset-validation best practices emerge, we can expect this innovative concept to gain traction rather quickly.
As with any emerging technology, patience is necessary to perfect any design. The key really is to harness the benefits of technology while hedging properly against potential risks and black swans. Let’s discuss a bit why RWA tokenization has yet to go fully mainstream. The biggest hurdle is obviously the lack of clear regulations. Many jurisdictions are still grappling with how to regulate tokenized assets, and this uncertainty is a major drag on innovation and adoption.
What’s more, there are many different blockchains, and they don’t use the same ledgers or consensus mechanisms. That is, they’re connected by bridge contracts or a centralized custodian. The lack of interoperability can create inefficiencies, and hinder the development of industry standards or best practices. Centralization also has a bad reputation among Web3 enthusiasts, and is therefore unlikely to be well-received by market participants.
Lastly, ensuring that digital tokens are actually backed by the underlying assets being reported will require robust systems for tracking changes in vault or wallet balances in real-time. Misrepresentation or fraud should be expected along the way, meaning that the verification aspect can’t be overlooked.
However, until regulatory clarity arrives and digital assets can be audited and subsequently covered by insurance products, only the boldest investors with high-risk tolerances are likely to participate. The good news is that regulatory sandboxes in places like Singapore are already showing us how it can be done.
At the behest of some forward-thinkers, the Monetary Authority of Singapore (MAS) conducted a pilot program culminating in November 2022, in which JP Morgan and SBI Digital Asset Holdings conducted live cross-currency transactions. The trades were executed using liquidity pools on a permissioned blockchain consisting of tokenized Singapore Government Securities Bonds, Japanese Government Bonds, as well as Japanese Yen and Singapore Dollar stablecoins.
Furthermore, the MAS announced two new pilot programs to study regulatory and risk-management strategies, as well as the development of industry standards as it pertains to interoperability and composability. MAS is still accepting proposals to their FinTech Regulatory Sandbox. The two that have been announced so far are as follows:
In Q1 of 2023, BlackRock CEO Larry Fink wrote to shareholders in an annual letter with incredibly bullish language on digital assets and developments in the blockchain space. “In particular, the tokenization of asset classes offers the prospect of driving efficiencies in capital markets, shortening value chains, and improving cost and access for investors,” Fink wrote. “At BlackRock we continue to explore the digital assets ecosystem, especially areas most relevant to our clients such as permissioned blockchains and tokenization of stocks and bonds.”
Citi Bank is also bullish on asset tokenization. For instance, they propose two emerging asset classes on the rise. In a recent report, Citi wrote: “tokenization of financial and real-world assets could be the killer use case driving blockchain breakthrough with tokenization expected to grow by a factor of 80x in private markets and reach up to almost $4 trillion in value by 2030.”
The author went on: “To be successfully adopted into the mainstream, blockchain needs the help of technology enablers, including (1) decentralized digital identities, (2) zero-knowledge proofs, (3) Oracles, and (4) secure bridges. The legal plumbing also needs to be altered to enable smart legal contracts that will provide a whole new set of rails for global commerce and finance to run on. Regulatory considerations are also necessary to allow adoption and scalability without hindering innovation.”
In essence, Oracles are a critical bridge between the off-chain world and blockchains. They provide the necessary data that allows the tokenization process to take place, ensuring the value, authenticity, and ownership of tokenized assets across disparate chains and databases.
For instance, oracles can provide real-time and historical price data of real-world assets. This data is crucial for creating, pricing, and trading asset-backed tokens. For instance, in the case of real estate tokenization, oracles can provide data about property prices, rental rates, occupancy rates, and other relevant information.
Oracles will also serve as the trusted third-party that verifies ownership of on-chain, tokenized RWAs. For instance, an oracle could verify the authenticity of a title deed for a piece of real estate or a fine art before it goes through the process of tokenization.
As mentioned, oracles will play a role in the KYC process, perhaps even a perpetual KYC network which tracks and updates itself in real-time. This will facilitate adoption if it satisfies financial regulators. For instance, Oracles can run a check to confirm that a new user meets the necessary legal requirements to use the protocol.
Lastly, Oracles can also provide updates on the condition or status of assets. For instance, in the case of a tokenized rental jet-ski, an Oracle could provide real-time data on the asset’s usage, condition, scheduled maintenance lifecycles, and so on. They could also track temperatures to guarantee food freshness, or the weather conditions in the case of natural disasters and subsequent insurance claims.
The destination is clear, it’s only the road to get there that is uncertain. Tokenized assets and near-instant settlements are on the horizon. It’s almost certain that behind the scenes, political pressure is being applied from the likes of BlackRock and other investors looking to bring about sensible regulation of digital assets in the United States (and elsewhere, for that matter). While we’re glad to see Singapore providing a model for the rest of the world to follow, we fully expect in the coming months that news about RWAs making their way on-chain will soon become the norm.
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