By Derek Bobbitt ’23
“I believe the next generation for markets and the next generation for securities will be tokenization of securities” — Larry Fink, DealBook Summit December 2022
This was a quote made this past December at the Dealbook conference by the CEO of BlackRock, the world’s largest asset manager, and it hints at where the company sees the financial industry expanding in the future. Specifically, it touches on tokenizing real-world assets or, as they are more commonly referred to, RWAs. RWAs include any physical asset that can be tokenized and brought onto a blockchain. Some examples of such assets include real estate, gold, fine arts, stocks, bonds, and maybe even startup equity pools.
We can dive into what this looks like in practice with the following example provided by GlobalX: Let’s say we have a $10M office building. By tokenizing this property, the ownership of this property can be split into 100,000 digital tokens (“shares” if that terminology makes more sense better — some division of equity/ownership) worth $100 each. These tokens can be traded securely on a blockchain with smart contract functionality ensuring that each owner holding a token receives their share of the building’s future rental income. But the question remains, so what? Blockchain has long been criticized as a technology searching for a use case, but I’d argue the utility and demand for RWAs is something both Decentralized and Corporate Financial communities can agree on.
- Fractional Ownership: We’ve seen the retail investment demand grow for fractional ownership with the initial rapid adoption of Robinhood. When you tokenize an asset, you can split it up into equivalent shares representing the value of the overall asset. Typically, this type of asset is only accessible to institutional investors with large amounts of dry powder waiting to be deployed. Now we can expand the number of investors who can participate without limiting them based on the amounts of capital they can deploy.
- Increased Liquidity: Not only does the above example provide an option for institutional investors looking to diversify their portfolios across different asset classes with increased liquidity options, but it also democratizes access so that smaller investors can participate. When liquidity is fractionalized and held by multiple parties, the liquidity options are increased.
- Removal of Intermediaries — By utilizing blockchain’s atomic/instant settlement capabilities, costs related to time and exchanges are significantly reduced even on a global scale.
However, as with most innovations, there are still some clear disadvantages and hurdles that need to be addressed before we will truly see growth in adoption:
- Hacks — The Web 3 Industry is notoriously fraught with scams as an area full of emerging technologies that consumers may not fully understand. If proper security measures aren’t in place, potential bugs in smart contract coding can be exploited by hackers.
- Licensing — Getting a regulated license for an asset tokenization could be a lengthy process, especially when regulations around taxation for digital assets are still undefined.
- KYC/AML — This would involve KYC and AML processes which many crypto participants would disagree with.
- Asset Seizing — Governments can freeze RWA’s physical counterparts.
- Liquidation Issues — Tokens can be sold in an instant, but most physical assets currently require certain processes for change of ownership to do so.
The concept of RWAs isn’t anything new, and has long been seen as a way to seamlessly “upgrade” our current financial system using blockchain technology without fully abandoning legal technologies. So why is everyone, even large corporate financial institutions, speaking about them now? It’s simple: infrastructure and adoption. For the first time, we have established DeFi protocols that have shown resilience through a bear market, and found product-market fit. These protocols can handle a multitude of infrastructure issues we’ve seen in the past: sufficient liquidity management, borrowing/lending, stablecoins, and oracles to connect blockchains to external data systems.
We’ve already seen glimpses of the future begin to unfold:
- Societe General proposed a historic $20M DAI loan in exchange for bond tokens
- Singapore leverages Polygon and Aave in first DeFi wholesale markets transaction
- Gold-backed Stablecoins pass $1B in market capitalization
Overall, tokenizing RWAs seems to be a direction that many see blockchain technology servicing in the coming years. Rather than chasing double-digit yields through ponzi-based projects like most of the crypto industry has been for the past five years, RWAs give us sustainable yield with minimized risk. Maybe if tokenized treasury bills or corporate bonds were around during this past bull cycle, educated consumers wouldn’t have parked their money with BlockFi, Celsius, or Anchor Protocol. Even BNY Mellon found that 91% of institutional investors believe that tokenization will revolutionize asset management, and it has been estimated that the RWA market could reach $16 trillion by 2030. We are on the verge of seeing true institutional adoption that isn’t just holding digital assets in funds, but utilizing the technology to directly benefit the financial industry’s best practices.