Written by: Itai Avneri is the Deputy CEO & COO at INX. He is a seasoned executive with over 20 years of experience in both finance and technology. As the Deputy CEO & COO at INX, he is responsible for heading INX’s unique offering as the only exchange that offers cryptocurrency, security tokens, and primary offering trading. Itai holds a BA in Economics and Information Technology from Ruppin Institute and an MBA from the Inter-Disciplinary School.
The digital asset industry has come a long way since Satoshi announced Bitcoin to the cypherpunk community 15 years ago. A strong indication of this maturity came early in 2024, when the U.S. Securities and Exchange Commission (SEC) approved a spot Bitcoin exchange-traded fund (ETF) for trading. No sooner had the Bitcoin ETF started trading than the titans on Wall Street, like Blackrock’s CEO Larry Fink, shifted to the tokenization of real-world assets (RWA) as the next megatrend to dominate capital markets.
While the Bitcoin ETF and tokenized RWA are both attracting institutional attention, and capital, there is one key difference in their implications on the digital asset markets. By giving investors an option of getting Bitcoin exposure without having to touch a blockchain, or a wallet, the Bitcoin ETF puts up a border between traditional finance (TradFi) and decentralized finance (DeFi), keeping the traditional investors out of the wider Web3 ecosystem.
On the other hand, tokenization is the bridge that could bring trillions of dollars from TradFi on-chain, representing a true ‘best of both worlds’ for investors and asset owners alike.
What Are Tokenized Real World Assets (RWA)?
Real-world assets are assets with intrinsic value in the real world that have been brought on-chain. The simple way to explain RWAs or tokenized assets is as “traditional assets converted into digital tokens on a blockchain.”
Stocks, bonds, venture capital, real estate, artwork and commodities are just some of the real-world assets that are being brought onto the blockchain in the form of tokenization. Unlike many crypto assets, which lack any underlying value, tokenized RWA is backed by real-world value and revenue streams, making them an attractive choice for discerning investors and institutions.
RWA tokens are not just digital representations; they carry the rights and benefits associated with the asset, such as income from rent or dividends. This makes it possible to tokenize dividend stocks and government securities. In fact, tokenized government securities are one of the fastest-growing use cases of tokenization, with over $860 million in total value locked.
What are the Advantages of Tokenized RWAs?
Tokenization offers several advantages over traditional assets, including:
- Democratization: Tokenization democratizes investment opportunities by enabling a broader range of investors, including those with smaller capital, to participate in markets traditionally dominated by institutional or high-net-worth individuals.
- Fractionalization: Fractionalization: Through fractionalization, tokenization allows assets to be divided into smaller units, making high-value investments like real estate or art more accessible and affordable to individual investors.
- Programmability: Programmability: The programmability of tokenized assets enables the embedding of complex features and rules directly into the token, allowing for innovative financial products and streamlined asset management.
- Automated Compliance: Tokenized assets can automate compliance with regulatory requirements, reducing the administrative burden and risks of non-compliance by encoding legal and regulatory obligations into the tokens themselves.
- Instant Settlement: Tokenization facilitates instant settlement of transactions, dramatically speeding up the process of buying and selling assets, reducing counterparty risks, and improving liquidity in the market.
All these benefits combine to provide markets that are traditionally illiquid with more liquidity and efficiency. The power of tokenization lies in its ability to democratize access to investments that were traditionally exclusive due to high entry costs or regulatory complexities. By breaking down these barriers, tokenization opens the door for a broader range of investors to participate in markets that were previously out of reach.
Lastly, RWA tokens are built on smart contracts that automate compliance and regulatory policies. They also streamline process transfers and settlements (instant settlements) reducing time and cost.
Market Insights and Predictions
The potential in asset tokenization is so much that the BCG predicts there will be over $16 trillion in tokenized securities by 2030. This growth represents a significant increase from $310 billion in 2022, potentially comprising 10% of global GDP by the end of the decade.
Citigroup suggests that we are approaching an inflection point where blockchain’s promised potential will be realized significantly, measured in billions of users and trillions of dollars in value.
Source: Citigroup
The recent report from Citigroup pegs the major driving forces behind this transformation as the adoption of CBDCs by large central banks, asset tokenization in gaming, and blockchain-based payments. It anticipates that by 2030, up to $5 trillion of CBDCs could be in circulation in major economies, with a significant portion linked to distributed ledger technology.
A Bank of America (BofA) research estimates that tokenized assets will become so popular in the future that “token portfolio” will simply be referred to as “portfolio.” According to their report on tokenization:
“Consumers might open an app to check the real-time market value of portfolio holdings, which include tokenized dollars, stocks, corporate bonds and interests in a private equity fund and commercial building that’s located on a different continent. Within the same app, they may sell 47.62765% of their private equity interest at 5:15pm to 20 different buyers through a liquid secondary market with 24/7 real-time settlement.”
From the Real World to Blockchain: Understanding The Tokenization Process
RWA tokens are fungible tokens like ERC-20 tokens but that is where the similarities stop. Unlike ERC-20 tokens, RWA tokens are usually classified as securities in most jurisdictions and must adhere to securities frameworks.
For example, if a RWA token is to be offered in the US, it must:
- be registered or exempt from registration under SEC guidelines
- follow KYC/AML requirements
- Be brought to the market by a registered broker.
- Be listed on exchanges registered as ATS with the SEC and FINRA.
- Have a transfer agent on record managing the cap table of the asset.
The RWA token issuer might also have to prepare legal documents like PPM (private placement memorandum) and subscription agreements.
On the technological front, real-world assets are represented as fungible tokens on the blockchain. Using special token standards like T-Rex and ERC-1404 that allow for unique identification and ownership. These standards provide a way to create tokens that can comply with various regulations like KYC (Know Your Customer) and AML (Anti-Money Laundering) laws, making it suitable for tokenizing Real World Assets (RWAs) in a legally compliant manner.
Due to the complexity of the tokenization process, most issuers usually opt to work with a team of experts to help them, like INX, which offers a full-service tokenization suite compliant with SEC regulations. Having a partner well versed in both the technical and legal aspects of RWA tokenization is crucial to bringing these to market successfully.
Will 2024 be the Year RWAs Boom?
2023 was a great year for real-world assets and tokenization, with the total value of RWA locked in DeFi growing an astounding 7.5x to reach around $5.6 billion according to DefILlama. All fingers point to 2024 being another breakout year for real-world assets. Institutions, driven by the desire to create liquidity for traditionally illiquid assets and streamline their processes, will continue to embrace tokenization as the answer to the modernization of capital markets.
Featured image via Unsplash.