From 0 to over 300M$ Market cap in a Year: Tokenized Real-World Assets

21 September 2023

 

I discussed how regulation will advance the development and market opportunity of the cryptocurrency market in one of my most recent columns. But how and under what circumstances will this occur? So what if cryptocurrency is regulated? Crypto natives, who have long chosen the path of self-regulation over allowing traditional financial regulators to play a key role, are undoubtedly not interested in it. The tokenization of real-world assets is a significant development that has already begun to take shape and even amass a sizable market cap. We will examine the distinctions between digitally native tokenized assets and real-world tokenized assets in this article, as well as the benefits of tokenizing real-world assets and the main difficulties that issuers must face.

Digitally Native Tokenized Assets vs. Real-World Tokenized Assets

Digitally native tokenized assets are entirely digital, existing solely on blockchain platforms. Examples include cryptocurrencies like Bitcoin or Ethereum but you could also say NFTs are entirely digital tokenized assets if the NFT represents ownership of an image or gives access to an exclusive online community. They derive their value from their inherent scarcity, demand, and utility within the blockchain ecosystem.

On the other hand, real-world tokenized assets are representations of physical assets (e.g., real estate, art, commodities) on a blockchain. These tokens are backed by tangible assets, and ownership is recorded on a blockchain, ensuring transparency and security. Real-world assets are tokenized to enhance accessibility, liquidity, and efficiency in traditional asset markets.

It's important to emphasize the differences in the tokenization's justification. While tokenizing real-world assets is done from the standpoint of efficiency, access to liquidity, and reducing trust and intermediaries, tokenizing natively digital assets is primarily done to promote self-custody, ownership of the user's personal data, and promote decentralization.

Benefits of Tokenized Real-World Assets

Accessibility and liquidity are improved because tokenization removes long-standing obstacles to asset ownership. Investment opportunities that were previously inaccessible are now available to investors thanks to fractional ownership, which enables them to own a portion of valuable assets. Tokens can also be traded round-the-clock on digital exchanges, increasing liquidity.

Global Reach and Interoperability: Assets that have been tokenized are not restricted by geographical boundaries. A global marketplace is created by the participation of investors from all over the world. Additionally, these tokens may be traded between various blockchain platforms, promoting interoperability.

Reduced Intermediaries and Costs: Transaction costs for traditional asset transfers are higher because there are frequently many intermediaries involved. Tokenization gets rid of a lot of these middlemen, which lowers costs and boosts productivity.

Security and Transparency: The immutability and transparency of blockchains are guaranteed by their very nature. A public ledger keeps track of ownership and transaction information, which lowers the possibility of fraud and offers a safe environment for transactions.

Challenges for Issuers

Regulation Compliance: Issuers must juggle a dense web of regulations and compliance requirements since the regulatory environment for tokenized assets is still developing. It is crucial for issuers to maintain legal clarity because different jurisdictions could have different requirements. In the world of regulated securities, for instance, a CSD maintains the records and displays a golden state of truth, but a decentralized ledger is not under the authority of a single party; how can you guarantee that the state of the ledger is always accurate? Token ownership would also require legal recognition in order to be equivalent to asset ownership.

How do you identify the user's wallet for KYC/AML purposes? A straightforward solution would be for the user to demonstrate ownership of the address by sending a message using the related private key and presenting official identification from the neighborhood. The counterparty may then provide the user a KYC NFT passport or store this information in their own local, centralized database. On-chain identity has some unresolved problems and risks, particularly when one loses access to their wallet or the private key is stolen.

Asset Appraisal & Valuation: Accurately estimating the value of real-world assets is essential for tokenization. To provide fairness and openness for investors, this procedure necessitates trustworthy valuation techniques. For instance, Oracle networks like Chainlink could be a crucial data provider for manual pricing or indexes.

Although blockchain technology is fundamentally secure, there are security threats that could arise from trades or smart contract flaws. Issuers must put strong security measures in place to protect against fraud or hacking. One significant distinction is that once implemented, smart contracts are immutable, making it nearly impossible to undo any damage if the issuer loses access for whatever reason. Regular audits and other security precautions could assist in resolving the problem.

Impact on Investors and Native Currency

The network, its investors, and the native currency of the smart contract platform are all significantly impacted by the tokenization of real-world assets:

greater usage (demand for blockspace) = greater transaction fees paid to network validators (network revenue), which is not difficult to understand. As the use of tokenized assets spreads, there may be a rise in demand for the platform's native currency, such as Ethereum's Ether. The value of the local currency may rise as a result of this increased demand. Investors should be aware of the dangers associated with investing in digital assets, such as the dangers of severe volatility and catastrophic loss.

Market Innovation and Efficiency: The tokenization of physical assets encourages market innovation and efficiency, potentially resulting in a more open and accessible global financial ecosystem. This is a presumption that hasn't been proven in practice.

Real Yield Opportunities for DeFi: Financial solutions based on yield- or dividend-bearing real-world assets could provide DeFi with the much-needed boost it requires in the current context of high interest rates. Investors should be aware that this may prevent sustainable or steady yields or returns from digital assets.

State of Tokenized Real-World Assets

Tokenization of RWAs in numbers, starting with market cap growth.

Market Growth (Total Market Capitalization of RWA's)

Source: Messari, VanEck Research, Data as of 31/08/2023. Historic performance is no guarantee for future results.

Source: Messari, VanEck Research, Data as of 31/08/2023. Historic performance is no guarantee for future results.

Platform of Choice

Issuers

Source: VanEck Research, Data as of 31/08/2023. This should not be understood as financial advice for any particular network or its native currency.

Source: VanEck Research, Data as of 31/08/2023. Historic performance is no guarantee for future results. This should not be understood as financial advice for any particular network or its native currency.

Type of Tokenized Assets:

Products

Source: VanEck Research, Data as of 31/08/2023. This should not be understood as financial advice for any particular asset type.

Conclusion

Tokenized real-world assets represent a significant evolution in the world of finance, offering a myriad of benefits to investors and issuers alike. While challenges persist, the potential for increased accessibility, liquidity, and transparency in asset markets is substantial. As the space continues to mature, the impact on investors and native currencies of smart contract platforms is likely to be even more pronounced, reshaping the way we think about traditional assets and investments. It is not just the assets themselves that are changing, but also the asset managers, issuers, data providers and all other intermediaries that will need to rethink their entire business model. For a while, we will be stuck in a hybrid world (both off-chain and on-chain), much like the theoretical concept of gradient descent, I believe we will slowly tend towards the global optimum of fully on-chain assets and minimize the number of intermediaries.

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