Preface
Since 2023, traditional and crypto giants such as Goldman Sachs, Siemens and Binance have been actively laying their groundwork in the RWA venue. Why is RWA, which is not a new concept, receiving renewed attention? Will short-term FOMO trigger the next round of bull market? This article will provide a comprehensive introduction to RWA, as well as in-depth thoughts on the opportunities and challenges of the RWA, an overview of the RWA ecosystem, and predictions on its future development trends.
Key Insights
♦ RWA (Real World Assets) is the process of converting the ownership (and any associated rights) of real-world tangible or intangible assets into digital tokens, i.e., by bringing their value to the blockchain to facilitate direct user transactions without the need for intermediary involvement.
♦ In the long term, RWA is a bridge connecting TradFi and Defi, and by utilizing the advantages of blockchain, it solves the pain points of traditional finance, improves transparency and efficiency, reduces costs, improves the efficiency of capital allocation and liquidity, and achieves de-intermediation; in the short term, the main reason for RWA's return to the spotlight is the fact that the high returns of the Defi protocols have become unsustainable, and the yield of the 1-year U.S. bond has risen to the 5% level,therefore, there is a desperate need for investors to find new platforms to boost their returns.
♦ RWA is still facing challenges such as unclear regulatory framework and low adaptability of public chain, and its trust requirements are completely different from Defi's native crypto protocols, which urgently needs compliance policies to promote traditional assets to be deployed on the chain with more confidence.
♦ RWA ecosystem has a wide variety of projects, but the top protocols are mainly debt ones, which is also the most promising segment among RWA venue, and may lead to "Yu'ebao" projects in the crypto market; while other underlying assets, such as agriculture crops, will be exposed to the risk of unstable returns.
Outline
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Background
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Introduction to RWA
2.1 What is RWA?
2.2 What problems does RWA solve?
2.3 How does RWA work?
2.4 Potential Risks and Challenges
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RWA Ecosystem Analysis
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Summary and Future Trends
1. Background
Following the release of Hong Kong's new crypto policy, the Exploration Unleashed: Web3 and RWAs Summit hosted by Dubai's RWA project BG Trade in Hong Kong on July 7, 2023, once again kicked off a fervent discussion on RWA-related topics, and since the first half of 2023, the traditional and crypto industries' focus on the RWA has been heating up.
First, Goldman Sachs announced the official launch of its digital asset platform GS DAP, which has helped the European Investment Bank issue a €100 million two-year digital bond; then Hamilton Lane, a private equity firm with $857B in AUM, tokenized a portion of its $2.1 billion equity fund on Polygon to sell to individual investors; Germany's third largest market cap listed company and electrical engineering giant Siemens also debuted a €60 million digital bond on Polygon, which was issued under Germany's Electronic Securities Act (eWpG) and purchased by DekaBank, DZ Bank, and Union Investment. By issuing the bond on the blockchain, Siemens no longer needs paper certificates and central clearing agencies, but can sell the bond directly to investors. Bonds can be sold directly to investors without the need for a bank to act as an intermediary; Swift is working with Chainlink and more than a dozen major financial institutions and financial intermediary services to explore how companies can leverage the existing Swift infrastructure to efficiently direct the transfer of tokenized value across a range of public and private blockchain networks, with participants including Australia and New Zealand Banking Group Limited (ANZ), BNP Paribas, Bank of New York Mellon, Citibank, Clearstream Banking, Euroclear, Lloyds Banking Group, SIX Digital Exchange (SDX), and the Depository Trust & Clearing Corporation (DTCC), the Chainlink CCIP will provide connectivity and interoperability between public and private blockchain networks. In addition, a number of crypto-friendly government agencies are actively testing the waters of RWA. In addition to the Hong Kong government, the Monetary Authority of Singapore (MAS) has announced a pilot project called Project Guardian, with JPMorgan Chase and DBS Bank as partners in the pilot, which uses a forked licensed version of the Aave lending protocol and Uniswap exchange running on Polygon's mainnet, JPMorgan Chase executed the first DeFi transaction on-chain, exchanging a $100,000 tokenized SGD deposit (the first time a bank has ever issued a tokenized deposit) for a tokenized JPY issued by SBI Digital Asset Holdings.
Crypto-native head institutions are also making moves in the RWA space. In April, Binance announced that it had become a node operator for the Layer1 blockchain Polymesh, an institutional-grade blockchain tailored for regulated assets such as security-based tokens, as well as MakerDAO, which is the DeFi project making the most headway in terms of RWA adoption. Currently, the protocol has over $680 million worth of RWAs backing the decentralized stablecoin DAI.OG-level DeFi protocols such as Aave and Maple Finance are also actively pursuing innovations related to the RWA space.
2. Introduction to RWA
2.1 What is RWA?
RWA (Real World Assets) is the process of converting the ownership of real-world tangible or intangible assets (and any associated rights) into digital tokens, i.e., by bringing their value onto the blockchain so as to facilitate direct transactions without the need for an intermediary.RWAs can be either tangible or intangible assets, with tangible assets including real estate, artwork, and precious metals, etc., and intangible assets including stocks and bonds, intellectual property, investment funds, synthetic assets, etc. RWAs, also known as "tokenized securities" or "security tokens," have a number of unique attractions for investors, such as the ability for investors to take partial ownership of assets for greater accessibility, lower investment thresholds, the ability to trade previously illiquid assets, and the fact that transactions are recorded on an immutable, decentralized ledger, thus enabling greater transparency. In addition, blockchain protocols allow for automated compliance, helping to reduce compliance costs.
RWA is not a new concept. The scope of STO a few years ago focused on bond financing for enterprises, but the market size did not achieve a breakthrough in the long run; in 2020, MakerDAO formally incorporated RWA into its strategic focus, and in addition to issuing the stablecoin DAI, MakerDAO passed a proposal to use RWA as a form of collateral in the form of tokenized real estate, invoices, and accounts receivable, in order to expand the issuance of DAI. MakerDAO is said to derive around 70% of its December 2022 revenues from RWA; Aave followed closely behind, announcing a live RWA marketplace at the end of 2021, also allowing collateralized lending of real assets. The RWA concept has been lukewarm, despite the addition of headline protocols to the layout. It wasn't until the entry of traditional and crypto giants this year that RWA was brought back into the limelight.
2.2 What problems does RWA solve?
2.2.1 Long term: bridging Tradfi and Defi
RWA is the bridge between TradFi and Defi, and in the long term, the drive to bring real world assets onto the chain comes from the needs of both the traditional financial world and the Defi space.
From TradFi's perspective, traditional finance is currently facing the following pain points: a.There exists a huge intermediary system in traditional finance. While intermediaries like regulation, third-party back-adjustment and credit bureaus, aggregators, and other intermediaries do provide strong security and trust support for the operation of the entire financial system, they also largely sacrifice market efficiency and increase operational costs; b. Many assets in traditional financial markets remain globally fragmented, and investment thresholds for assets like real estate and private placements are also very high, requiring unaffordable capital support, and the global allocation of capital is very inefficient, less liquid and more costly. The application of RWA in the field of Defi can well solve the above pain points: a. Improve efficiency: Blockchain's distributed ledger improves reconciliation efficiency, and Atomic settlement allows users to deliver assets at the same time as payment, eliminating the delay of T+2 settlement; b. Reduced costs: Autonomous protocols that are automatically executed reduce the need for intermediaries. Using blockchain-based record keeping, bond issuance costs can be reduced by up to 90% and fundraising costs by up to 40%; c. Improved transparency: Public chains allow for real-time auditing, improving the ability to verify the quality of asset collateral and systemic risk exposure, and public dashboards showcasing on-chain activity effectively reduce disputes around record-keeping; d. Built-in Compliance: Complex compliance rules can be programmed directly into tokens and applications that provide token services, and dApps can implement privacy-protecting KYC tools to comply with regulations while protecting users' privacy without the need to hire a separate compliance team to do the consulting, dramatically reducing compliance costs and risks; e. Improve market liquidity: The private market, as a less liquid market, is largely inaccessible to individual investors with trillions of dollars worth of assets in it due to restrictions such as high investment thresholds and policies. Tokenizing assets in the private market (e.g., pre-IPO stocks, real estate, carbon credits) can improve the accessibility of that market.
And from Defi's perspective, the DeFi ecosystem has proven to be extremely resilient even in the face of extreme adverse market volatility, rapid deleveraging events, and the collapse of centralized cryptocurrency institutions such as FTX, despite the public's mixed views on cryptocurrencies. According to DefiLlama, as of July 12, the DeFi ecosystem had a total TVL of $44.61B (peaked at $248B) and billions of dollars in daily trading volume. However, the main factors preventing DeFi from growing further globally are that, at present, DeFi is mostly an internal circular economy with little connection to the real-world global economy of traditional businesses and services, and that DeFi's historically rapid growth has been attributed in large part to a game of capital wheeling and unsustainably high yields fueled by inflationary token rewards, which is the equivalent of playing supercomputers with a Minesweeper. Defi's pure potential is untapped. As Hong Kong government official Leung Hon-king puts it, "Is Web3 trading in virtual currencies only?The answer is no. Our goal is to be able to have Web3 empower and serve the real economy. The trading volume of virtual currencies such as Bitcoin and Ethereum is too small, only $1 trillion. Our goal, which is a trillion-dollar business opportunity, is to use tokenization to increase the liquidity of all types of assets, including bonds, real estate and alternative assets."
2.2.2 Short term: providing a new platform for revenue growth
Since the explosion of the DeFi protocols in 2020, they have been a driving force in attracting users and traders to the cryptocurrency space.Experiments within DeFi have provided innovative financial applications such as decentralized automated market makers, stablecoins, lending, insurance, swaps, synthetic assets and derivatives. As asset prices rise and new users join, DeFi's total TVL soars to a peak of $248 billion in December 2021.The Defi protocol drives growth by temporarily increasing yields primarily by offering users token rewards for the protocol's native tokens (e.g., Compound rewards lenders with COMP tokens). Such high returns are unsustainable in a bear market in 2022 as token prices fall and interest in cryptocurrencies wanes. Stablecoin USDC's historical borrowing rate peaked in December 2020, with Aave peaking at 18% and Compound at 8%. Today, their yields have fallen to 0.05% and 2.21%, respectively. By comparison, the 1-year U.S. bond currently yields 5.35% and investors are not exposed to potential agreement risk. So for the crypto market and crypto investors who favor higher yields, RWA is one of the few tracks that can be backed by solid returns.
2.3 How does RWA work?
According to Binance's RWA research report, the process of RWA is divided into three stages: (1) off-chain normalization; (2) information bridging; and (3) RWA protocol demand and supply.
a. Off-chain normalization
Before proceeding with asset tokenization, assets must first be normalized off-chain, including clarifying the value of the asset, the asset owner, and the legal procedures to protect the relevant property rights.
b. Information Bridging
The information related to the economic value and ownership of real assets is stored in the blockchain ledger after being uploaded to the chain, which mainly includes: Tokenization: Information collected during the off-chain normalization phase is converted into code and represented by metadata in the form of digital tokens. This metadata ensures complete transparency of the economic value and ownership of the asset through the blockchain. As mentioned earlier, this process is referred to as "tokenization." Regulation and Compliance: Different regulatory policies exist for assets that require some type of regulatory oversight or are considered securities, and tokens can have compliance built in;
c. Demand and Supply of RWA Protocols
The RWA-focused DeFi protocol drives the entire process of tokenizing real-world assets. On the supply side, the DeFi protocol oversees the formation of RWAs. On the demand side, the DeFi protocol facilitates investor demand for RWAs. In this way, most DeFi protocols that specialize in RWAs serve both as a starting point for RWA formation and provide a market for the final RWA product.
2.4 Potential Risks and Challenges
While RWA can offer many benefits to institutions and investors, there are a number of challenges and prerequisites to realization that must be considered for its potential to be truly realized.
a.Regulatory Clarity: A major impediment faced by many financial institutions interested in asset tokenization is the lack of regulatory clarity. Certain jurisdictions, such as the EU, Switzerland, the UK and Japan, have made tangible progress in establishing clear frameworks, while others, such as the US, are still largely in the process of discovery;
b. Permissions: In order to comply with existing and upcoming financial regulations around blockchain and asset tokenization, token issuers must typically add permissions by implementing KYC/AML checks (e.g., during issuance/redemption or at the time of transfer);
c. Identity: The need for fine-grained permission control requires robust solutions to determine user identity and risk profile. DID and other privacy-preserving identity solutions are a prerequisite for most institutions to venture into RWA tokenization.
d. Cross-chain: The expanding multi-chain ecosystem has resulted in institutions having to access more and more chains in order to access/issue RWAs. Solutions such as the Cross-Chain Interoperability Protocol (CCIP) enable institutions to not only connect their existing back-end systems to the blockchain, but also connect RWAs across chains.
e. Proof of Reserve: Since RWAs represent off-chain assets, DeFi applications have limited knowledge of their true collateral. Oracle solutions such as Chainlink Proof of Reserve address this challenge by providing on-chain collateralization data such as TrueUSD.
3. RWA Ecosystem Analysis
Although RWA still has a long way to go in realizing high PMF, the ecosystem has become sizable as the attention of the organization and the market increases:
(Source: Unreal RWA Primer)
Depending on the underlying assets, RWA programs mainly include: a. Fixed income, mainly based on U.S. bonds, stocks, real estate, art and other assets, Treasuries/Treasury ETFs are currently the largest proportion of RWA, this category is also an area of focus, although the stablecoin type of projects have been oligopolistic, but the "crypto market Yu'ebao" is still possible to take advantage of the segmentation; b. Loans, the underlying assets mainly include personal home mortgages, corporate loans, car mortgages, etc. c. Equity, which accounts for a relatively small portion of the RWA ecosystem, partly because most of the underlying assets in the equity market can be traded in traditional financial markets and are subject to strict legal regulation.
On a data level, according to rwa.xyz, as of July 13, 2023, the cumulative borrowing volume of RWA lending agreements reached $4.4 billion, with an active borrowing of $540 million (peaking at $1.4 billion in July 2022, excluding MakerDAO), and then, as a result of the continuous withdrawal of institutions, some lending agreements experienced bad debts, leading to a continuous decline and has not yet to rebound:
The average APR is now 11.08%, with the active borrowing volume of each category accounted for as follows:
A few representative projects are briefly introduced here.
3.1 MakerDAO
MakerDAO is a DeFi stablecoin project that has arguably made the greatest strides in RWA adoption. Currently, the protocol has over $680 million worth of RWA backing the decentralized stablecoin DAI. By introducing RWA as collateral, MakerDAO was able to expand the market issuance of DAI, strengthen the stability of its peg, and increase the protocol's revenues (approximately 70% of MakerDAO's revenues in December 2022 come from RWA).The majority of MakerDAO's RWA collateral (approximately $500 million) is U.S. Treasuries managed by Monetalis (MIP65). These assets provide the agreement with a source of income from otherwise idle USDC collateral.MakerDAO has also launched a vault backed by $100 million worth of loans from a Philadelphia-based community bank called Huntingdon Valley Bank (HVB).HVB has utilized MakerDAO to support the growth of its existing business as well as investments around real estate and other related verticals, and participated as the first commercial loan between a U.S.-regulated financial institution and a decentralized digital currency. In another vault, Société Générale borrowed $7 million from MakerDAO, a position backed by €40 million worth of AAA-rated bonds as OFH tokens.
3.2 Ondo Finance
Ondo Finance was the most high-profile RWA project in the first half of the year, securing a $20 million Series A round led by Founders Fund and Pantera Capital in April.Ondo Finance tokenizes short-term U.S. Treasuries, investment-grade bonds, and high-yield corporate bonds.Ondo also launched Flux Finance, a DeFi lending protocol for borrowing stablecoins against tokenized U.S. Treasuries, including USDC, FRAX, DAI, and USDT, with average borrowing rates currently around 5%. However, the overall development direction of the project is centralization and compliance, and the subsequent probability is that it will only adopt blockchain technology, but will not pursue decentralization like crypto-native projects. Its governance token $ONDO is mainly used to pay platform fees, lending collateral, voting governance and ecosystem incentives.
3.3 Goldfinch
Goldfinch is a DeFi credit platform founded in 2020 by a former Coinbase employee. It issues cryptocurrency loans to users without requiring them to own cryptocurrency collateral themselves.According to its whitepaper, Goldfinch's lending model relies on four core participants: borrowers, backers, liquidity providers, and vetters.Goldfinch's lending model is close to that of traditional banks. The borrower is the participant seeking financing, and at the beginning of the lending process, the borrower proposes a pool of borrowers, which determines the terms of the loan, such as interest rate and repayment schedule. The borrower pool is then evaluated by the backers, who decide whether to provide first-loss capital. If approved, the borrower can continue to borrow and repay through the borrower pool.Goldfich currently has $101 million in active loan volume and no bad loans at this time. Compared with traditional credit institutions, Goldfich's model lowers the threshold for borrowing and can help users with lower credit ratings to obtain loans to a certain extent; however, because no collateral exists, its senior pool is also exposed to a certain degree of default risk.
3.4 RealT
RealT tokenizes real estate, and its underlying assets are real estate in the states of Detroit, Cleveland, Chicago, Toledo, and Florida, U.S.A. RealT lowers the threshold of investment by selling partial ownership of real estate, enabling investors to gain access to real estate investment opportunities. To tokenize a property, it is first necessary to confirm the value and ownership of the property off-chain, which requires RealT to commission a third-party agency to appraise the property, confirm ownership, and design a response to changes in the property's equity (e.g., in the event of a tenant's non-payment of rent, or if the property is repossessed by a mortgage, etc.). The data about the property is then tokenized and uploaded to the chain via Oracle.RealT does not tokenize a real-world physical asset, but rather shares in a special purpose vehicle (SPV) that holds title to the property, the right to the property's income, and other property covenants, in accordance with the ERC-20 standard protocol. In addition, RealT has built in KYC technology into the protocol to bring in investors and sellers in a legally compliant manner. However, real estate RWA projects are heavily influenced by real-world real estate market prices.
Overall, although there are more types of projects in the RWA venue, they are mainly stablecoin-based credit lending projects, which have higher risks than other lending protocols and do not really bring off-chain assets onto the chain, making the development space of RWA too limited, while other physical-based projects have not seen significant development. And except for debt and real estate, other RWA projects generally face the problem of poor standardization and liquidity of underlying assets, such as crops and cash crops, the growth cycle and income will be affected by weather, climate and other uncontrollable factors, increasing the volatility of investment returns and delivery cycle. We suggest focusing on debt projects, for example, MakerDAO and Ondo Finance have launched investment products based on U.S. bond yields, which may become the "Yu'ebao" in the crypto market.
4. Summary and Future Trends
RWA is extremely innovative as a solution to connect TradFi and Defi, and may even disrupt the status quo of traditional finance with huge space for imagination, providing unprecedented convenience and accessibility for global mass investors, and RWA is also very likely to trigger the investment interests of non-web3 natives; however, the overall venue is still in the immature and very early stage, and we are skeptical that short-term FOMO will continue to fuel the crypto market, and there is still a lack of a well-suited public chain and a clear regulatory framework to support the development of RWAs. The major RWA protocols are deployed on Ethereum, and while they can enjoy crypto-native network effects, public chain information is open and transparent and not subject to any regulatory constraints, and many RWA protocols, especially those that bring securities or credit-based assets onto the blockchain, are subject to regulations and limit their protocols to entities that have gone through a rigorous KYC/KYB process; operationally, the token standards and permissionless transparency may not be appropriate for RWA protocols; public chains are scrutinized on the public ledger, and certain RWA markets may have sensitive information that should be kept confidential. From a regulatory compliance perspective, a clearer framework could help give traditional practitioners greater confidence in uploading assets onto the chain to access global liquidity.
In terms of trust requirements, given that RWA relies on real-world assets, it may never be the same as the DeFi native ecosystem, which deals only with crypto-native assets. Most institutions will not feel comfortable deploying trillions of dollars worth of assets on the blockchain without the necessary precautions and protections to mitigate operational and regulatory risks; meanwhile, trust-less DeFi protocols are likely to continue to exist that can focus on crypto-native assets as a sandbox for financial experimentation and a decentralized alternative to financial services, thus contributing to changes in the global financial system by delivering tremendous value.