Since its introduction in 2017, digital asset tokenization has yet to take off in a meaningful way, limited to stablecoins and NFTs.
However, this is changing radically. Tokenization, the process of converting real-world assets (RWAs) into digital tokens on a blockchain network, is currently gaining momentum, garnering significant interest from financial institutions in recent years and attracting the attention of both retail and institutional capital investors in 2023.
Tokenization is increasingly being hailed as a revolutionary breakthrough in the financial world, bringing the benefits of blockchain technology to traditional assets.
In this blog, we lay out the basics of tokenization. We will explore the underlying mechanics of tokenizing real assets, how tokenization works, share our thoughts on the main use cases, and what it may mean for the future.
Why RWA tokenization might take off
There are several reasons for the rise of RWA tokenization. On the one hand, the higher interest rates of the current cycle are improving the economics of certain tokenization use cases. Tokenized real-world assets are becoming a means of hedging against market volatility.
The current high-yield environment gives tokenization a different meaning as an opportunity to digitize financial assets such as sovereign bonds, money market funds, and repurchase agreements.
Currently, certain real-world asset classes have limited liquidity and high barriers to entry, making them difficult to access. Many of these assets face restrictions on transferability and divisibility.
We are also witnessing a shift in the way governments and regulators around the world view real-world assets. Jurisdictions around the world are being forced to consider regulatory changes in order to be able to benefit and/or launch their own real-world assets to suit their own needs.
More importantly, many financial services firms have significantly strengthened their digital asset teams and capabilities since tokenization first came to prominence five years ago. As these digital asset teams mature, we’re likely to see tokenization increasingly used in financial transactions.
What is asset tokenization?
Blockchain allows existing real-world assets (RWAs) and capital to be ‘tokenized.’ This practice is centered around converting tangible physical assets into digital tokens, making them easily traded, transferred, and managed using distributed ledger technology.
These tokens act as digital certificates of ownership, capable of representing a wide range of assets in digital form and combining information and allocable digital rights, all connected in a programmable and automated manner.
Once generated, these tokens are recorded on the blockchain, ensuring immutable and tamper-proof integrity.
From Stablecoins and NFTs
Tokenization can create many types of tokens. Most of the tokens that exist today include stablecoins and NFTs. What happens in the crypto space is called utility tokens.
An example of this is a stablecoin, which is a cryptocurrency pegged to the value of a real-world stable asset and designed to be fungible or replicable. They are designed to reduce the volatility associated with other cryptocurrencies. They are primarily used in DeFi transactions.
Another type of token is an NFT — a non-fungible token, or one that cannot be copied — which is a digital proof of ownership that people can buy and sell. They can include art and collectibles, concert tickets, loyalty programs, certificates, digital twins, tokenized versions of intellectual property, and more exotic assets like sports teams, racehorses, art, and even shares in celebrity fame.
Towards the tokenization of real-world assets
But this situation is changing fundamentally. The trend of tokenization of real-world financial assets is becoming increasingly evident. Especially since this year, some established financial giants have accepted the concept of tokenizing real-world assets, including securities, stocks, investment funds, payment settlements, real estate and commodities.
The RWA asset tokenization process involves multiple steps including asset procurement, digital asset issuance and custody, distribution and trading, as well as asset servicing and data verification.
What has happened now?
Major financial institutions are exploring tokenized financial instruments on blockchain, demonstrating growing confidence in decentralized networks.
Traditional financial giants including BlackRock, Fidelity, Bank of New York Mellon, JPMorgan Chase, Goldman Sachs, UBS and HSBC are already using blockchain to tokenize a range of real-world assets.
These institutions are beginning to tokenize assets for more than just operational uses and savings such as repo and collateral management, and are now tokenizing products with their own client base as buyers.
JPMorgan has already developed tokenized funds, and we will soon see the development of more structured instruments that include assets from new revenue streams such as private credit.
HSBC noted that it plans to launch digital asset custody services for institutional clients, focusing on tokenized securities issued on third-party platforms, such as private and/or public blockchain-compatible tokenized bonds or tokenized structured products.
This growing trend in favor of tokenization has also been supported by governments around the world. This is by reforming regulations to better accommodate the tokenization of real-world assets. In Asia, for example, governments and policymakers such as Hong Kong and Thailand are actively adapting their use in real-world assets, seeking to unlock new revenue streams and reduce costs. Regulators in Japan, the United Kingdom and Switzerland have also said they will test the tokenization of fixed income, foreign exchange and asset management products.
What might RWA tokenization bring?
Once viewed with skepticism, tokenization is now seen as a viable option for governments and financial institutions around the world. They are now more aware of the benefits of tokenization, including the ability to run operations 24/7 and provide 24/7 data availability.
With the help of blockchain, tokens can be transferred directly (within minutes) between parties without the need for intermediaries (clearing, settlement and custody), thereby reducing transaction costs and increasing asset liquidity in credit markets.
Since tokenized assets are recorded on the blockchain, this provides a transparent and immutable record of tokenized ownership, which will also enhance security, support self-sovereign identity solutions and enhance data privacy.
Blockchain provides instant trade settlement and a higher degree of automation (through embedded code that activates only when certain conditions are met), replacing redundancies with lean and efficient models, protecting data while facilitating automated procedures including auditing and compliance, and minimizing counterparty risk.
Tokenization can also democratize access to assets that may not be accessible to many by breaking these assets (which have historically been difficult to invest in) into fragments, making them accessible across borders. By reducing barriers to entry, many people who currently do not have bank accounts will be able to invest.
Different RWA use cases for tokenization
The tokenization of financial assets such as bonds, stocks and shares allows these assets to be fragmented. As a result, their exposure to investors around the world increases significantly.
Other benefits include fractional trading of these assets, leading to larger liquidity pools and a wider range of investors. Tokens can be traded on decentralized networks, which is cheaper, faster, and safer than traditional asset exchange methods. In addition, the use case of tokenization of financial assets supports efficient processing of daily issuance, increases secondary liquidity through more investors, and reduces costs.
We are also seeing growing interest in private equity and treasury funds. The tokenization use case for funds could be applicable across the value chain and support the entire life cycle of decentralized investments. Better portfolio diversification as well as lower transaction costs are possible.
Fund managers may benefit from greater flexibility and control over asset allocation. They may realize operational efficiencies and greater access to investors with global reach through diversification.
Lower barriers to entry, better price discovery, increased liquidity, and lower issuance and servicing costs through digitalization.
The tokenization process also makes it easier to track and serve investors and allows for built-in compliance, near-instant and low-cost transfers and settlements through smart contracts.
Payment Settlement Delivery versus Payment (DvP) settlement of token-based securities or other financial asset transactions can be automatically synchronized through the use of smart contracts, without the need for intermediaries such as CSDs. This can bring a number of important benefits, including real-time settlement and reduced costs. Real Estate The tokenization of real estate assets has traditionally been complex and slow. Tokenization involves converting ownership into digital tokens on a blockchain network. Real estate tokenization has the potential to revolutionize the traditional real estate investment landscape. This allows for fractional ownership and more efficient transfer of ownership due to near-instant settlement.
Tokenization also provides greater transparency, reduces transaction costs, and eliminates intermediaries, making real estate investment more accessible to a wider range of investors. It also makes transactions easier in global markets, providing a safer and more streamlined method for fundraising and investing in real estate projects.
Where is the market for tokenized real-world assets heading?
Industry experts believe that tokenization could be a big thing as traditional financial institutions continue to adopt blockchain technology. Banks and financial giants are increasingly exploring the use of tokenized financial instruments within institutional decentralized finance frameworks.
The market for tokenization of real-world assets is expected to reach trillions of dollars by 2030. This growth highlights the growing recognition and adoption of tokenized assets. However, predictions for the size of the tokenization opportunity vary.
Citigroup estimates that tokenized digital securities trading volume will reach $5 trillion by 2030, and Boston Consulting Group estimates that it will reach $16 trillion. This would mark a significant increase from the current value of about $300 billion. Looking at the traditional securities market, Boston Consulting Group estimates that tokenized securities assets will account for about 10% of global GDP by 2030.
Asset Manager 21.co predicted in a recent report that by 2030, the market value of tokenized assets could reach $10 trillion in a “bull case” scenario and $3.5 trillion in a “bear case” scenario.
Challenges: Obstacles and Solutions
Despite all these positives, the introduction of tokenization also brings with it a number of challenges that could serve as a barrier to widespread development and adoption.
Regulatory issues, lack of standardized processes, and reluctant incumbents pose challenges to the widespread use of tokenized RWAs around the world. There are other obstacles such as technical bottlenecks, limitations of current infrastructure, and interoperability that limit its adoption.
Legal and Regulatory Hurdles Most tokenization efforts face significant legal and regulatory hurdles during initial offerings, as many of the laws governing the space are still new and many major jurisdictions still lack a clear legal framework for tokenization. Due to regulatory ambiguity, multiple platforms are often required to handle tokenized assets in different jurisdictions.
Interoperability issues and lack of standardization
And there are interoperability issues and a lack of standardization. Most institutions rely on private blockchains, which mostly do not communicate with other blockchain platforms. Private networks may make interoperability more difficult in the future. One possible result may be fragmented cross-chain liquidity and challenges for investors to enter, especially in the secondary market.
Missing granularity
Another weakness of the tokenization industry to date is actual product distribution and capital syndication. Currently, most tokenization of financial assets is simply a digital representation of the reserves held by companies. It ignores the granularity at which various assets actually exist, such as their financial obligations, liabilities, or cash flows.
Real-time settlement is incomplete
Another obstacle is that some of these platforms only settle the transaction portion on-chain, not the cash portion, so the real-time settlement process is incomplete.
Reluctant incumbents
As with any new technology, it is common that those in power may be reluctant to see progress. Take for example the pension fund or asset management industries. On the funding side, certain parties have already made a lot of profit from existing inefficiencies. Similarly in the asset management industry, incumbents impose administrative burdens when transferring assets, especially those investments that are protected by tax.
Lack of expertise and skills New technologies bring new challenges. Expertise around tokenization remains scarce, and knowledge is not widely available. This can be quite challenging for anyone who wants to harness and unlock the full potential of such innovations.
Resolving obstacles
Widespread adoption will require overcoming significant barriers, particularly related to the complexity of integrating into existing real-world systems. Appropriate safeguards should be put in place to protect investors and the economy as a whole. Tokenized real-world assets may also require the creation of a robust, scalable infrastructure designed to merge with the traditional financial ecosystem rather than attempting to replace it.
However, in the past 2023, we have made incredible progress in overcoming these issues. The establishment of the world's first comprehensive cryptocurrency regulatory framework, MiCA, in Europe, and more relaxed regulatory stances in other countries around the world to ensure security and build trust are paving the way for easier adoption of tokenization in financial infrastructure. Given the large number of solutions entering the market, interoperability issues are also increasingly being addressed, including the establishment of tokenization protocol standards.
RWA Tokenization: A Transformative and Disruptive Force
The tokenization of real-world assets is itself a great opportunity to cross the boundaries between the virtual and real financial worlds. It becomes a major transformative force in redefining the legitimacy of the blockchain industry in the global financial landscape.
By ensuring complete and immutable visibility of transactions, blockchain solidifies its credibility and builds a solid bridge between the two worlds.
It opens the door to closer integration between cryptocurrencies and traditional asset classes, including fiat currencies, stocks, government bonds and real estate.
The future of tokenization is expected to be dynamic and transformative as it has the potential to revolutionize various industries. The use of security tokens that adhere to regulatory frameworks has the potential to disrupt various financial markets and industries, changing the way financial transactions are performed today.
It could significantly reduce existing operational layers - trading, clearing, settlement, custody and reporting - by eliminating or reducing the need for intermediaries. It could also cause significant disruption to traditional financing technologies and methods, and change the structure of traditional financial services and global capital markets.
The tokenization of real-world assets firmly expands the opportunities for automation and simplification of back-office operations, replacing legacy systems with cost-effective instant settlement.
Forward-looking
Tokenization has the power to revolutionize a wide range of industries, providing significant opportunities to shape the future of finance and investing, and could have a considerable impact on the global economy. Tokenization is reshaping and revolutionizing the way many institutions raise funds, trade and manage financial assets. In addition to bringing significant efficiency gains to the entire process, it also opens up the potential to create new revenue streams.
2024 will be the year of breakthrough for RWA tokenization.
Wishing you all a great 2024 too!