Summary

  • Through the combination of physical assets and blockchain, real world assets (RWA) can be formed after physical tangible assets are tokenized.

  • RWA has rich utility in the DeFi field.

  • RWA is credited with bridging the gap between TradFi and DeFi.​

  • Large financial institutions have begun to get involved in the RWA field, indicating the expansion of this field.

Tokenization, the conversion of an asset or utility into a digital currency, is a technology that stands out in the blockchain ecosystem and is getting a lot of attention. Real World Assets (RWA) refers to the tokenization of tangible assets with clear monetary value, such as gold, real estate, and carbon credits, into a tradable digital form.

RWA's utility in the field of decentralized finance (DeFi) is extremely broad. The integration of RWA and DeFi is a well-known example of the integration of traditional financial assets and DeFi.​

How does RWA work?

Before introducing the utility of RWA in DeFi, we first explain how it works. Specifically, how do we ensure that RWAs representing real-world assets are legitimate tokens? The entire process can be divided into three stages: off-chain formalization, information bridging and RWA protocol supply and demand.

Off-chain formalization

Before real-world assets can be integrated into a digital ledger, their value, ownership, and legal status must be clearly established in the physical world.​

When estimating the value of RWA, various factors such as the market price, historical performance, and physical condition of the asset need to be considered. These assets must have undisputed legal title, evidenced by a deed or invoice.

information bridging

This stage is the tokenization process. In this process, information about the asset is converted into digital tokens. Data about the asset’s value and legal ownership will be embedded in the token’s metadata. Since the blockchain is open and transparent, anyone can verify the authenticity of the token based on metadata.

When dealing with assets that fall within the scope of regulation or are classified as securities, the use of regulatory techniques is a critical component. This may include engaging a licensed security token issuer, adhering to cryptocurrency-specific KYC and business KYB standards, and using an approved security token trading platform.​

RWA protocol supply and demand

The final step is about demand and supply, where RWA-focused DeFi protocols come into play. This type of agreement has two major functions: first, it effectively converts new RWA, which helps to provide more such digital assets. At the same time, these agreements can also make investors interested in buying and trading these assets.​

Through the above three-stage approach, RWA is no longer just an abstract concept, but has become a practical and key component in the DeFi field, bringing the influence and trust of real-world valuation and legal frameworks into the decentralized digital field.

Why RWA can rewrite the history of DeFi

One of the most important indicators of DeFi is "total value locked" or "TVL". The TVL metric measures the amount of funds locked in various DeFi protocols. Higher TVL roughly equates to higher utility. In November 2021, riding on the bull market momentum of the so-called "DeFi Summer", the total TVL reached a peak of approximately US$180 billion.​

However, as the market went lower, DeFi TVL fell to $49.87 billion by June 2022. This valuation fell by 72.3% in just 7 months! Due to leaks of liquidity in the market, certain DeFi protocols that lack real utility and have poor token economics are doomed.

As a result, the mentality of regular DeFi investors has changed significantly. More and more investors are turning to stable long-term investment opportunities rather than pursuing quick profits. This trend will be particularly evident after 2021, when the trend to pursue stable asset classes such as RWA becomes increasingly apparent.​

The following are facts and figures related to the RWA market, reflecting the growing interest in this market.

  • RWA’s on-chain value (excluding stablecoins) grew by $1.05 billion in 2023.

  • Among them, US$855.7 million (82%) came from income-generating assets such as treasury bonds, real estate and private credit.

According to analyst research for the period January 1 to September 30, 2023:

  • Active on-chain private credit loans grew by $210.5 million

  • Treasuries and other bonds increased by $557 million.

What is a RWA issuer?

For RWA to be successfully put on the chain, the issuer must practice the following three key activities:

  • Acquire tangible assets in the physical world.

  • Convert these assets through tokenization.

  • Issue tokens to users in the blockchain network.

The following are several RWA issuers:

  • Centrifuge: One of the largest issuers of private credit loans on the chain.

  • Franklin Templeton: TradFi giant founded in 1947. The institution has more than $1.5 trillion in assets under management (AUM) and recently began issuing tokenized Treasury tokens.

  • WisdomTree: The market leader in trading platform trading products with nearly $96 billion in assets under management.

Advantages of using RWA in DeFi

Tokenized real-world assets (RWA) offer a number of significant advantages that will reshape investment strategies and the cryptocurrency finance landscape.​

  • Increased liquidity: Tokenize assets such as real estate that were originally illiquid and slow-moving and convert them into tokens. These tokens will attract more investors to participate in underlying asset transactions.

  • Ownership split: Ownership split is one of the most attractive use cases of RWA. Dividing assets such as real estate into tokens can lower the transaction threshold for ordinary users. This allows a group of investors to pool funds and jointly own a property in the form of tokens.

  • Open and transparent: The blockchain ledger is open and transparent, ensuring that every transaction and ownership details of RWA are recorded and publicly verifiable.​

  • All-inclusive: Tokenizing assets through DeFi channels paves the way for new markets and financial instruments. This not only brings new opportunities to existing investors but also attracts new players to enhance the overall stability and growth potential of the financial ecosystem.

Limitations of using RWA in DeFi

RWA is a pioneering approach that combines physical assets with digital finance. However, RWA still has limitations and challenges.​

  • Regulatory complexity: RWA and DeFi are subject to cumbersome regulatory requirements. Regulatory requirements vary based on factors such as the asset, geography, jurisdiction, and even the specific blockchain platform used for tokenization.​

  • Security Issues: For RWA, maintaining a connection between physical assets and digital tokens is critical. This connection must be unbreakable to prevent fraud and legal disputes.

  • Scalability: Platforms that support RWA tokenization need to be able to handle high-throughput transactions and data.

Conclusion

RWA is an exciting development in the DeFi space and promises to expand DeFi functionality and audience. RWA is expected to create a more interconnected financial field and integrate traditional finance and decentralized finance. However, there are many obstacles to overcome to achieve this goal, including strict regulatory compliance and ensuring market integrity.

Further reading

  • What is DeFi’s real rate of return?

  • An introduction to DeFi 2.0 and its importance

  • What are the liquidity pools in the DeFi field? How do they work?


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