RWA Tokenization Beyond Speculation

Rethinking RWA Tokenization Moving Beyond Speculative Investment

Author: Jasper De Maere, Research Director at Outlier Ventures; Translation: 0xjs@LianGuai

The digitalization and financialization of real-world assets (RWAs) through the storage of digital copies (tokens) on the blockchain has the potential to fundamentally change the interests and ownership related to everyday assets. As the financial industry explores this more and more, we believe that RWA tokenization will have an impact on every industry as blockchain technology spreads in society over the next decade.

1. Summary

A Tale of Two Trends

Tokenization is a tale of two trends, happening on two dimensions of real-world assets (RWA): the digitization and financialization of RWAs. (i) Digitization is the transformation of physical assets into digital format and further improving the representation and utilization of these assets in digital databases. (ii) Financialization is the trend of transforming physical assets into financial instruments through the reconstruction of cash flows and investment opportunities.

Both of these structural trends are now accelerated by blockchain-based tokenization, reshaping RWAs. (i) Digitization is driven by the ability of blockchain to transform physical assets into digital assets, and (ii) financialization leverages the programmability of tokens to achieve innovative financial engineering. The framework of this article aims to uncover the impact of tokenization on the digitization and financialization of RWAs. Our goal is to provide founders and investors with a deeper understanding of the full potential of RWA tokenization.

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The Timing Is Right

The excitement around real-world asset tokenization (RWA) today is different from the initial hype in 2019-2020. We believe there are three key differences compared to the previous cycle.

Firstly, the current landscape involves increased participation from financial actors such as banks, hedge funds, and asset management companies, unlike the previous cycle where retail investors were the most excited. These institutions bring substantial pools of assets and deep expertise, accelerating the adoption of financial asset tokenization.

Secondly, technological advancements in blockchain have improved scalability, security, and interoperability, along with enhanced development tools and standards. Major financial institutions are currently piloting tokenization projects, demonstrating their commitment and excitement towards the innovation and possibilities of RWA tokenization.

Lastly, the regulatory environment is favorable to the tokenization of real-world assets (RWAs), with significant progress in digital asset regulation providing a solid framework for institutional participation. A prime example is the UK’s Electronic Trade Documents Act, which seamlessly integrates with blockchain applications of RWA tokenization. Additionally, the emergence of central bank digital currencies (CBDCs) and stablecoins fills previous gaps and enables on-chain transaction settlements. The combination of progressive regulation, technological advancements, and improved transfer mechanisms holds promise for the future adoption of RWA tokenization.

Unrecognized Potential

We believe that the potential total addressable market (TAM) of tokenized assets has been underestimated in previous estimates and will reach $200 trillion by 2030. Previous estimates projected a potential TAM of $10-15 trillion by 2023. We believe this is a conservative estimate and expect the true potential to be much greater. While the methods used for these estimates may seem reasonable, they are not comprehensive.

They do not consider the potential growth in value of tokenized assets. The appreciation in value is a result of creating markets around tokenized RWAs. Having a market helps discover the price of previously illiquid assets. We believe this will lead to an increase in asset value as it becomes easier to fall into the hands of those who appreciate the asset.

Another oversight in this approach is underestimating the ability of tokenization to segregate different asset elements. For example, tokenization can separate carbon credits from a piece of land. By doing so, it can create independent liquid markets for these elements, further discovering prices and promoting the appreciation of specific parts of the asset.

II. Framework Overview

The tokenization of RWAs has sparked two distinct trends that make it difficult to assess net profits. These trends are structural and have been emerging over the past decade. Tokenization of RWAs is the driving force behind the next phase of these two trends:

• Asset Digitization – transforming physical assets into digital formats or migrating existing digital assets to new infrastructures (i.e. blockchain) to unlock more benefits.

Tokenization Examples – inventory, supply chain assets, financial products…

• Asset Financialization – the process of transforming any asset into a financial instrument through the redesigning of cash flows, investment opportunities, and capital formation.

Tokenization Examples – data, intellectual property, in-game assets…

As the tokenization of RWAs drives the financialization and digitization of assets, we expect more assets to become intangible financial assets over time.

III. Benefits

We believe that tokenization can bring three main benefits by leveraging the characteristics of blockchain technology:

1. Efficiency – improving existing processes and operations by increasing asset transparency, traceability, etc. Challenges – forming alliances; Examples – inventory management, trade finance, medical records, supply chain assets…

2. Liquidity – allowing assets to change ownership in a transparent and structured manner and creating markets around assets. Challenges – liquidity fragmentation; Examples – venture capital, art, collectibles, music, retail real estate, carbon credits…

3. Ownership Decentralization – Allows for transparent and structured distribution of asset ownership. Challenges – Ownership regulation; Examples – Decentralized Physical Infrastructure (DePIN), Internet of Things, Machine as a Service…

4. Why now?

We believe this time is indeed different. After nearly five years of initial hype, the tokenization of RWA seems to have changed. We have identified three key reasons that make us believe this time is different.

• More thought sharing and activities – We see more participants actively trying the technology and sharing their thoughts.

• Technology stack and SDK – We see significant progress in blockchain technology stack and SDK, particularly in the scalability, security, and interoperability of tokenized assets.

• Regulatory clarity – Over the past few years, we have seen improvements in regulations to accommodate the tokenization of RWA, and with more stakeholders openly expressing interest, this situation will only accelerate.

5. Why is there so much attention on financial assets?

The financial industry is currently at the forefront of blockchain-based asset tokenization. Tokenization is expected to fundamentally change the digital representation and trading of financial assets such as stocks, bonds, and real estate. Powerful use cases exploring blockchain integration and tokenization in the financial sector are being explored.

We believe there are four main reasons why tokenized RWA narratives are receiving so much attention in the financial market:

• Strong fit – RWA tokenization has a strong fit in the financial industry. It facilitates and improves the decentralization of existing (i) processes, (ii) liquidity, and (iii) financial asset ownership.

• Lingo & Founders-Market Fit – Financial professionals are already familiar with the concepts of efficiency, liquidity, and decentralized ownership. Therefore, they quickly recognize the value proposition of RWA tokenization. This understanding is not common in other industries such as media, healthcare, utilities, etc.

• Intangible Assets and Digital Representation – Financial assets are already largely intangible and digital, making them easier to tokenize.

• Huge value – Financial assets constitute the world’s largest pool of assets. Hence, the opportunities associated with tokenizing these assets are unparalleled.

6. Why are we confident that the adoption of RWA tokenization will continue?

We believe that tokenization will continue to dominate the market in the coming years. In addition to its strong fit, we also see other trends in the financial market that will accelerate the adoption of RWA tokenization:

• High capital costs – The high risk-free interest rates expose the real costs of capital inefficiency. In the past 18 months, the costs of inefficient clearing, trading, and financing activities have exponentially increased, prompting financial institutions to seek solutions.

• Rushing in – Many large financial institutions have committed to building their own tokenization platforms. While we don’t believe this is the final state of RWA tokenization, financial institutions are now starting to fill the blockchain with financial tools.

• Bottom competition – In recent years, sales and trading, asset management, and other business lines have faced cost pressures due to increased regulatory burdens and the maturity of banks/financial technology challengers. As tokenization exploration becomes more serious, we believe existing financial participants will realize its scale and cost-effectiveness potential.

Seven, what excites us?

It is commonly believed that there are three distinct layers in the technology stack that supports RWA tokenization.

• Standards – Defining the representation of assets and ownership.

• Infrastructure – Providing the infrastructure to reflect and store RWAs on the blockchain.

• Applications – Providing utility for holders of tokenized assets.

We see exciting developments in infrastructure and applications.

1 Infrastructure

There is still a long way to go for infrastructure before we are ready for the ultimate game in RWA tokenization. Nevertheless, there are interesting opportunities in the short term, especially in tokenizing financial assets.

From general purpose to specific use-case tokenization infrastructure

In the past five years, we have seen significant technological advances to facilitate tokenization. We have seen L1 scalability, wallets, token standards (ERC20, ERC721, ERC3643, ERC2222, etc.)… General-purpose tokenization infrastructure is maturing. As tokenization use cases become more complex, we expect innovation and founder attention to shift from general purpose to use-case specific tokenization infrastructure.

Opportunity for founders is in building infrastructure for existing buyers

We continue to see bottlenecks in the demand side of tokenization. While there are many opportunities to tokenize and segment asset classes, we see many vertical industries struggling to build liquidity markets around these tokenized assets, even for assets that already have liquidity markets. We believe that the opportunity for founders now lies in building infrastructure for existing buyers.

Here are some things that excite us:

• DAO Treasury Tools: Tools that allow DAOs to make and execute decisions quickly, manage treasuries through tokenization of assets, and diversify them.

• Risk Management and Assessment Tools: Traditional investors are interested in the yields provided by government bonds, but find it difficult to evaluate the risk premium required for tokenized products. On-chain index tools can help investors quantify and adapt to the risk.

• Regulation-Prioritized User Access Tools: Regulatory compliance remains a bottleneck. There are tools that need to be compatible, but they should be simplified and abstracted for better user access and experience.

• Complete Token SDK: Assets are represented through simple tokens, without the need for additional smart contract functionality to automatically execute terms and conditions related to the underlying assets. If we want to transition from “dumb” tokens to “smart” tokens, we need to provide users with tools to improve token smart contract programming. It also requires regulation to enforce these rules.

Interoperability of tokenized assets in a multi-chain reality

We believe that as blockchain moves from a single universal categorized ledger to modular and vertically or application-specific constructions, we are moving towards a multi-chain reality. This is particularly evident in the financial services sector, where we are currently seeing tokens being launched on both permissioned and permissionless blockchains.

• We believe there should be interchain interoperability for tokenized assets. Here are some examples:

• Data streams

• Liquidity aggregators

• …

2 Applications

We classify applications based on their advantages rather than their ultimate market. Here’s a quick review of different advantages and some application examples.

Efficiency

Tokenization can unlock benefits between stakeholders operating on the same value chain, but doesn’t necessarily maintain consistency in economic incentives.

• Sustainable reporting – Blockchain can be used to track carbon emissions across the entire value chain.

• Financial markets – Financial market infrastructure and processes differ completely across asset categories. Tokenization can standardize practices across asset classes.

• Digital identity – Tokenizing personal data and storing it in web3 wallets allows individuals and legal entities to control information flow and digital footprints.

• …

Liquidity

Although challenging, we believe that creating a liquidity market through tokenization of RWAs can unlock financial value embedded in currently illiquid assets.

For the exciting use cases that excite us, we further break down liquidity into 1) tradability and 2) securitization.

Tradability – Tokenization has the potential to create a market for previously over-the-counter (OTC) assets.

• Carbon credits – Blockchain-traded carbon credits combine efficiency and liquidity, improving the efficiency (transparency, reporting…) and liquidity of previously inefficient markets.

• Collectibles – Tokenization brings efficient, low-cost tradability to previously OTC markets.

• …

Securitization – Tokenization has the potential to create new assets by separating a portion of the asset and putting it on the chain. These newly created assets can then be used to create a liquid market.

Real estate rights example – The separation of digital real estate rights from overall real estate rights. These rights are then used to define asset ownership in an augmented reality-based metaverse and can be traded openly. (See Darabase).

By creating a liquid market around real estate rights, Darabase expects the global value of real estate rights to increase by 2%. The price increase stems from the underutilization of digital real estate rights, as they are not tradable and thus not fully utilized.

Other examples include intellectual property, trademarks, and other markets.

As tokenization spreads across industries, we expect to see more of this asset securitization.

Decentralized Ownership

Decentralized ownership aligns with the benefits of the web3 narrative. We believe the change in ownership depends on whether we are dealing with financial asset ownership or physical asset ownership.

1. Financial Asset Ownership

The application of financial assets revolves around capital formation and the ability to access capital.

• Private markets – Previously inaccessible venture capital and private equity opportunities are now within reach.

• Real estate – Real estate ownership in the United States currently accounts for about 60% of disposable income, excluding the middle class. Tokenization can restructure real estate ownership.

2. Physical Asset Ownership

Tokenization restructures capital formation around capital-intensive industries. Traditionally, capital-intensive industries have been difficult to enter due to high initial investment requirements. Through decentralized ownership of physical assets, barriers to entry into these industries can be lowered, and the challenges of existing business models can be reduced, thereby improving efficiency.

• Decentralized physical infrastructure (DePIN) – Computing, telecommunications, storage, utilities, etc.

• Machines as a service

• Democratization of artificial intelligence – Allocating artificial intelligence capabilities through partial ownership of infrastructure and computing power.

• Internet of Things – Redistribution of asset ownership structures to unlock the full potential of the Internet of Things and smart cities.

3. How do we view adoption?

There are many aspects of change, but we believe there are two prerequisites for adopting tokenized assets.

Regulation – The regulatory framework for this new asset class is crucial. Without regulation, not only will token holders be unable to comply, but it will also be impossible to enforce embedded terms and conditions related to the tokens.

Product demand – While partially related to regulation, buyers need to have a clear demand for tokenized products. We are currently in a stage where infrastructure is surpassing demand. We need to see a resurgence in demand for these services.

We have formulated an adoption framework based on leveraging the above key advantages in different applications.

8. Financialization of physical assets

We believe another important trend will open up new markets and asset classes, namely the financialization of physical assets.

In recent years, driven by advances in technology and education, the trend of financializing physical assets has become apparent. Financialization means that the influence of financial markets, tools, and motives on the management and utilization of physical assets in a broader economy is increasing. This trend enhances liquidity and investment opportunities, particularly in the realm of physical assets where financial returns and cash flows traditionally had less impact on value propositions.

We believe that tokenization will play a key role in the next phase of financialization by unlocking efficiency, liquidity, and decentralized ownership of these assets. We see tokenization bringing liquidity and decentralization to the cash flows associated with these physical assets. While it was previously difficult to separate these cash flows from the physical assets due to transparency and efficiency concerns, tokenization offers a technological solution that enables the financialization of physical assets. This movement will eventually make them both physical assets and financial assets, similar to what has happened in the real estate sector.

9. Challenges

In addition to specific challenges related to major benefits, RWA tokenization also faces overall challenges. Here are some key challenges:

• Network effects – Blockchain-based applications rely inherently on network effects. For RWAs, the need for user network effects to convert efficiency, liquidity, or decentralized ownership into viable value propositions and convince new users to tokenize RWAs and mainstream blockchain is crucial.

• Oracle problem – Difficulties arise when representing tangible RWAs with digital assets. A secure and reliable way is needed to ensure that data inputs (tokens) reflect the state of real-world assets.

• Tokenization standards – Standardizing the tokenization of real-world assets is crucial for ensuring compatibility, regulatory compliance, and investor trust in blockchain-based finance. However, the decentralized nature of blockchain and the need to address legal and technical challenges make achieving universal standards a complex task. Overcoming these challenges is crucial.

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