Financial History, Legal System, and Technological Cycles The Trillion-dollar Narrative of RWA Cannot Withstand Scrutiny

RWA's Trillion-dollar Narrative Crumbles under Scrutiny

Author | Beichen

As the cryptocurrency market remains sluggish, the concept of RWA (Real World Assets) has gained popularity and become one of the few grand narratives recognized by all parties in the industry, even attracting the interest of traditional institutions such as Goldman Sachs and Citigroup.

The reason why RWA is a trillion-dollar narrative is largely because it is still too far from realization, leaving ample room for imagination.

However, it should be noted that the narrative of RWA is much more confusing than that of DePIN. To judge whether a DePIN project is reliable, you can simply rely on your own professional knowledge as a practitioner (for example, if you have the technical knowledge of an IoT practitioner or the business knowledge of a crypto practitioner, you can judge how unreliable Helium is). On the other hand, the narrative of RWA involves financial history, legal systems, and the cycle of blockchain technology. These knowledge areas are unrelated to the productivity of the crypto industry and become irrelevant blind spots.

This article starts with common sense to explore the grand narrative of RWA, and welcomes rebuttals and corrections.

Financial History: From Securitization to Digitization to Tokenization

“Put real-world assets on the blockchain!” This story is indeed tempting, especially in the context of tightening liquidity.

Therefore, you will see voices from the crypto industry, traditional financial institutions, and even governments advocating the narrative of RWA. It can be said that people from different fields have made a misjudgment of RWA due to their lack of knowledge of financial history, and as a result, a multi-part ensemble has unexpectedly formed in the market, further reinforcing their misjudgment.

When you incorporate these voices (referring to all research reports and discussions advocating RWA) into the perspective of financial history, you will find that these claims are exaggerated—they have skipped the historical processes of asset securitization and asset informatization, and directly proposed the solution of asset tokenization. The summarized advantages of RWA solutions are nothing more than three points: increased liquidity, simplified transaction processes, and removal of financial intermediaries.

If it was discovered in 1970 and proposed the solution of “packaging illiquid assets into tradable securities and putting them on the blockchain,” it could be said to be a financial genius, but now it is 2023.

Let’s take the BCG report that has been widely cited as an example. They advocate putting real assets such as real estate, cars, stocks, metals, and artworks on the chain and conservatively estimate that the value of tokenized assets will reach $16 trillion by the 2030s.

So here’s the question, if the goal is to solve liquidity, do these assets need to be tokenized? The answer is that they need to be securitized. If the goal is to simplify transaction processes, do these assets need to be tokenized? The answer is that they need to be informatized.

We will briefly review the changes in financial instruments since 1970 from the perspective of asset carriers, and their fallacies become clear.

Asset Securitization Increasing Liquidity

Although mortgage bonds were issued by the American agricultural railway in the 19th century, true asset securitization started in 1970 when Ginnie Mae issued securities backed by mortgage portfolios. Simply put, it is packaging the unrecovered mortgage loans of banks and selling them to investors in the financial market. This not only enables banks to retrieve funds in advance, but also provides investors with stable financial products, directly promoting the prosperity of the real estate market.

The financial magic of asset securitization lies in the fact that those illiquid assets were originally idle, but they were revitalized through securitization. This method quickly expanded from bank loans to corporate bonds, accounts receivable, and even parking fees. In short, all assets can be securitized.

The wave of asset securitization released astonishing liquidity and created numerous financial empires during its growth process (such as investment banks shown in “The Wolf of Wall Street”). However, it later caused the 2007 financial tsunami due to relaxed regulations (mainly caused by junk bonds and aggressive leveraged buyouts).

Asset securitization has developed a very mature operation model (asset types, business logic, product principles, transaction structures, etc.) and market norms (issuance filing, listing, etc.) in decades of development. However, the trillion-dollar market advocated by RWA today is actually mostly the market of asset securitization. When they are bragging, they seem to forget about asset securitization.

So, returning to a very realistic and thought-provoking question – if real-world assets are for addressing liquidity, why choose the RWA market instead of the larger and more compliant market of asset securitization?

This question actually existed when ICO was advocated in 2017, but today the answer about ICO is already clear, which is that ICO and IPO are in different ecological niches, and the irreplaceable advantage of ICO is a lower entry barrier. Today, the people who advocate RWA still make the same mistake as those who advocated ICO replacing IPO back then – they have not recognized their own ecological niche, they do not focus on the irreplaceable advantages of RWA, but attempt to replace the market of asset securitization with asset tokenization.

Asset Informationization Simplifying Processes

Another advantage of RWA is the ability to simplify complex transaction processes in the real world, thereby improving capital efficiency. RWA indeed has this advantage, but we need to clarify which simplified processes are brought by blockchain technology and which have already been achieved in the wave of asset informationization.

For example, Bitcoin has implemented the global payment function of the SWIFT system using blockchain technology, and Uniswap has implemented the listing and trading functions of centralized exchanges on the blockchain with just 500 lines of code. But today, the touted efficiency revolution brought by RWA has already been achieved in the wave of informatization, and it has just been moved to the blockchain again.

When they tell the story of RWA, it seems like they have forgotten about the wave of informatization, so it is necessary for us to trace back the history.

In 1971, Intel launched the first commercial CPU, marking the formal arrival of informatization. The wealth created by society began to transform from material form to information form, and this wave also swept the financial industry.

NASDAQ was founded in 1971, at that time it was not an exchange, but a quotation system that integrated over-the-counter trading information. You can understand it as a platform for comparing prices across the network. Although the functionality was simple, it was already quite disruptive compared to the ticker tape quotation machines that were popular ten years ago (by the way, ticker tape quotation machines were also very disruptive compared to earlier manual price modifications on blackboards). This was a leap in efficiency brought by technological revolution to capital.

With the continuous advancement of the wave of informatization, the financial industry has more information tools. For example, the adoption of electronic trading systems allows investors to complete the entire process from price discovery to execution of trades by themselves, without the need to call or fax their brokers (so ordinary traders can trade dozens or even hundreds of times a day, a capability previously limited to institutional professional traders). This was another leap in efficiency brought by technological revolution to capital.

Now let’s look at how RWA is being touted to improve capital efficiency – they directly compare it with assets that have not undergone informatization transformation, so of course they will reach conclusions that favor them. However, most of the efficiency improvements can be achieved through traditional financial technology, without the need for blockchain (for example, for RWA projects in real estate, spending a few thousand dollars to create a small program is sufficient).

Asset Tokenization Without Intermediaries

Reviewing the securitization and wave of informatization, it is not difficult to see that most of the functions of RWA have been filtered out. Now let’s take a closer look at how many assets in the real world need to be tokenized.

Notice that it is first necessary to select a portion of the assets in the real world that are suitable for securitization, then select a portion of the already securitized assets that require informatization, and then select a portion of the already informatized assets that require tokenization.

Citibank’s report believes that almost anything of value can be tokenized, and predicts that there will be $4 trillion to $5 trillion of tokenized digital securities by 2030, while trade finance transaction volume based on distributed ledger technology (DLT) will reach $1 trillion.

If it’s not a case of pretending to be ignorant (like the annual top 10 predictions from CICC), or financial workers just trying to meet KPIs, then Citibank is also just like this. Because securitization enables traditional assets to be divided and traded, and informatization reduces transaction costs, and none of these are the merits of RWA.

The real role of RWA lies in the decentralization of transactions. In traditional financial markets, the ownership and transactions of assets usually require authentication and regulation by intermediaries, which consume a lot of time and cost. RWA can reduce the need for intermediaries, as even the most classical blockchain like Bitcoin can meet basic transaction needs.

However, this is not a problem to be solved at the technical level, but a problem to be solved by policies. In fact, if RWA targets a trillion-dollar market, it still needs intermediaries for authentication and regulation, just like the complex processes in traditional financial markets.

Therefore, there is no motivation to tokenize real-world assets. The application scenarios mentioned when advocating RWA, such as carbon credit limits and real estate, are similar to the projects initiated in small towns. As for the analysis that the future multi-chain ecosystem will bring challenges to the RWA market, it can be seen as a joke of groundless worries.

Of course, as a believer in the crypto industry, I firmly believe in the future of tokenization. But common sense tells me that everything must follow the historical process. Currently, the majority of real assets do not need tokenization, but securitization and informatization. The market for tokenization is definitely not as big as they claim.

Legal System: From Regulation to Law Enforcement to Legislation

After examining the transformation of financial instruments, you will find that the real driving force behind RWA cannot rely on mature traditional assets, but on the black and gray industries (such as DeFi) at the legal level.

However, for those who advocate the trillion-dollar narrative of RWA, the future seems bright, as more and more countries and regions express their support for RWA. This not only lacks knowledge of financial history but also lacks knowledge of the operation and maintenance of power, which is why they are attracted by grand narratives.

The operation of the financial system cannot be separated from the cooperation of the legal system. The legal system here refers to the broad sense, including legislation, law enforcement, compliance, regulation, etc. The modern financial system is multi-tiered, and the corresponding legal system is also diverse.

Due to complexity and limitations in length and level, this article does not explain in detail (but the next article, together with domestic law firms, will provide a more in-depth and specific explanation). However, a brief explanation can be given from regulation to law enforcement to legislation.

Ordinary people have the most contact with the legal system at the regulatory level. The trillion-dollar narrative of RWA largely involves securitization and informatization, and these areas have established very clear regulatory norms.

Whether it is the Anglo-American legal system, the continental legal system, or even the Islamic customary law in the mountains of Afghanistan, any local government must first ensure that it does not disrupt the order. Therefore, although some places operate on a blacklist system (anything not explicitly prohibited is allowed), and some places operate on a whitelist system (anything not explicitly allowed is prohibited, and even what is allowed requires layers of approval), they have all formed their respective financial regulatory systems.

If RWA extends its reach into these regulated areas, there are only two possibilities – either it is allowed, but with the same high barriers as traditional finance, or it is not allowed and becomes part of the black market. Therefore, whether it is allowed or not, there is no need for large-scale real-world assets to be made into RWA.

Some may argue that countries/regions like Hong Kong, Malta, and Salvador are open, but what is the difference between their RWA and traditional finance, except that it is operated on the blockchain (or a consortium chain)?

However, if you intentionally evade regulation, you may not necessarily be enforced unless it causes disputes (such as resorting to legal action) or the confiscation income of law enforcement agencies can cover their expenses.

If RWA wants to fundamentally solve the problems of regulation and law enforcement, it has to be addressed at the legislative level. However, the resources required to promote legislation (from legal to financial market gears)are far outweighed by the market size of RWA.

Crypto practitioners often know nothing about the world on the other side of the great firewall (even domestic practitioners become nervous when they see police officers), and their understanding of the need for legislative confirmation of RWA is as simple as opening a massage parlor in the red light district and needing to pay off the authorities. In short, they are using their limited life experience to understand the institutional structural level of the game, so they make common sense mistakes.

Here is a very simple but extremely effective question to identify a “tǔgǒu” (a derogatory term for someone who lacks understanding and knowledge) – Do you believe that Zhou Gongzi from Jiangxi is real? The answer is that anyone who believes that the background portrayed in Zhou Gongzi’s circle of friends is real can basically be judged as someone who knows nothing about the power system. Due to space limitations, the specific reasons are not explained, but in short, Zhou Jie’s focus and level of understanding are from the perspective of someone who has not encountered privileges, which is why he can make the same “tǔgǒu” believe.

So those who advocate RWA’s trillion-dollar narrative, if they are not pretending to be clueless, are basically “tǔgǒu”.

In 2019, a traditional asset trading exchange confidently told me that they should be the ones to receive the first license for digital currency exchanges in China, not Huobi or OKEx (there were rumors at the time that licenses were being issued), but the reality proved them wrong. I believe that they, who have been running an exchange in Beijing for many years, did not lie at the time, they must have communicated with the regulatory authorities, but at most, they only communicated with the director who decides whether to stamp their approval. This position carries a lot of power, but has no decision-making authority, let alone pushing for legislation.

So even experienced insiders will underestimate the difficulty of financial regulation, largely due to their lack of understanding of financial history and their reliance on path dependence based on short-term success experiences to make decisions.

Because there are indeed many cases of industry regulation (such as mobile payment and internet medicine) that first form industry rules through self-discipline norms and then transform into regulatory rules or even laws. However, the problem is that this kind of competition that creates established facts and then obtains legal recognition only exists at the channel end. RWA involves mapping real assets to the digital world and circulating them, requiring the reconstruction of the entire institutional structure (from upstream to downstream, from business to regulation).

Only countries/regions that mainly rely on external markets, such as Hong Kong and Dubai, will announce embracing RWA without any psychological burden, after all, they won’t surprise people even if they operate casinos.

The institutions that are now advocating the trillion-dollar narrative of RWA are hoping for a policy shift. However, those policies that are deploying Web3, at best, only produce a highlight in their governance with little significance. Just like the so-called Web3 policy of Hong Kong, it is only a small part of Li Ka-chiu’s governance agenda, but it seems like Hong Kong is going all-in on Web3 in the crypto industry.

The momentum of RWA in Hong Kong is largely due to the active embrace of technical bureaucrats for the sake of KPIs, and then it becomes a straw for the crypto industry to rely on, forming a partial distortion of signals and blinding the peripheral cryptocurrency circle. In fact, the energy that Hong Kong officials can mobilize to promote this matter is similar to that of a director who has been stamped by Beijing—they have no decision-making space at all, let alone promoting it at the legislative level.

Let’s predict the future direction of RWA in Hong Kong. The institutions in the crypto industry are like vendors growing spontaneously in the black market. Faced with competitive pressure, they choose to leave and use their accumulated experience to be recruited to the corners of large shopping malls to set up stalls, seemingly upgrading from a stall in the black market to a stall as an embellishment in the mall, but the autonomy of operation is also handed over to the mall, realizing the transition from a vendor to an employee.

In other words, if RWA transactions still follow the traditional financial system (payment system, clearing and settlement system, etc.), then it is like a stall in a large mall that has been renovated, rather than a truly free stall.

Technological Cycle: From the Network Layer to the Application Protocol Layer to the Application Layer

Looking back at financial history, the conclusion is that RWA does not have such great market potential, and looking at the legal system, the conclusion is that RWA does not have such a large space for survival. Now, let’s analyze what stage the industry is in and what stage RWA is in from the technological cycle of the crypto industry.

Since the birth of Bitcoin to the present, the crypto industry has evolved very complexly. The general evolution path is from the most basic public chain (which includes the network layer, data layer, consensus layer, incentive layer), to the most basic application layer protocol based on the public chain (various smart contracts that have been used infinitely and have also monetized “access”), and finally to real applications.

However, public chains are also constantly evolving, from the early days of Bitcoin to Bitcoin-based sidechains, to Ethereum, and later Polkadot and Cosmos, and now the ZK concept of public chains. There are a wide variety of applications based on different public chains. But whether it is a public chain, an application layer protocol, or an application, what truly has vitality is the logic reconstructed with crypto, rather than directly copying things from the Internet.

At this stage, it can only be said that the most basic public chain has already been established. As for the application layer protocols based on public chains (which are the key components that can achieve “minimum functionality”), there are not many at present. For example, in the social field, Lens is still exploring its direction, and it is still too early for various applications based on protocols to explode.

So when will the trillion-dollar narrative of RWA happen? It is when the infrastructure of blockchain is very well-established. Obviously, it is not now, and not even in the next bull market.

Of course, this article is not completely pessimistic about RWA, but it emphasizes that the trillion-dollar narrative of RWA is unreliable. RWA still has opportunities in the crypto industry, and that is to reconstruct real-world assets with crypto logic, allowing blockchain to give them irreplaceable functionality (rather than doing securitization or informatization, which already have better solutions).

For example, Maple Finance and Helix, which do corporate lending, and Solve Protocol, which explores decentralized bonds, their functionality can only be achieved with “crypto is indispensable”. This is the direction where RWA can truly take root in the crypto world, instead of directly borrowing mature solutions from traditional finance.

The evolutionary path of RWA in this direction will be similar to the transformation of the financial industry by the wave of informatization during the Web2 era – not only transforming the form of assets, but also the business models, organizational structures, and even business strategies of the financial industry. More importantly, it directly gives birth to new wealth and creates new wealth empires.

Summary

This is the most challenging article I have ever written. Often, a small judgment represents the view of the entire world’s knowledge and experience.

The popular trillion-dollar narrative of RWA today largely relies on the market for securitization and the informationization of securities assets. It also requires legislative confirmation to proceed smoothly, which is a cost that is almost impossible to achieve (if there are resources to promote legislation, doing RWA would be a waste of resources).

So we still need to look at RWA from the original evolutionary logic of the crypto industry, which is currently in the stage of building application layer protocols. Just as the social field of Web3 needs key components that can achieve “minimum functionality” like Lens, RWA also needs similar key components. The future new leaders will emerge from here.

As for the trillion-dollar narrative of RWA, it is still far from mature at the moment. Financial informationization only developed after the implementation of the “information superhighway plan” back then, and blockchain is still at the beginning now.

At the crucial moment when technological innovation in the crypto industry stagnates, the narrative of RWA is certainly attractive. Just like when Moses told the Israelites who were working as slaves in Egypt that he was chosen by God to lead them to the promised land flowing with milk and honey, RWA is the promised land of the crypto industry. However, the narrative of RWA is obviously more cunning, because even Jesus had to feed five thousand people with five loaves and two fish, and yet people believe in the promise of RWA just like that.

Therefore, the size of industry volume does not necessarily represent correctness, and in many cases, it may even be more effective as a contrarian indicator. I even think that this applies not only to the crypto industry, but also to the traditional financial industry. For example, the recent collapse of Zhongzhi was actually destined three years ago, but there were still high-net-worth individuals rushing into it, which indicates that there are still many opportunities in this era.

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