Let’s talk about the pitfalls of doing RWA projects

Exploring the Risks of RWA Projects A Conversation Worth Having

RWA is the tokenization of Real World Assets through blockchain technology.

This article, from the perspective of the RWA project, sheds light on the pitfalls encountered in the project, and also provides six unreliable observations about the selection of industry entry points related to RWA.

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The wind of tokenizing real world assets has actually been blowing for many years.

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And it’s blowing again this year.

In theory, there can be many types of RWA assets, including physical assets such as real estate and artwork, financial assets such as stocks, bonds, and cash, as well as IP or copyright, and other intellectual property assets.

Except for stablecoins (which can barely be considered RWA), previous RWA projects haven’t made much progress.

This year’s trends are mainly driven by the US interest rate cycles and the promotion of national bonds.

Hong Kong’s local policies are also leaning towards on-chain Hong Kong financial assets. Apart from frequent activities in DLT bond issuance, they even issued STO licenses yesterday.

I know a lot of project teams from the previous cycle (many are still alive) and have discussed with them about the pitfalls they encountered.

More importantly, what changes have already occurred or need to be paid attention to in this cycle?

The Unchanging Basic Steps of RWA

In the 6 unreliable observations about RWA, there is a point that resonates:

RWA = Law + Code

All assets are either supported by laws or by code.

RWA assets may require both legal and technical support.

Since that’s the case, RWA projects may have several basic steps that cannot be avoided:

• Asset Acquisition

If it’s RWA real-world assets, then there must be assets involved.

Whether it’s cash, stocks, or real estate, the type of assets must be determined before token issuance.

Some conscientious projects will acquire assets in advance, while others will acquire them after investors purchase tokens.

In any case, asset acquisition is necessary.

If it doesn’t involve asset acquisition (such as synthetic assets in DeFi), then it can’t be considered an RWA project.

• Asset Custody

Custody is something that many project teams or investors easily overlook.

However, from a compliance perspective, it’s likely that all RWA project teams and regulators will eventually reach a certain degree of agreement on custody solutions.

After all, if there is no custody solution at all, it’s easy for the project team to run away. This is a bloody lesson learned from hundreds of years of capitalist development in the West.

If it is a physical asset, it may involve storage in a physical location, and non-physical assets (IP/financial assets, etc.) may also require custodian or trust companies.

Even in the traditional financial industry, underlying asset flight happens occasionally. The scallops of Zhangzi Island in China, for example, often need to move frequently according to the market value of the listed company. This kind of thing would happen more in the early stages of RWA.

• Token Distribution

Whether it is traditional financial assets, RWA, or various dog coins, distribution is a crucial aspect that project teams pay great attention to.

In the traditional financial field, asset distribution is mainly done through brokers and fund managers.

In the cryptocurrency field, exchanges and airdrops may be the main scenarios for token distribution.

RWA asset tokens are currently quite awkward. Cryptocurrency users are not interested in such assets because they lack imagination, while traditional financial domain customers often adopt a wait-and-see attitude due to regulatory uncertainties and underlying asset uncertainty.

• Follow-up Services

Similar to other traditional financial assets, RWA’s underlying assets also require follow-up maintenance.

If it is a physical asset, it may involve warehousing or even logistics. Even immovable assets such as houses need regular management.

If it is non-physical assets, there needs to be periodic net asset value calculations, compliance costs, etc.

Based on these basic steps, let’s delve a little deeper into the pitfalls and opportunities within them.

Blockchain Infrastructure is a Pit

Although the development of blockchain technology is advancing rapidly, after assets are put on the chain, blockchain infrastructure still has a significant impact on the liquidity of assets.

Currently, Ethereum is arguably the most liquid public chain, right?

But Ethereum’s supported transaction throughput is limited, and the transaction fees are also expensive. Frankly speaking, it may only be suitable for conceptual or toy-like projects, and it cannot be compared with the performance and cost of traditional finance.

What about adopting Ethereum L2 or other public chains?

Then we will encounter the headache of cross-chain when putting assets on these low-fee and high-performance L2 chains or other public chains.

On these chains, it is often found that users may not have funds on this particular chain.

So, either we hope there will be a chain in the future that is cheap, high-performance, and has many users, or we hope for some amazing project teams that can solve the problem of cross-chain.

Traditional Financial Intermediaries are also a Pit

In terms of asset securitization, there is not much difference between RWA and traditional finance in essence.

It’s just that one turns assets into tokens, while the other turns them into securities.

Tokenization in theory can simplify the intermediary links of traditional financial services, see the battle of the future King of the Mountain: the fate of asset securitization.

But as the heavyweight pioneer of RWA, Ye Kai from the Huili Fund said:

According to SFC’s circular, Hong Kong regards RWA/STO as the tokenization of traditional securities, including digital bonds, digital ABS, and digital REIT

All (RWA) product designs must add a layer of traditional financial (fund) structure and then tokenize it.

It’s extremely conservative, and it requires hiring SFC-approved DLT platform providers, wallets, licensed exchanges, custodians, market makers, auditors, law firms, external consultants, etc… everywhere.

Not only does this fail to save any steps, but it also adds steps on top of the existing system.

This is what they call “taking off your pants and farting”.

The biggest loophole lies in the lack of clear regulations

Previously, it was mentioned that STO licenses were issued in Hong Kong, which was seen as a positive move for RWA; however, upon closer examination, the restrictions on RWA products are still significant.

Regardless, this does provide a relatively clear regulatory stance.

In other regions, such as the US, the attitude is even more ambiguous, and the SEC is hesitant about approving Bitcoin spot ETF applications.

Mainly because there are too many interests involved.

In today’s financial system, Swift and the Federal Reserve are core nodes, and they have the ability to impose sanctions and restrictions on almost all transactions involving the US dollar.

Therefore, it is difficult to directly abandon existing interests when new technological solutions emerge.

Fortunately, from a technical perspective, it is currently possible to achieve tokenization while safeguarding the existing interests of the US (see The US’s Strategic Plan? Analyzing the Tokenization Plans of the Federal Reserve and Swift), but this plan is still in the conceptual stage, and it’s uncertain when it will be implemented.

During this period, if the US insists on settling within the existing centralized node system (such as DTCC/Swift/Fedwire), then RWA will have to “take off their pants and fart” globally.

Lack of market acceptance

For RWA projects, the advantage lies in the backing of underlying assets and stable value; however, the disadvantage is the lack of imaginative space like other cryptocurrencies.

If regulatory policies were clear, many traditional distribution channels (such as banks/wealth management companies) would be happy to join.

If token standards were unified and purchase restrictions were minimal, it would also be possible to list on exchanges.

However, even tokens backed by deposits issued by banking giants can only circulate within their own banks (see besides BlackRock, what other strategies do other financial giants have?), and banks are even more reluctant to sell assets from other banks.

As for the debate over RWA assets standards, DTCC may have its own ideas.

In addition, with the abundance of meme and various ecological play projects, many people are choosing to abandon their biases and embrace the bubble.

Is the growth flywheel quietly starting?

Although RWA faces so many issues, after all, the future is a trillion-dollar market.

Currently, the TLV of stablecoin’s single track has exceeded hundreds of billions of dollars.

If RWA breaks through in the next bull market, what changes will it need?

I have come up with a growth flywheel for your reference:

Compared to the previous bull market, the current on-chain infrastructure is much more mature.

Especially various Ethereum L2 chains are likely the preferred on-chain choice for many RWA projects. Additionally, if projects like Chainlink can better address cross-chain issues, it would provide long-term support for the market.

The maturation of on-chain infrastructure will reduce on-chain costs and facilitate the realization of financial intermediation on the chain.

Projects like Centrifuge are striving to move various traditional off-chain intermediation services online. Of course, there are also more specialized on-chain projects serving KYC/AML/finance/audit-related services that are already serving various on-chain ecosystems.

It is believed that in the future, the regulatory principle will be “same behavior, same regulation”, which means that regardless of whether the intermediation services are provided on-chain or off-chain, they should hold the same status in terms of regulation.

In many places, DLT (distributed ledger technology) has already gained legislative recognition, and even Swift and the Federal Reserve have proposed their own conceptual plans.

The maturity of on-chain intermediation services will help promote regulatory recognition for the entire industry according to the principle of “same behavior, same regulation”.

Once the regulatory attitude is clear, the establishment of industry standards and the acceptance of traditional channels should be just a matter of time.

If RWA assets, with the help of channels, reach a scale and transaction volume similar to securitization, it will bring new business ecosystems and profit points to on-chain infrastructure, further promoting its maturity.

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