Analysis of Real World Asset Tokenization Technology

Tokenization of real-world assets ( RWAs ) refers to digital tokens recorded on the blockchain that represent ownership or legal rights to tangible or intangible assets. The scope of tokenization is broad and includes real estate, commodities, artwork, intellectual property, and financial instruments.

By implementing fractional ownership, tokenization enhances asset liquidity, allowing more people to participate in investments. The immutable ledger of blockchain ensures transparent ownership records, reducing the risk of fraud. Tokenized assets traded on decentralized exchanges bring unprecedented market accessibility and efficiency.

McKinsey expects that by 2030, the total market value of various tokenized assets ( excluding cryptocurrencies and stablecoins ) will reach approximately $2 trillion, with a pessimistic scenario of $1 trillion and an optimistic scenario of up to $4 trillion.

Current System

Tokenization of real-world assets is the representation of off-chain asset ownership in the form of digital tokens through blockchain or distributed ledger technology. This process connects the characteristics, ownership, and value of the asset with its digital form. Tokens serve as digital holding instruments, allowing holders to assert ownership over the underlying asset.

Historically, physical possession certificates were used to prove asset ownership, but they were vulnerable to threats such as theft and loss. In the 1980s, digital holding tools emerged, but were limited by the technology of the time that failed to materialize. The financial industry turned to centralized electronic registration systems to record digital assets, which improved efficiency but introduced new costs and inefficiencies.

System Based on Distributed Ledger Technology

The development of distributed ledger technology ( DLT ) makes it possible to re-examine digital securities or tokens. DLT consists of protocols and frameworks that allow computers to propose and verify transactions within a network while keeping records synchronized. Decentralization reduces administrative burdens and decreases the risk of system failures associated with reliance on central entities.

The DLT system simplifies the transaction execution, clearing, and settlement processes through a single consensus mechanism, making it more efficient compared to the handling by multiple intermediaries in traditional systems.

Decentralized Solutions

Blockchain is a distributed ledger technology that operates through a decentralized network of computers. Tokens can be issued on both private permissioned chains and public permissionless chains. Private permissioned chains are controlled by central entities, restricting access to specific users. Public permissionless chains do not require central authority control and are open to all users.

The choice of blockchain determines the level of control that the issuer can maintain. Public permissionless chains grant the issuer less control. The choice should align with the issuer's goals and the expected functions of the Token.

A key advantage of asset tokenization is automation through smart contracts. Smart contracts are programs on the blockchain that automatically execute when specific conditions are met. This automation increases efficiency and lowers costs.

Tokenization Methods

The tokenization of real-world assets can be analyzed through two key attributes: the form of the asset and ownership. The form includes the economic characteristics of the asset, and ownership verification requires off-chain or on-chain ledgers.

There are four methods of tokenization, differing in the degree of direct association between the token and the underlying asset:

1. Direct ownership: Digital tokens themselves serve as the official record of ownership, applicable to digitally native assets.

2. 1:1 asset-backed Token: The custodian holds the assets and issues Tokens that represent direct rights to those assets.

3. Over-collateralized Token: Use assets that are different from the expected representation of the assets as collateral to issue tokens.

4. Insufficiently collateralized tokens: Tokens that track the value of certain assets but are not fully collateralized carry higher risks.

Advantages of Tokenization

The tokenization of real-world assets is primarily achieved through distributed ledger technology to improve efficiency:

• Atomic settlement: Smart contracts execute both stages of the transaction simultaneously, eliminating counterparty risk.

• Liquidity enhancement: Increases the transferability of assets, making non-tradable assets tradable.

• Reduce intermediaries: Smart contracts replace traditional intermediaries in verifying data.

• Achieve automation: Smart contracts automatically execute predetermined conditions, simplifying manual tasks.

• Promote Compliance: Encode regulatory requirements into the blockchain to enhance compliance efficiency.

• Automated Market Maker: Automatically matches buyers and sellers through liquidity pools, reducing costs and improving efficiency.

Risks and Costs of RWA Tokenization

Tokenized assets face challenges in terms of technology and regulation. Technical risks include cybersecurity, scalability, and so on. Regulatory issues involve anti-money laundering, governance frameworks, and more.

Investor education, market risks, and environmental impacts are also factors that need to be considered. Transitioning to a tokenized financial system involves huge costs, including infrastructure changes, integration costs, and educational expenses.

Overall, tokenization brings opportunities and challenges to the financial system. Fully realizing its advantages requires addressing various issues, including technology, regulation, education, and more.