Real World Asset (RWA) Tokenization And Risks To Solve

July 24, 2023 - Around 6 mins mins to read

Real-world asset (RWA) protocols have become a hot trend in decentralized finance (DeFi). Besides the outstanding benefits such as increased liquidity, improved accessibility and increased transparency in asset markets, etc., this process also poses a number of challenges that need to be overcome in order to realize its full benefits.

Real World Asset (RWA) Tokenization And Risks To Solve

What are Real World Assets (RWA)?

Real World Assets (RWA) are assets that possess a value that is inherent, tangible, or physical in nature and reside in the physical world. RWA’s scope is broad and includes everything from actual items such as real estate, liquor, merchandise, artwork, and vehicles, to contractual or legal rights such as patents and copyrights. These assets often form the basis of financial portfolios in various investment contexts. They act as collateral for the loan and serve as the primary investment target for institutional funds and individual investors.

How does RWA appear in blockchain?

We are on the threshold of an amazing, comprehensive transformation in the financial sector, justified by the emerging decentralized finance sector. Traditional financial firms increasingly interact with Ethereum-based real-world asset protocols, leading to RWA outperforming blue chip DeFi. Then, Tokenization, the process of converting tangible or intangible assets into digital tokens on the blockchain, is revolutionizing how we interact with real world assets.

Blockchain technology enables the tokenization of RWA, allowing these assets to be represented digitally. Tokenization permits fractional ownership, reducing the barrier to entry and providing increased liquidity. Investors can buy and sell fractions of a property or artwork, for example, instead of the entire asset. Additionally, these tokenized assets can be incorporated into decentralized finance (DeFi) platforms, creating avenues for lending, borrowing, and earning interest in a peer-to-peer manner.

Tokenization involves representing real-world assets on the blockchain using digital tokens. These tokens can be bought, sold, and traded on a variety of platforms, allowing partial ownership and increased liquidity. Some of the most common tokenized real-world assets include:

Real Estate: Asset tokenization allows partial ownership, allowing investors to buy and trade shares of real estate without having to purchase the entire property.
Art and collectibles: Tokenization could democratize access to high-value art and collectibles, allowing more people to invest in and own shares of these assets.
Intellectual Property: Tokens can facilitate the management and monetization of intellectual property rights, such as patents, copyrights, and trademarks.
Commodities: Tokenizing commodities, such as gold or oil, can increase liquidity and allow investors to trade these assets more efficiently.

Challenges RWA is facing

Regulatory challenges

One of the top and hardest challenges in real-world asset tokenization is regulatory hurdles. This is an advanced technology, its implementation requires legal acceptance and, therefore, regulatory innovation for this financial instrument. Regulatory challenges have also emerged as a trend in 2023 and show that there is no unified approach to crypto adoption and regulation worldwide: we see the measures taken by the SEC, which is not inclined to regulate outdated law, side-by-side with the actions of the Hong Kong regulator, which provides a different, Web3-aligned world control system.

Real-world asset management can prove complicated due to differences in legislative structures between countries. Such assets may fall under the jurisdiction of different regulatory authorities, thus complicating the tokenization and regulatory compliance process.

It must be acknowledged, however, that regulation and supervision are the inalienable prerogatives of sovereign states and affiliated organizations that no state has voluntarily renounced.

Lack of liquidity

One of the main challenges with RWAs is that they can be difficult to convert to cash quickly without incurring significant costs. This illiquidity can be a barrier for investors who need to quickly adjust their portfolio or access cash.

DeFi offers certain advantages over TradFi by making smart contracts transparent and enabling the financialization of assets to a large extent by making them divisible, transferable, and tradable on decentralized platforms. From there, the real assets can improve the account optimally.

Maintenance costs

Many RWAs require significant maintenance and management. For example, real estate assets need maintenance, machinery may need regular maintenance, and even intellectual property rights need legal protection, all of which can add to the cost of owning these assets.

Interactive abillity

Interoperability of different blockchain networks and standardization of asset encryption protocols are constant developments in the crypto space. Diversity between blockchains increases scalability, but carrying encrypted assets often exists on different blockchain networks, which can limit their accessibility and liquidity. The development of cross-chain standards and solutions will be essential to promote interoperability and seamless exchange between different tokenized asset platforms.

Property valuation and price discovery

Accurate valuation and valuation of tokenized assets can be challenging, especially for illiquid or unique assets such as artwork or intellectual property. Developing standardized valuation methods will be essential to promote transparency and fair pricing.

Depository and asset management

Ensuring secure custody and management of encrypted assets is crucial to maintaining investor confidence. Developing robust solutions for asset custody, such as decentralized storage or trusted third-party custodians, will be essential for the growth of the tokenized asset market.

Knowledge of Defi is still an elusive concept

Despite the fact that the DeFi field has been growing for several years, its level of understanding and technology is still far from average. Many market participants, including investors and businesses, may not be fully aware of the opportunities and benefits offered by tokenizing real-world assets. Spreading DeFi knowledge and attracting new entrants into the market requires significant education and awareness efforts.

Moreover, currently the Defi ddax market is going through a golden age, making its profit compared to Trafi not too much of a difference, but Defi has more risks, so many investors are withdrawing from this field.

Conclusion

Despite these barriers and limitations, real-world asset tokenization presents significant opportunities for DeFi, such as tapping new sources of capital, diversifying risks, and creating new investment opportunities. Real-world asset tokenization offers countless opportunities to transform the way we interact with and invest in tangible and intangible assets. By increasing liquidity, democratizing access, and promoting transparency, tokenization can revolutionize traditional asset markets and open up new opportunities for investors and asset managers.

However, for the incorporation of RWA into the Defi world to fully exploit its potential benefits, a number of challenges must be addressed, including legal and regulatory frameworks, asset pricing, custody and asset management, and interoperability. By working together, governments, regulators, technology providers and the wider community can develop solutions to these challenges and pave the way for a more efficient, transparent and inclusive asset market.

Businesses operating in this space need to continue to research, develop, and refine tokenization processes and technologies to ensure that they meet the highest standards of security, usability, and reliability.

DISCLAIMER: The Information on this website is provided as general market commentary and does not constitute investment advice. We encourage you to do your own research before investing.

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