Blockchain Technology and Tokenization of Real World Assets: Underlying Logic Clarification and Pathway for Large-scale Application Implementation

In 2023, the most eye-catching topic in the Blockchain field is undoubtedly Real World Asset Tokenization (RWA). This concept has not only sparked heated discussions in the Web3 world but has also attracted significant attention from traditional financial institutions and government regulatory bodies in many countries, being regarded as a strategic development direction. For example, several authoritative financial institutions have successively released their own tokenization research reports and actively promoted related pilot projects.

At the same time, the Hong Kong Monetary Authority clearly stated in its 2023 annual report that tokenization will play a key role in Hong Kong's financial future. In addition, the Monetary Authority of Singapore, together with the Financial Services Agency of Japan and several financial giants, has launched an initiative called "Project Guardian" to deeply explore the enormous potential of asset tokenization.

Although the topic of RWA is gaining popularity, there are differing opinions within the industry regarding the understanding of RWA, and discussions surrounding its feasibility and prospects are quite controversial. On one hand, some believe that RWA is merely market hype and cannot withstand in-depth discussion; on the other hand, there are those who are full of confidence in RWA and optimistic about its future.

This article will share a cognitive perspective on RWA, providing a deeper discussion and analysis of the current situation and future of RWA.

Core Viewpoints:

• The future key development direction for the tokenization of real-world assets will be the establishment of a new financial system using DeFi technology, driven by authoritative institutions such as traditional financial institutions, regulatory authorities, and central banks, built on a permissioned blockchain. Achieving this system requires a computational system (Blockchain technology) + non-computational systems (such as legal frameworks) + on-chain identity systems and privacy protection technologies + on-chain fiat currencies (CBDC, tokenized deposits, fiat stablecoins) + complete infrastructure (low-threshold wallets, oracles, cross-chain technology, etc.).

• Blockchain is the first effective technology to support the digitization of contracts after the development of computers and networks. Essentially, blockchain is a platform for digital contracts, where contracts are the basic form of asset representation. The token (Token) is the digital carrier of assets after the formation of contracts. Therefore, blockchain has become an ideal infrastructure for the digital representation/tokenization of assets, that is, digital assets/tokenized assets.

• Blockchain, as a distributed system jointly maintained by multiple parties, supports the creation, verification, storage, circulation, and execution of digital contracts, as well as other related operations, solving the problem of trust transmission. Furthermore, as a "computational system", blockchain meets humanity's demand for "repeatable processes and verifiable results". Therefore, DeFi has become a "computational" innovation within the financial system, replacing the "computational" aspects of financial activities, where automated execution not only reduces costs and increases efficiency but also enables programmability.

• For traditional financial systems, the significance of Real World Asset Tokenization ( lies in the creation of digital representations of real-world assets (such as stocks, financial derivatives, currencies, equities, etc.) on the blockchain, extending the benefits of distributed ledger technology to a wide range of asset classes for exchange and settlement.

• Financial institutions enhance efficiency by adopting DeFi technology, using smart contracts to replace the "computational" aspects of traditional finance, executing various financial transactions automatically according to predetermined rules and conditions, and enhancing programmability. This not only reduces labor costs but also, in specific contexts, it can empower businesses with new possibilities, particularly providing innovative solutions for small and medium-sized enterprises (SMSE) to address financing challenges, opening a highly promising door for the financial system.

• As traditional finance and governments worldwide increasingly focus on and recognize Blockchain and tokenization technologies, and as the foundational infrastructure technology of Blockchain continues to improve, Blockchain is moving towards integration with traditional world architecture and addressing real pain points in practical application scenarios, providing feasible solutions for actual situations rather than being confined to a "parallel world" that is disconnected from reality.

• In the future, under a pattern of multiple different jurisdictions and regulatory systems for permissioned blockchains, cross-chain technology will be particularly important for solving the problems of interoperability and liquidity fragmentation. Tokenized assets on the blockchain will exist on both public Blockchains and permissioned chains operated by financial institutions, and cross-chain protocols similar to CCIP will enable the connection of tokenized assets across any blockchain to achieve interoperability and realize the interconnectivity of all chains.

• Currently, many countries around the world are actively promoting legal and regulatory frameworks related to Blockchain. At the same time, Blockchain infrastructure, such as wallets, cross-chain protocols, oracles, and various middleware, is rapidly being improved. Central Bank Digital Currencies (CBDC) are also continuously being implemented, and token standards that can represent more complex asset types, such as ERC-3525, are emerging. Coupled with the development of privacy protection technologies, especially the ongoing development of zero-knowledge proof technology, and the increasingly mature on-chain identity systems, we seem to be on the brink of large-scale application of Blockchain technology.

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1. Introduction to Asset Tokenization Background

Asset tokenization refers to the process of expressing assets in the form of tokens on programmable Blockchain platforms. Typically, assets that can be tokenized are divided into tangible assets (real estate, collectibles, etc.) and intangible assets (financial assets, carbon credits, etc.). This technology, which transfers assets recorded in traditional ledger systems to a shared programmable ledger platform, represents a disruptive innovation for the traditional financial system and could even impact the future financial and monetary systems of humanity as a whole.

First, a phenomenon needs to be raised: "There are mainly two distinctly different groups regarding the cognition of RWA asset tokenization," which can be referred to as Crypto RWA and TradFi RWA. The RWA discussed in this article is from the perspective of TradFi.

) RWA from the perspective of Crypto

The RWA of Crypto can be regarded as the unilateral demand from the Crypto world for the yield of financial assets in the real world. The main background is the continuous interest rate hikes and balance sheet reduction by the Federal Reserve, which has significantly affected the valuations in the risk market. The reduction in the balance sheet has greatly extracted liquidity from the crypto market, leading to a continuous decline in yields in the DeFi market. At this time, the nearly 5% risk-free yield from U.S. Treasury bonds has become highly sought after in the crypto market, with the most notable being MakerDAO's large-scale purchase of U.S. Treasury bonds this year. As of September 20, 2023, MakerDAO has purchased over 2.9 billion in U.S. Treasury bonds and other real-world assets.

The significance of MakerDAO purchasing U.S. Treasury bonds lies in DAI's ability to diversify the assets it supports through external credit. Additionally, the long-term extra yields from U.S. Treasury bonds can help stabilize DAI's exchange rate, increase the elasticity of its issuance, and incorporating U.S. Treasury bonds into its balance sheet can reduce DAI's dependence on USDC and minimize single-point risks. Moreover, since the income from U.S. Treasury bonds will flow entirely into MakerDAO's treasury, MakerDAO has recently increased DAI's interest rate to 8% by sharing part of its U.S. Treasury bond income to boost DAI's demand.

The approach of MakerDAO is clearly not replicable by all projects. With the skyrocketing price of MRK tokens and the market's heightened enthusiasm for RWA concept speculation, a variety of RWA concept projects have emerged, aside from a few larger projects that follow compliance routes. Various assets from the real world are being tokenized and sold on the blockchain through all possible means, including some rather outrageous assets, leading to a mix of quality in the entire RWA sector.

The RWA logic of Crypto mainly revolves around how to transfer the rights to the income generated by assets (such as the income rights of US Treasury bonds, fixed income, stocks, etc.) onto the blockchain, how to use off-chain assets to mortgage loans and obtain liquidity of on-chain assets, and how to bring various real-world assets onto the blockchain for trading (such as sand, minerals, real estate, gold, etc.).

Therefore, we can see that the RWA of Crypto reflects a one-sided demand from the crypto world for real-world assets, which still faces many obstacles in compliance. MakerDAO's approach is actually for the MakerDAO team to enter and exit funds through compliance channels and purchase U.S. Treasury bonds through formal means to obtain their yields, rather than selling these yields on-chain. It is worth noting that the so-called RWA U.S. Treasury bonds on-chain are not the U.S. Treasury bonds themselves, but rather their rights to yields. Additionally, this process involves converting the fiat currency income generated by U.S. Treasury bonds into on-chain assets, which increases the complexity of operations and friction costs.

The rapid rise of the RWA concept is not solely attributable to MakerDAO. In fact, a research report released by a major bank has also sparked strong reactions in the industry. This report reveals the keen interest of many traditional financial institutions in RWA, while also igniting the enthusiasm of a large number of speculators in the market. They are spreading rumors about major financial institutions soon joining this field, further elevating market expectations and speculative atmosphere.

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) RWA from the perspective of TradFi

From the perspective of Crypto, RWA mainly expresses the unilateral demand of the crypto world for the asset returns of the traditional financial world. If we look at this logic from the perspective of traditional finance, the scale of funds in the crypto market is basically negligible compared to the trillions of dollars in traditional financial markets. Whether it is U.S. Treasury bonds or any other financial assets, it is unnecessary just to have an additional sales channel on the Blockchain.

From the perspective of traditional finance (TradFi), RWA is a bidirectional approach between traditional finance and decentralized finance (DeFi). For the traditional financial world, DeFi financial services that are automatically executed based on smart contracts represent an innovative financial technology tool. The RWA in the traditional financial sector is more focused on how to combine DeFi technology to achieve asset tokenization, empowering the traditional financial system to reduce costs, improve efficiency, and address the pain points present in traditional finance. The focus is on the benefits that tokenization brings to the traditional financial system, rather than just seeking a new asset sales channel.

It is necessary to differentiate the logic of RWA. Because RWA from different perspectives has vastly different underlying logic and implementation paths. First, there are different implementation paths in choosing the type of blockchain. The RWA of traditional finance follows the path based on Permission Chain, while the RWA of the crypto world follows the path based on Public Chain.

Due to the characteristics of public chains such as no admission requirements, decentralization, and anonymity, the RWA of crypto finance will not only face significant compliance obstacles for project parties, but users also have no legal rights protection when encountering bad events like Rug. Moreover, the rampant hacker activities place high demands on users' security awareness. Therefore, public chains may not be suitable for the tokenization issuance and trading of a large number of real-world assets.

The traditional finance RWA-based permissioned blockchain provides the basic prerequisites for legal compliance across different countries and regions. Meanwhile, conducting KYC on-chain to establish an on-chain identity system is a necessary prerequisite for achieving RWA. Institutions that hold assets under the protection of a legal framework can issue them in compliance with the law.