Tokenisation to Real-World Asset (RWA) Tokenisation
By Anju B Nair, Sr. Technical Content Writer, Kerala Blockchain Academy
In the ever-evolving digital innovation landscape, a few concepts hold much transformative potential compared to others. From the realms of finance to the corridors of cybersecurity, Tokenisation is one such concept that stands as a beacon of technological prowess, promising to revolutionise how we perceive and interact with digital assets. But what exactly is Tokenisation, and why does it wield such immense influence in today’s interconnected world?
Tokenisation helps convert real-world assets into digital assets, allowing them to be easily traded, transferred and managed. It serves as a technological art that enables converting the rights of an asset into a digital token on a blockchain. Tokenised assets can represent various instruments such as stocks, bonds, commodities, real estate, art, collectables, medical data, financial data, personal data, and more. Tokens can represent a particular asset or utility ( tangible or intangible ). Anything can be tokenised on a blockchain if it has value.
While the concept may seem technical at first glance, its implications extend far beyond the confines of technology, enabling industries with inherent advantages.
By representing real-world assets as digital tokens, Tokenisation allows fractional ownership, enhances liquidity, and fortifies security in transactions, laying the groundwork for a decentralised and democratised future.
This blog will demystify Tokenisation, exploring its multifaceted dimensions and uncovering its manifold opportunities across diverse sectors.
Let’s define the Token first, as the rest of the tale begins here.
Tokens typically represent assets or utility. They are digital assets created on top of an existing blockchain network, such as Ethereum, Binance Smart Chain, or others. By nature, Tokens can represent many forms of assets, including cryptocurrencies, digital collectables, real-world assets like real estate or commodities, loyalty points, voting rights, etc. To mark precisely, they are mainly classified into four categories: utility tokens, security tokens, payment tokens, and stablecoins.
Utility tokens like Ethereum (ETH) and Cardano (ADA) enable users to interact with specific blockchain platforms. They serve as a virtual currency that resides on its blockchain, giving access to specialised products or services the blockchain is working on.
Security tokens represent traditional securities and are subject to financial regulations. They are used the same way a stock, bond, certificate, or other investment asset is used.
Payment tokens facilitate the transfer of value within decentralised networks and can serve multiple purposes. Bitcoin (BTC) is the most well-known example.
Stablecoins maintain a stable value relative to specific assets, combining the stability of traditional assets with the benefits of blockchain technology. Depending on their use case and regulatory environment, they can function as payment tokens.
Apart from the primary classification above, there are also other classifieds. One such is the Governance Tokens that grant voting rights on the blockchain network. They are primarily used for decision-making in decentralised networks or organisations. The other popular token model is Non-Fungible Tokens (NFTs). These unique tokens represent ownership of specific assets, valued for their uniqueness and provable scarcity in digital art and collectables. You can read more on NFT here.
All these tokens are typically created and managed through smart contracts, which are self-executing contracts with the terms of the agreement directly written into code. Smart contracts enable the issuance, transfer, and management of tokens in a decentralised and automated manner without intermediaries. This ensures transparency, security, and immutability of token transactions on the blockchain.
The Inception Point
Well.. the concept of Tokenisation existed well before the invention of blockchain technology. The financial industry is said to be the early adopter of Tokenisation. The industry used the idea to protect client information, converting sensitive information such as credit card numbers, social security numbers, and other sensitive data into a string of alphanumeric characters. These were then processed through a cryptographic function, creating a unique Token.
While the process is akin to today’s Tokenisation, it was earlier designed to protect sensitive data. On the other hand, today’s blockchain-enabled tokenisation process aims for a much larger vision of secure and flexible Tokenisation of assets, significantly increasing the potential application of such tokens across industries.
The Industry Spread
Tokenisation made its first footprint in the Financial industry. However, it is embraced by many industries today, such as healthcare, sports, and enterprise. As per the Bloomberg report, Tokenisation has immense potential in the future, with some predictions that it will reach up to $5 trillion in tokenised assets by 2030.
How Does Tokenisation Work?
Here is a step-by-step breakdown of how Tokenisation works:
- Identify the physical or financial asset, such as real estate, art, or intellectual property, that will be tokenised.
- A token representing the asset is then generated on a blockchain, incorporating built-in code that automates the execution of predefined regulations.
- Self-executing smart contracts are used to automate the token’s issuance, trading, and compliance, encoded with the terms of the asset’s management and exchange.
- Tokens are traded or transferred on a blockchain network, leveraging its secure, transparent, and decentralised nature.
Real-World Asset Tokenization ( RWA)
Real-world assets, as mentioned at the beginning of this blog, represent tangible and intangible assets in the physical world (e.g., real estate, bonds, commodities, etc.). The Tokenisation of RWAs allows us to bring these off-chain assets onto the blockchain, opening a new realm of possibilities regarding composability and potential use cases. By tokenising RWAs, market participants are exposed to increased efficiency, higher transparency, and reduced human errors as these assets are stored and tracked on the blockchain.
Asset universe eligible for tokenisation is not limited to equity shares or bonds. It can be of anything in value. Tokenisation facilitates fractional ownership and turns high-value assets more accessible to a broader network of investors via the division of assets into smaller, more affordable units.
The Tokenisation of real-world assets (RWAs) is continuously gaining traction with increasing user adoption and the entrance of large institutional players. Coupled with relatively low decentralised finance (DeFi) yields, rising interest rates have contributed to an uptake in RWAs, specifically in tokenised treasuries.
Benefits That Call For Action
- Tokenisation lowers entry barriers, such as high minimum investments and long lockup periods, making RWAs more accessible to a broader investor base.
- Tokenisation enables issuers to reach a wider audience, potentially increasing capital inflow and revenue opportunities.
- Blockchain’s single source of truth eliminates the need for multiple reconciliations, streamlining financial transactions.
- Blockchain technology accelerates the settlement process, eliminating the need for an intermediary.
- Tokenisation opens assets to a larger market, enhancing liquidity and reducing the liquidity premium of traditionally illiquid assets like art or real estate.
- By bypassing intermediaries, tokenisation reduces transaction costs and speeds up exchanges.
- The blockchain provides a transparent, cryptographically verifiable record of a token’s history, enhancing trust and reliability.
- Tokenisation allows investors to purchase fractional asset interests, making investments more divisible and accessible.
- Unlike traditional markets with set trading hours, crypto tokens can be traded 24/7 worldwide, providing constant market access.
- Blockchain’s single source of truth eliminates the need for multiple reconciliations, streamlining financial transactions.
Reliability of Real-World Assets in DeFi
Real-world assets (RWAs) hold considerable significance within the decentralised finance (DeFi) sector for several compelling reasons. DeFi platforms enable users to access, trade and leverage these assets in a decentralised and borderless manner (via tokenising ). They serve as vital connectors between the digital realm of blockchain technology and the tangible assets of the physical world. You might be amused by how.
While DeFi predominantly revolves around digital assets and cryptocurrencies, the inclusion of real-world assets such as stocks, commodities, or real estate can now bridge the gap with the traditional financial system. The integration of real-world assets thus offers numerous benefits to DeFi. Firstly, it expands opportunities for diversification, thereby mitigating risks by allowing DeFi participants to invest in assets beyond the cryptocurrency domain. Secondly, it promotes financial inclusivity by reducing barriers to entry. It enables individuals without access to conventional financial markets to participate in the financial market via DeFi.
Traditional investors may find DeFi more appealing due to the yield-generating prospects associated with these assets, such as lending and borrowing.
The State of Challenges
There is no doubt that tokenising physical assets comes with several serious risks and difficulties. For instance,
- Regulatory Obstacles: It is challenging to address always the changing regulatory environment, which differs significantly between jurisdictions.
- Custody of Assets: Protecting the underlying financial or legal assets supporting digital tokens is crucial. To stop theft, fraud or improper handling of the assets, it is critical to opt for reliable and secure custody solutions.
- Market Acceptance and Liquidity: To sustain liquidity and pricing stability, active marketplaces or exchanges are necessary for Tokenised assets. Investor confidence may be weakened by illiquidity and price volatility caused by low trading volumes.
- Technological Breakdown: Smart contracts and blockchain networks may be subject to hacking, software faults or other vulnerabilities. These risks may lead to asset loss or manipulation.
- Crypto Education: The lack of a thorough understanding of tokenised assets by investors, companies and regulators may prevent uptake and regulatory acceptability.
Conclusion
Enhanced interoperability among blockchain networks will likely facilitate a global ecosystem for tokenised assets. Likewise, the advancements in blockchain technology and decentralised finance (DeFi) are expected to introduce more intricate avenues for revenue generation and innovative financial products. Integration with the Internet of Things (IoT), enabling real-time asset monitoring and security measures, holds promise for public trust in tokenised assets.
References
