how is tokenization changing the financial landscape?

What are Real-World Assets?

Tokenization is the process by which real assets are transformed into digital entities represented on a blockchain. This transfer of information from a real asset on the blockchain makes it possible to transmit and exchange its property rights through a token on dedicated platforms.

In order to maintain a connection between the real asset and its digital representation, oracles play a primary role. An oracle is an external data source that provides protocols and blockchains with real-time information about underlying assets. The oracle thus facilitates the interaction between the blockchain and the outside world.

Traditional assets such as real estate, works of art or gold are often characterized by their lack of liquidity, which makes it difficult to buy and sell them. Tokenization overcomes this limit. It allows investors to benefit from immediate liquidity on assets that were previously illiquid.

Moreover, the tokenization of RWA allows greater accessibility to investments traditionally reserved for a financial elite. Assets such as luxury goods, real estate have often been out of reach for small portfolios due to their high cost. Tokenization creates tokens that represent a fraction of the ownership of the actual asset which means investors can buy fractions of those assets. This significantly lowers barriers to entry, opening up investment to a wider range of investors.

RWA tokenization also allows for easier portfolio diversification. Unlike volatile cryptocurrencies, tokenized real assets offer reassuring stability and familiarity for traditional investors.

For native cryptocurrency holders, the falling yields offered by decentralized finance (DeFi) protocols, especially on stablecoins, encourage diversification into other types of assets. RWA tokens present themselves as an attractive option, as they allow holders to engage in more tangible and diverse investments.

Moreover, RWA tokenization can also result in significant time savings. The traditional process of buying, selling or managing real estate is complex and expensive. It requires many steps and intermediaries to succeed.

Thus, tokenization affects a wide range of assets and has many advantages. It offers the possibility of combining the advantages of DeFi while attenuating the speculative aspect of the latter. The potential for RWA tokenization is all the more promising as traditional finance has vast volumes of capital, far greater than that already committed in decentralized finance.

This is why many players in traditional finance are interested in it. Citibank, the 3rd largest bank in the United States by assets, predicts that the tokenization of real assets will reach a value between 4,000 and 5,000 billion dollars by 2030.

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Barriers to the adoption of Real World Assets

Tokenized real-world assets have many advantages, but their development is limited by a multitude of factors.

Building regulations

One of the main obstacles to the tokenization of real assets today is the absence of clear regulation. Indeed, regulators are in full reflection on these issues and it is therefore difficult for both token issuers and investors to see clearly.

Limited liquidity

Although tokenization can potentially increase the liquidity of assets, actual liquidity may still be limited. In the difficult market conditions we are currently experiencing, some tokens may have little or no demand in the markets, making it difficult to trade them and convert them into real assets.

Moreover, liquidity is closely linked to the trust of the blockchain on which the token is issued. In the event of technical problems or hacks of the blockchain in question, this can have an impact on the liquidity of the tokens.

security and hacking

Smart contracts may contain bugs or vulnerabilities that could be exploited. Tokenized assets are also subject to the risks of hacking and theft, just like other digital assets.

The intrinsic value of RWAs in the face of a potential systemic crisis

Finally, in the event of an economic crisis and loss of confidence in the financial markets, what intrinsic value would real tokenized assets really have? In such a situation, isn’t it better to have one gram of physical gold rather than one gram of tokenized gold? Does the token really have its physical equivalent in the issuer’s reserves?

Real-world asset use cases

Traditional financial markets

Tokenization of shares of a company

For companies, IPOs are long, tedious and expensive procedures. Because of this administrative burden and the exorbitant cost (the cost of such operations can reach several million euros), many companies prefer to give up this approach.

The tokenization of a company’s capital makes it possible to represent the company in the form of tokens, regardless of size. This also opens up possibilities in terms of governance rights and profit rights, but this is not mandatory. For example, it is entirely possible to issue a token corresponding to a share of the company’s capital, without granting a right of governance proportional to this share.

The complexity of this operation lies mainly in the legal aspects. Should these tokens be considered as security tokens? Finally, another advantage of the tokenization of a company’s shares is to allow these tokens to be used as collateral for loans from banks.

Bond tokenization

Bond tokenization has many benefits for bond markets. One of the main benefits is increased liquidity. By enabling fast and efficient exchange of bonds, tokenization facilitates transactions and attracts new investors to this market.

Additionally, tokenization makes bonds more accessible by splitting them into multiple tokens, allowing individual investors to participate in bonds that were once reserved for institutional investors. By reducing intermediaries, tokenization also contributes to the reduction of costs associated with bonds as well as the reduction of time to market.

Société Générale has also been innovative in this area by issuing in April 2019 100 million euros of bonds in the form of security tokens on the Ethereum blockchain. Most recently in 2021, it issued the first structured product on the Tezos blockchain (XTZ).

Société Générale issues a security token on the Tezos blockchain (XTZ)

gold and commodities

The tokenization of raw materials has several advantages. Take the example of gold. The 1 kilogram ingot is traded at the current price of around 55,000 euros. Gold tokenization enables fractionalization of ownership which allows more people to access gold. Additionally, gold-backed cryptocurrencies offer superior liquidity and can serve as inflation protection.

A concrete example is the Pax Gold token (PAXG), a stablecoin with a valuation of $480 million that is backed by physical gold held by the company Paxos. Each token is redeemable for one ounce of gold (about 31.1 grams) held in vaults by Paxos and its partners.

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real estate

The benefits of asset tokenization apply particularly to asset classes that are generally considered illiquid and can benefit from better transparency, greater efficiency, and lower minimum investments.

This is the case with real estate, which has always involved long and costly transactionswith paperwork and manual processes. Tokenization streamlines the process and brings transparency to the industry. Additionally, fractionalization brings liquidity to an illiquid asset class, reduces the high capital investment requirement, and expands access to real estate to more investors.

Institutional real estate

Institutional real estate refers to investments in real estate made by financial institutions and institutional investors such as pension funds, insurance companies, asset management companies, sovereign wealth funds, etc. This market is characterized by large entry tickets and low liquidity as the majority of buyers want to benefit from long-term passive income.

On the one hand, tokenization would reduce the entry ticket by splitting the property and would also open up opportunities for individual investors, wealthy families who cannot have access to this type of product. The latter could thus bring liquidity to the market through OTC (over-the-counter) offers.

For Ami Ben-David, founder and CEO of Ownera (a company that designs and deploys P2P solutions to interconnect private markets), where the impact of tokenization could be the greatest is on collaterality. Indeed, banks could very well grant loans against this type of collateral. In the event of a default, the bank would recover the token rather than having to go to court.

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luxury goods

The tokenization of luxury goods can have several advantages. Luxury goods have the particularity of being considered low-risk investments for several reasons (intrinsic value, demand decorrelated from economic fluctuations).

This is why the tokenization of these assets, followed by their use as collateral for loans appears to be relevant.. In addition, the market for luxury goods is illiquid by nature and sales on the secondary market are difficult to trace.

Recently, the DeFi Arcade protocol, which specializes in the loan of NFTs, announced that it had made a loan of $14,500 thanks to the tokenization of 2 Rolex watches in the form of NFTs and used as collateral. The advantage for the lender is that in the event of default, he can use the NFTs to buy back the watches.

As far as the world of fine wines is concerned, the potential of tokenization is less about collateralization, but more about the traceability of potential resales as well as optimal storage conditions.

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What future for the tokenization of Real-World Assets?

Regulation is necessary and it would be utopian and counterproductive to reject it. Nevertheless, it opens up many debates and involves different approaches depending on the country. The most sulphurous of these debates is undoubtedly whether digital tokens should all be considered as security tokens, that is to say as financial securities.

In the USA

According to Zoé Cruz, founder and CEO of Menai Financial Group, the public authorities are intransigent on 3 points: investor protection, market manipulation and the obligation of identity verification (KYC). We thus understand that in the United States, the regulation is tougher, with the desire to consider the majority of tokens as security tokens.

In USA

The Financial Markets Authority (AMF) recalls, in a 2023 report, that the regulation of decentralized finance (DeFi) is necessary to guarantee transparency, security and user protection. Besides, the AMF also advocates a coordinated approach at European and even global level. This is also the intention of the MICA regulation, which aims to establish a clear and harmonized regulatory framework for players in the crypto-asset market within the European Union.

MiCA and TFR: key takeaways from cryptocurrency regulation in the European Union

Conclusion on the tokenization of real-world assets

The tokenization of real assets offers potential benefits such as increased liquidity, wider accessibility to investments and portfolio diversification. However, challenges remain in terms of regulation, effective liquidity and security.

Despite this, tokenization presents opportunities for innovation. Its future impact will depend on how regulators and industry players address these challenges..

This article was written by Émile Brémond of the student association KryptoSphère