RWA, the asset that bridges the real world and DeFi

RWA, the asset that bridges the real world and DeFi

  • June 22, 2023
  • |
  • Korea Blockchain Week
Introduction

Decentralized finance (DeFi), which enables peer-to-peer financial transactions without intermediaries, has emerged as one of the most intriguing developments in the blockchain ecosystem. DeFi has garnered significant attention by addressing the opacity, slow transaction processing speed, and high entry barriers of traditional financial markets. With the advent of smart contracts, protocols facilitating various financial activities such as lending, swapping, and liquidity provisioning have emerged on the blockchain, attracting substantial capital and fueling explosive growth in the DeFi market.

However, beneath the steep upward trend, concerns have arisen about speculative and fraudulent practices, overshadowing tangible benefits for the general consumer. The Terra-Luna crash in May 2021 further highlighted the risks of DeFi, causing considerable losses and drawing increased attention from governments worldwide, as well as the related industry. People have started to demand tangible assets with real value in the blockchain ecosystem, rather than mere "digital data," leading to a growing demand for DeFi's integration with real-world assets.

In this context, initiatives to digitize tangible assets have gained momentum, leading to an intensified focus on Real World Assets (RWA). RWA refers to the process of tokenizing assets from our physical environment, facilitating their trade on the blockchain. This article will delve into the concept of RWA, its benefits, and practical use cases.

What is RWA?

As mentioned earlier, RWA refers to the tokenization of real-world assets with tangible value, enabling them to be traded on the blockchain. Unlike intangible assets such as BTC or ETH, which have limited value creation within the blockchain ecosystem, RWA brings the value of tangible real-world assets into the blockchain ecosystem. One prominent example is real estate. For instance, by tokenizing a real-world building A and trading it on the blockchain, one can assert ownership and distribute the associated revenue, just as they would in the physical world.

Advantages of RWA

By introducing RWA into DeFi, we can expect the following positive effects:

1. Stable token prices

One of the main hurdles deterring individuals and institutional investors from investing substantial funds in the blockchain ecosystem is the extreme volatility of cryptocurrencies. This factor is particularly off-putting for institutional investors who manage significantly larger assets than individual investors. The inherent instability in the DeFi market's asset values can result in considerable losses, dissuading potential participants. RWA provides a potential solution to this concern. By introducing tangible assets into the blockchain, RWA underscores the inherent value of physical goods. This emphasis contrasts with the often intangible assets within the blockchain ecosystem. Consequently, asset value can be maintained with greater stability, offering a reliable benchmark for evaluation.

2. Liquidity for illiquid assets

RWA can facilitate the liquidity of traditionally illiquid assets in the real world through tokenization. Real estate serves as the most prominent example, where tokenization can bring liquidity to highly illiquid assets in the physical world. This not only facilitates easier transactions but also attracts various market participants, acting as an incentive for broader market engagement.

For example, using real estate again as an example, in the physical world, a buyer would have to pay the full price for a property. However, through RWA tokenization, one can trade small amounts using numerous "tokens" and acquire corresponding rights. This allows diverse investors to participate in the financial market, contributing to the diversification of the market.

Token issuance and distribution structure of Kasa, one of the innovative financial services in real estate tokenization, Source: Kasa Korea

 

3. Cost savings

Product transactions facilitated by RWA occur through smart contracts on the blockchain. Consequently, risks associated with counterparties or intermediaries, as well as transaction fees traditionally paid to intermediaries, can be significantly reduced. Additionally, utilizing smart contracts simplifies complex procedures, resulting in faster and safer transactions.

4. Flexibilization of Risk Management

Every step of the transaction utilizing RWA is recorded in real-time on the blockchain. This enables anyone, anywhere, to access transaction details, ensuring transparent management and supervision. As a result, risk management for investors becomes more convenient, and the movement of physical assets can also be tracked through the on-chain movement of RWA tokens. In other words, the information asymmetry of existing physical assets can be resolved through transactions using RWA.

Use Cases of RWA Utilization

Tokenized securities, commonly known as Security Token Offerings (STOs), are one of the hottest topics in the Korean financial market this year, representing a prominent use case of RWA by tokenizing traditional financial market assets and bringing them onto the blockchain. Countries such as the United States, Japan, and Singapore, which embraced digital assets early on, have observed a national-level movement to introduce STOs, as evidenced by the publication of "Regulatory Framework for the Issuance and Distribution of Security Tokens" by the Korean Financial Services Commission in February of this year.

Japan, which established laws regarding STOs ahead of South Korea, has various examples of STO cases. Starting with SBI Securities' subsidiary, SBI e-Sports, issuing 1,000 shares of common stock (worth approximately 50 million yen) using STOs in October 2020, a wide range of attempts have been made since then.

2021

2022

Various institutions/companies participating in the Japanese token securities market ecosystem, Source: NH Investment & Securities.

Not only in Japan but also in Korea, significant movements by financial institutions and fintech companies have begun following the guidelines. They are striving to restructure business operations, which were previously limited to pilot cases designated under existing financial regulatory sandboxes (innovative financial services), into more specific and regulatory-compliant approaches.

In Conclusion

There are still considerable challenges to overcome for RWA to realize its true potential, such as the limited scale, unclear regulations, and restricted scope of utilization. However, the emergence of RWA is undeniably an intriguing development in the traditional financial ecosystem. By bringing real-world assets into the blockchain ecosystem, RWA can create new investment opportunities, enhance transparency, and reduce fraud, among other innovations. We need to pay attention to the progress of RWA, as highlighted in last September's report, "Decentralized Finance (DeFi): Innovative Potential and Associated Risks," published by the Federal Reserve Bank of the United States.

One such change that could significantly expand the scope of DeFi would be the development of mechanisms that grant on-chain tokens with legally enforceable claims on “real world” financial assets (such as corporate and consumer debt) as well as physical assets (such as ownership rights to buildings and other property).”

 

 

DeSpread — Website | Twitter | DeSpread Research | Portfolio Hub 

DeSpread, founded in 2019, is a consulting firm specializing in Web3 & blockchain. Consisting of practice leaders with many years of practical know-hows in all fields of Defi, NFT, Metaverse & Gaming, Network Validation and Web3. DeSpread provides solutions and go-to-market strategies to grow the protocol by actively participating in the ecosystem.  

Writer: Declan Kim, Research Analyst at DeSpread

#RWA #STO #DeFI #DeSpread