Introduction.  The world of cryptocurrencies on blockchains and the world of traditional assets in markets have often stood in stark contrast to one another since Bitcoin’s creation in 2008. The lack of a reliable bridge between these two worlds has limited the impact of cryptocurrencies on assets in the real-world outside of on-chain speculation and prevented adoption of the benefits that blockchain technologies can bring to real world processes. Improvements in efficiency, increased liquidity for illiquid assets, speed of transaction clearance, and bringing a more tangible basis to token valuations have all been limited by the lack of a reliable link between on-chain and off-chain transactions and assets. Smart contracts enable value to be tokenized on blockchains, which gives virtual representations to different types of assets that are either fungible or non-fungible. Advances in tokenization have enabled the walls between off-chain and on-chain assets to come down, creating new possibilities in how value is articulated. “Real-world assets,” (RWAs) that have been static in real-world contexts are being given a new, second life as on-chain digital assets, and blockchains are having the benefits of tangible assets added into their ecosystems. With this paradigm shift comes tremendous potential benefits, and a new host of regulatory challenges.

How We Got Here. RWAs “include everything from real estate and commodities to securities and other financial instruments.” The original hype around using blockchains to represent off-chain, traditionally illiquid assets like real-estate, commodities, art, and collectibles dates to the Initial Coin Offering (ICO) boom of 2017-2018. The much-touted narrative failed to materialize as crypto prices crashed, and during the next bull market in 2020-2021, most crypto market participants pivoted to Decentralized Finance (DeFi) and Non-fungible Token (NFT) crypto products. When the claimed benefits of RWAs failed to materialize, it caused many to believe the narrative around RWAs was just that, and that there were no true applications between traditional illiquid assets off-chain and their on-chain counterparts. Illiquid assets refers to assets like real estate, fine art, collectibles, and other assets that are difficult to sell quickly, have high transaction costs, price uncertainty, and risk of selling at a loss due to these factors.  Advances in DeFi technology reveal that real-world assets can also include financial products like stocks, bonds, derivatives, futures, and intellectual property (IP). The technology advances in DeFi in turn gave builders the ability to create usable versions of the original real-world asset ideas pioneered in 2017. We next turn to “tokenization,” a concept in crypto that makes it possible to link RWAs with their digital equivalents.

Tokenizing Real World Assets.  Tokens in crypto are a bit of a misnomer, as a token simply represents a smart contract standard to make usage and interaction consistent. When we refer to tokens, we are really referring to smart contracts. Traditional token standards include ERC20 and ERC721 on Ethereum, representing fungible and non-fungible assets. While these aren’t the only token standards and different token standards exist on other blockchains, they represent a good starting point for understanding the different use cases. The key benefit to creating a token on a blockchain is that it makes assets programmable, liquid, and independently verifiable. Programmability of tokens enables custom logic to be created for different use cases and needs.  Programming can be as finely grained as the customer or client wants it to be. Liquidity is an important use case when traditionally illiquid assets are represented as digital equivalents, because ownership can be fractionalized and democratized among market participants. Assets on a blockchain are transparent and can be independently and automatically verified and audited, bringing transparency to formerly opaque assets and markets. Finally, tokenizing assets also increases their interoperability in different contexts: an asset can live on a blockchain and is no longer locked in an illiquid, closed system as it was before, to the benefit of market participants and the economy. 

Types of Assets Subject to Tokenization. While the types of tokens are broad, RWAs include tokens that are a specific, tokenized version of an asset, commodity, or security not originally on a blockchain. Importantly, tokens are interoperable with one another offering new possibilities in how RWAs can interact with smart contracts, allowing RWAs to interface with the blockchain native tokens including the following:

• Tangible assets are real world assets with a specific monetary value and a physical form.
• Fungible assets consist of tokens that have equivalent value to each other, so most cryptocurrencies fall into this basket. 
• Non-fungible assets carry a unique design and are not interchangeable, such as NFTs or art or other unique assets. 
• Currency tokens represent fiat currencies, such as the dollar or kroner, in digital format that are often used in connection with stablecoins. 
• Utility tokens are issued to raise funding for developing cryptocurrencies or for providing benefits within a specific crypto ecosystem but may not be actively traded. Utility tokens can also be used for purchasing products and services being offered by the cryptocurrency issuer. 

Asset Tokenization and Securitization. Asset tokenization enables a user to transform any real-world asset into a digital token that provides a higher level of liquidity. Asset tokenization permits fractional ownership of assets as well, something that can be hard to do with real world assets such as art or real estate or IP. Securitization of assets allows a user to convert assets that carry low liquidity into security instruments with considerably higher liquidity. This permits trading in markets and over-the-counter deals using security tokens. Asset tokenization can assist in developing markets for various types of assets by enabling digital platforms where different parties can perform trading and transact on the blockchain.

How to Tokenize Real-World Assets. At a high-level, assets can be tokenized using technology from protocols such as Chainlink, a decentralized computing platform that helps connect existing systems to the blockchain. An asset can be tokenized by following these broad steps: 

1) Determine the asset to be tokenized. 

2) Determine the type of token (fungible or nonfungible) and the corresponding token standard (ERC20 or ERC721 for example), and other attributes the token will need to possess.

3) Select a blockchain the token will be issued on. For example, Chainlink’s Cross-Chain Interoperability Protocol (CCIP) or helps make tokenized assets available across different blockchains.

4) Determine off-chain connections such as off-chain data feeds to maintain asset integrity on-chain, and Proof of Reserve (PoR) to transparently verify the assets backing the RWA. 

5) Deploy the smart contracts and mint the tokens, making them available for the desired use case. Note the above is a broad overview and would likely differ slightly in practice, depending on the use case and requirements of the RWA.

Tokenization Efforts through 2023. While RWAs apply to tokenizing intangible and tangible off-chain assets, more efforts have been directed to the tokenizing of financial products like U.S. treasuries and securities. Current efforts in the web3 space to create and utilize tokenized RWAs are still evolving. MakerDAO has experimented with tokenizing US treasuries, and has plans to facilitate mortgage loans. Chainlink, the provider of CCIP, has created tools that make it much easier for blockchains to communicate with one another and with off-chain payment networks like SWIFT. Integrating tokenized assets into traditional banking networks via SWIFT creates the opportunity to increase access to traditional banking assets like US treasuries, increasing liquidity in the volatile interest rate environments that have persisted the past few years. Commodities are another natural extension for RWA innovation, to greatly increase efficiency, transparency, and reduce costs in validating delivery of the underlying commodity. While intangible assets have certainly been a focus for current offerings through MakerDAO, Realio, and other protocols, working out tokenization for intangible assets also opens the door to consistent standards and applications for tangible RWAs, where they are arguably needed the most because they open up so many new possibilities. 

Current Lack of Legal and Regulatory Certainty. As the technology supporting cryptocurrency, DeFi, Fintech, ETFs, etc., is being heavily developed, the legal and regulatory basis for doing business in this sector is underdeveloped in the United States, despite the introduction of several bills in Congress and a major set of reports from all involved Executive agencies in response to the Digital Assets Executive Order issued on March 9, 2022..  Clarification is needed before the potential benefits of tokenizing assets, such as reducing costs, increasing transparency, increasing liquidity, and creating assets with parameters programmed to client needs. Challenges remain in the legal and technological landscape. The US has not provided comprehensive legislation creating a robust regulatory framework around these assets to date, leaving a lot of their usage in legal limbo. As discussed earlier, the technology side is experiencing rapid innovation, particularly in the realm of intangible, financial focused RWAs. The lack of legal clarification, particularly in the US, has impacted the ability of builders to create sustainable and integrated product offerings. With a robust legal framework, the benefits of RWAs would rapidly become available not only to financial institutions, reducing costs and friction, but primarily to investors and entrepreneurs, where the impact could ultimately be far greater. By democratizing the access to traditionally illiquid, real-world assets like real estate and art, investors not only gain new opportunities, but can also work together to decide how they want to integrate these assets into their investing portfolios. Entrepreneurs stand to gain immensely, as the programmability of RWAs enables custom products to be built, and new paradigms to be potentially created in the tokenizing of Intellectual Property (IP) and how current systems are implemented for builders. The opportunity exists to reduce friction, costs, and complexity while also increasing access and transparency. However, this opportunity will not come unless legal frameworks are clarified and made simple to work with. A clarified legal framework also brings the possibilities of meeting environmental goals with carbon offset tokens, bringing transparency and a greater variety of offsets available to be created and used. Instead of fearing what can happen with these assets, it makes more sense to empower entrepreneurs and investors to build with these assets in a way that benefits market participants, instead of simply restricting them without providing any means to develop a simple and powerful legal framework. 

Spot Bitcoin ETFs. Recently, the Securities Exchange Commission (SEC) approved the establishment of eleven new Bitcoin Exchange Trade Funds (ETF) in the U.S. The approval was compelled by a court decision involving a spot Bitcoin ETF, rather than a derivative Bitcoin ETF, which has been available since 2021. These spot bitcoin ETFs invest directly in bitcoins as their underlying asset and are directly linked to the secure custody of bitcoins rather than to more speculative futures contracts such as those held in derivative bitcoin ETFs. Investors should be aware that the new ETFs will charge management fees and brokerage commissions although gas fees and exchange fees to buy and hold bitcoins directly will be eliminated.   

The development of spot Bitcoin ETFs may be an indication that the tokens issued for real world tangible assets that are held securely and tracked transparently on a blockchain may be amenable to regulation. Commodities and other tangible assets represented by tokens could be traded through ETFs to increase the liquidity of smaller or specialized markets for such assets. This would allow improvements in the creation and trading of such assets as carbon credits and offsets or specific quantities of biofuels that might otherwise not have large initial markets.  Press reports indicate that the new spot bitcoin ETFs are popular among investors, having reportedly bypassed silver as the second largest ETF commodity class or assets under management in the first week of trading.  

Challenges Asset Tokenization Must Address. Obviously the legal and regulatory environment in the United States must be normalized through legislation and more specific regulatory norms, rather than the current patchwork of state regulations and federal litigation that is defining the rules for the sector now.  A code of conduct and common standards for tokens and issuers would help to curb abuses and permit individuals and organizations to participate in the sector on a more level footing.  Continued progress on reliable and secure digital management systems to protect against cybercrime and ensure secure custody of real-world asset tokens will also help develop the potential of RWAs. With a common-sense legal framework in place, RWAs stand to create new markets for formerly illiquid assets, and greatly improve the transparency and efficiency of existing markets. 

Additional Sources

1. https://medium.com/@Elifhilalumucu/comprehensive-real-world-assets-guide-rwas-f88ce579f043
2. https://coinbase.bynder.com/m/6b06d39244af53f1/original/Tokenization-and-the-New-Market-Cycle.pdf
3. https://www.coindesk.com/business/2023/04/14/tokenization-of-real-world-assets-a-key-driver-of-digital-asset-adoption-bank-of-america/ 
4. https://www.blockchain-council.org/blockchain/asset-tokenization/?gad_source=1&gclid=Cj0KCQiAnfmsBhDfARIsAM7MKi2trIwqoBIiLOE_sapHJ0nVAL4Y3_lvdvXGRsQH4mFw_4wxKNXpoW8aApBBEALw_wcB  The Complete Guide for Asset Tokenization on Blockchain
5. https://blog.chain.link/real-world-assets-rwas-explained/ 

 
1 “Comprehensive Real World-Asset Guide: RWAs, Av. Elif Hilal Umucu, 8/31/2023, https://medium.com/chainlink-community/comprehensive-real-world-assets-guide-rwas-f88ce579f043 

2 “Real-World Assets (RWAs) Explained,” Chainlink, December 22, 2023, https://blog.chain.link/real-world-assets-rwas-explained/

3 Ibid.

4 “Coinbase Institutional, Market Intelligence: Tokenization and the New Market Cycle,” David Duong and David Han, October 30, 2023, https://www.coinbase.com/institutional/research-insights/research/market-intelligence/tokenization-and-the-new-market-cycle

5 Executive Order on Ensuring Responsible Development of Digital Assets downloaded from https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/ 

6 https://www.forbes.com/sites/digital-assets/2024/01/24/bitcoin-overtakes-silver-as-second-largest-etf-commodity/?sh=57442bc01322