Technical Analysis of Real World Asset Tokenization Mechanism

Tokenization of real-world assets (RWAs) refers to digital Tokens recorded on the blockchain that represent ownership or legal rights to tangible or intangible assets. The scope of tokenization encompasses a wide range of asset classes, including real estate, commodities, artworks and collectibles, intellectual property, and financial instruments.

By enabling fractional ownership, tokenization enhances the liquidity of assets, making investment opportunities that were once limited to high-net-worth individuals and institutional investors more accessible to the general public. The immutable ledger of blockchain ensures transparent ownership records, reducing the risk of fraud; at the same time, tokenized assets traded on decentralized exchanges bring unprecedented market accessibility and efficiency.

According to analysis, it is expected that by 2030, the total market value of various tokenized assets (excluding cryptocurrencies and stablecoins) will reach approximately 2 trillion dollars, with a pessimistic scenario of 1 trillion dollars and an optimistic scenario of up to 4 trillion dollars. These estimates do not include stablecoins to avoid double counting, as these instruments are typically used as cash payment tools in the settlement of tokenized asset transactions.

Current System

The tokenization of real-world assets refers to the representation of off-chain asset ownership in the form of digital tokens through blockchain or similar distributed ledgers. This process connects the characteristics, ownership, and value of the asset with its digital form. Tokens, as a digital holding tool, enable their holders to assert ownership over the underlying asset.

Historically, physical certificates were used to prove ownership of assets. While useful, these certificates were vulnerable to theft, loss, forgery, and money laundering. In the 1980s, digital holding tools began to emerge as a potential solution. However, constrained by the computing power and cryptographic technology of the time, these tools failed to materialize. Instead, the financial industry turned to centralized electronic registration systems to record digital assets. Although these paperless assets brought certain efficiency gains, their centralized nature required the involvement of multiple intermediaries, which in turn introduced new costs and inefficiencies.

System Based on Distributed Ledger Technology

The development of Distributed Ledger Technology (DLT) has made it possible to rethink the concept of digital securities or tokens.

DLT is composed of a series of protocols and frameworks that enable computers to propose and validate transactions within a network while maintaining the synchronization of records. By decentralizing record-keeping, this technology shifts responsibility away from a single central authority. Such decentralization reduces administrative burdens and decreases the risk of system failures associated with reliance on central entities, making the system more resilient.

Decentralized Solutions

Blockchain is a distributed ledger technology that operates through a decentralized network of computers. Tokens can be issued on two types of blockchains: private permissioned chains and public permissionless chains.

A private permissioned chain is controlled by a central entity and restricts access to specific users, forming a controlled ecosystem. A public permissionless chain, on the other hand, does not require control by a central authority and provides open access to all users. When tokens are issued on a public permissionless chain, they can be integrated with decentralized finance (DeFi) protocols, thereby enhancing their utility and value.

The choice of blockchain determines the level of control that the token issuer can maintain. Compared to private permissioned chains, public permissionless chains grant the issuer less control. The choice of blockchain architecture should align with the issuer's goals and the expected functions of the Token.

A key advantage of asset tokenization is the automation achieved through smart contracts. Smart contracts are programs on the blockchain that execute when both parties meet specific conditions. These contracts automate financial transactions and administrative tasks, reducing the need for manual work and intermediaries. By eliminating counterparty risk, this automation makes operations more efficient and secure, enabling faster and lower-cost transfers.

Tokenization Methods

The tokenization of real-world assets can be analyzed through two key attributes: the representation of the asset and ownership. The representation includes the economic characteristics of the asset, while the verification of ownership requires a ledger, which can be off-chain or on-chain.

Understanding the difference between digital enhanced assets and digital native assets is crucial. Digital enhanced assets maintain ownership through off-chain ledgers while using blockchain tokens as a digital representation. Digital native assets are essentially digitized, with their tokens directly representing value and ownership.

The four main methods of tokenization are:

1. Direct Ownership: Digital tokens themselves serve as the official ownership record, eliminating the need for custodians.

2. 1:1 Asset-Backed Token: The custodian holds the asset and issues a Token that represents direct rights to the underlying asset.

3. Over-collateralized Token: Issue asset tokens by using assets that represent the underlying asset or related rights in a manner different from what was expected as collateral.

4. Insufficient collateral tokens: The issued tokens are intended to track the value of a certain asset, but are not fully collateralized.

Advantages of Tokenization

The tokenization of real-world assets is primarily achieved through distributed ledger technology, bringing the following advantages:

1. Atomic settlement: Achieving instant settlement of transactions through smart contracts, eliminating counterparty risk.

2. Liquidity Improvement: Enhance the transferability of assets, making previously non-tradable assets tradable.

3. Reducing intermediaries: Decentralized data structures reduce reliance on traditional intermediary institutions.

4. Automation: Automate many manual tasks through smart contracts to improve efficiency.

5. Promote Compliance: Enhance efficiency and uniformity in compliance through standardization and automation of processes.

6. Automated Market Maker: Transforming traditional market-making mechanisms through smart contracts, reducing costs and improving performance.

Risks and Costs of RWA Tokenization

Despite the many advantages brought by tokenization of assets, its adoption still faces significant challenges, mainly including:

1. Technical risks: cybersecurity vulnerabilities, limitations in system scalability, settlement processes, network stability, and efficiency issues.

2. Regulatory challenges: Anti-money laundering compliance, governance framework, identity verification, and data protection and privacy issues.

3. Market Risk: Speculative trading can lead to assets being overvalued and increased price volatility.

4. Environmental Concerns: The high energy consumption of blockchain consensus mechanisms raises environmental concerns.

5. Infrastructure Costs: The infrastructure changes required to support blockchain and tokenization technologies involve significant investments.

6. Integration costs: The costs of connecting the new system to the existing financial infrastructure.

7. Educational costs: The costs of educational activities aimed at improving understanding and overcoming skepticism.

Tokenization has brought revolutionary changes to the financial system, but to fully realize its advantages, it is still necessary to overcome these multifaceted challenges.