Explore Real-world Assets (RWAs): The Next DeFi Trend in 2024

8 min read
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Real-world Assets (RWAs) in crypto are not a new topic, but they are always relevant. They represent a groundbreaking application idea that the DeFi community has been eagerly hoping to turn into reality. In this article, we will delve into this subject in detail to determine if it truly deserves such eagerness.

At the forefront of the new DeFi trends in 2024 is Real-world Asset (RWA), a concept that is steadily gaining traction after Liquid Staking Derivatives (LSD) and LSD Finance (LSDfi). This article aims to demystify RWAs in the DeFi context, exploring their significance, challenges, and the potential they hold for the future of finance.

What Are Real-world Assets (RWA) In DeFi ?

Real-world Assets in DeFi refer to tangible or intangible assets from the traditional financial world that are tokenized and integrated into the DeFi ecosystem. These assets can range from real estate and commodities to traditional finance instruments, intellectual property, and carbon credits. Unlike typical cryptocurrency assets, which are inherently digital, RWAs serve as a bridge between the physical and digital finance realms, bringing a new dimension of assets into the blockchain space.

The integration of RWAs into DeFi is significant for several reasons. Firstly, it diversifies the asset base in DeFi, traditionally dominated by crypto-assets. This diversification not only attracts a broader range of investors but also enhances the stability and resilience of the DeFi ecosystem.

Additionally, tokenizing real-world assets opens up liquidity opportunities, making assets that were previously illiquid or difficult to divide easily tradable and accessible.

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Real-world Assets Categories

For categorization, RWAs can be broadly classified into two groups: tangible and intangible assets. Each group can then be further divided into subcategories based on their specific sectors. The following provides a framework for such categorization:

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  • Real estate: houses, land, warehouses,…
  • Commodities: gold, silver, diamonds, gems, oil, minerals…
  • Collectibles: Artwork, trading cards, antiques…
  • Currency: stablecoins pegged by fiat currencies
  • Bonds: bonds issued by governments or private entities.
  • Securities: corporate stocks.
  • Certificates: patents, inventions, certifications, copyrights, carbon credits.

How Are Real-world Assets Integrated Into Blockchain?

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Step 1: Off-Chain Formalization

In this initial phase, real-world assets that are prepared for on-chain integration are typically provided by either individuals or dedicated asset providers, such as real estate exchanges or precious metal and gemstone centers. These entities, referred to as Asset Providers, are responsible for appraising the assets and taking them into their custody. This custody is crucial as it ensures both the physical and legal safeguarding of the assets. Furthermore, legal service providers play a critical role in supporting all related real-world operations, guaranteeing that every step adheres to legal standards and is fully protected under the law. In the event of any disputes, the involved parties can rely on legal frameworks and predefined agreements to resolve their issues.

Step 2: Information Bridging

This pivotal step involves transitioning the asset’s value from the physical world (off-chain) to the digital blockchain environment (on-chain).

  • Tokenization: Assets are converted into digital tokens based on their characteristics and intended use. This can result in the creation of either fungible tokens or unique non-fungible tokens (NFTs). Specialized service providers, skilled in tokenization, carry out this process, leveraging the capabilities of various blockchain platforms like Ethereum, Polkadot, Polygon, and Onyx. Once tokenized, asset information is securely logged and made transparent on the blockchain, ensuring immutability.
  • Oracles: These are vital elements within the RWA ecosystem. Oracles function as bridges that convey real-world data to on-chain systems. They keep blockchain protocols updated with the latest information, like the current market prices of gold, oil, or the value of specific tokenized stocks. Chainlink is a prominent player in the field of Oracles, known for its reliability and accuracy.

Step 3: RWA DeFi Protocol

The final stage involves introducing these tokenized real-world assets into the DeFi (Decentralized Finance) ecosystem. Once in the DeFi world, these assets enter a vibrant market that branches into a multitude of sectors. Two standout areas at present are:

  • Lending: These are protocols designed for RWA-based borrowing and lending activities.
  • Trading: These platforms facilitate the trading of RWAs among users.
  • Yield Farming: protocols that offer users the opportunity to earn returns by depositing their assets into specific protocols.
  • DAOs (Decentralized Autonomous Organizations) collectively manage real-world assets, like jointly purchasing and renting out a property and subsequently sharing the rental income.

Integrating real-world assets into the blockchain can be a complex process, particularly for high-value and legally intricate assets like real estate. Despite these complexities, the growing support and enthusiasm from major institutions underscore the potential and importance of this trend.

In the next part, we will delve into the unique benefits and opportunities offered by RWAs.

Advantages And Opportunities of A Borderless Market

Looking beyond the decentralized finance (DeFi) market, it’s clear that blockchain’s ambition is to find practical applications in everyday life, not just in finance but across various sectors like healthcare, education, transportation, and gaming. RWAs are key in driving this societal shift towards blockchain.

The Concept of a Borderless Trading Market

Traditional financial markets often pose challenges in purchasing foreign assets like real estate or stocks. With blockchain, however, these assets become accessible globally with just a few clicks. Imagine owning a villa in the Bahamas from your living room. This on-chain ownership concept opens up international markets, removing geographical barriers and enhancing liquidity and cash flow.

Boosting Capital Efficiency with DeFi

DeFi is creating a parallel financial market that competes with traditional finance, offering users more advantageous options. For example, a business looking to mortgage property for a loan might find DeFi platforms offering lower interest rates compared to traditional banks. This ideal scenario assumes a seamless DeFi operation, from asset tokenization to the final transaction.

Simplifying Financial Processes

DeFi’s edge lies in its ability to bypass third-party intermediaries. Transactions are direct, facilitated by smart contracts, streamlining procedures that are typically complex in traditional finance. For instance, mortgaging an asset in DeFi requires just asset ownership and approval from a lending protocol, significantly cutting down on the paperwork and processing time.

However, this simplicity also transfers the responsibility of risk management to the users, relying on their trust in smart contracts and their own asset management skills.

The global asset market is estimated at around 900 trillion dollars, dwarfing the current cryptocurrency market. The integration of RWA into DeFi could bring a substantial influx of capital, potentially increasing market capitalization and liquidity. The success of this integration, however, hinges on RWA’s ability to demonstrate its advantages over traditional models.

New Economic Models with RWAs

RWAs in DeFi are also crafting innovative economic frameworks.

Let’s take real estate fractionalization as an example. This process simplifies co-ownership among unrelated parties through trustless transactions on blockchain, utilizing smart contracts. Platforms like RealT are pioneering in this space, demonstrating how property can be divided, sold, and managed for rental income distribution.

Additionally, Yield Farming is emerging as a lucrative model for RWA owners seeking profit generation.

Insurance products are also becoming integral to safeguard on-chain assets against legal risks and disputes.

Challenges in Real-world Assets Integration

The primary challenge for RWAs in DeFi is navigating the complex legal landscape. Current asset tokenization practices lack formal legal backing, highlighting the need for a regulatory framework to build trust in on-chain asset transfers.

Verifying information is another significant hurdle. Trust in RWA extends beyond smart contracts to include third-party services like asset custody, valuation, and legal advisement.

A case in point is the recent depegging of USDR (Real USD). USDR, a real estate-backed stablecoin issued by TangibleDAO, plummeted to $0.5 from its intended stable value of $1. This incident occurred when the highly liquid portion of its collateral, DAI, was withdrawn, leaving less liquid, opaque assets in the pool, leading to the depegging of USDR.

Therefore, in the realm of RWAs, the role of off-chain appraisal is crucial. This process should be conducted by reputable and transparent entities, backed by legal protections. Only then can it facilitate the trust needed for on-chain transactions.

Smart Contract Risks

One of the inherent risks in Decentralized Finance (DeFi) is the reliability of smart contracts. Unlike traditional finance, where third-party institutions are trusted to manage transactions and safeguard assets, DeFi entrusts this role to smart contracts. If a smart contract has vulnerabilities, users risk losing their assets with no clear recourse.

Beyond smart contract risks, users themselves pose another risk. Owning significant assets in a digital wallet requires users to be vigilant against potential cyber attacks, underscoring the need for personal security measures.

Potential Growth of Real-world Assets in 2024

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Analyzing the advantages and challenges of RWAs, it’s evident that there’s significant work to be done for their widespread practical application, especially in legal aspects.

However, this doesn’t mean that RWAs lack the potential for explosive growth in the near future. Support is evident from major entities in both the crypto and traditional markets.

Take Blackrock, for example, with its massive $9.4 trillion in asset management, continuously advocating for Real World Assets. Blackrock’s CEO has even stated that “tokenization is the next generation of the market.” Recently, Blackrock has moved to tokenize its stocks through JPMorgan and Barclays.

It’s worth noting, however, that while financial institutions make such claims, their behind-the-scenes actions remain less transparent. Each person should form their own opinions, but these developments are undoubtedly positive signals for RWAs.

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The TVL of Real-world Assets Protocols. Source: Defillama

On the on-chain front, according to Defillama data, the total value locked (TVL) in RWA protocols has reached $5.8 billion, a 30-fold increase since the beginning of 2023. This shows that this sector is attracting significant investment.

Regarding RWA’s practical implementation, it’s not an overnight process, considering legal frameworks and the need for blockchain infrastructure security. Additionally, educating users is crucial. Just as eBay and Amazon took years to shift shopping behaviors from traditional stores to online, RWAs might require years for users to transition from online shopping to on-chain transactions.

For retail investors like us, the wait isn’t for practical solutions to materialize but for profitable opportunities based on these developments. New solutions often experience bursts of growth to test their value before stabilizing, if their practicality is proven. Thus, we might not have to wait as long as we did for Amazon or eBay to witness a significant RWA wave.

An Infographic of The Updated Real-world Assets Ecosystem

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Information Bridging in RWA and DeFi

Blockchain Infrastructure for RWAs

High-security blockchain platforms are essential for Real World Assets (RWA), with Ethereum often being the first choice. Other notable platforms include Polygon, Polkadot, and RWA-specific blockchains such as Onyx, Intain, Provenance, Realio, Polymesh, and Mantra.

Tokenization Protocols

Built on these blockchain layers, several protocols facilitate asset tokenization: Centrifuge, Securitize, Polymath, Tangible, Toucan Protocol, Cache.gold, FlowCarbon, and Backed Finance.

Oracles in RWA

As we stated above, oracles play a crucial role in integrating real-world data into the blockchain, with Chainlink being a leading name in this domain for some time.

RWA DeFi Protocols

In the protocol layer, protocols are often categorized based on the RWA product, as discussed earlier.

Currently, the most competitive areas in RWA and DeFi are Tokenization and Lending. This trend is understandable as they represent the initial entry points for assets into DeFi. Tokenizing real-world assets and transferring them into DeFi protocols for collateralization, minting stablecoins, and their subsequent use in DeFi protocols set the stage for other DeFi segments to flourish.

Conclusion

Tokenizing real-world assets for integration into DeFi isn’t a novel idea. It’s been around since the early days of DeFi’s foundation. However, only recently have we begun to see the potential of fiat in this context. Legal barriers and trust issues still prevent RWA from realizing its full explosive potential.

With the advancement of technology and the gradual enhancement of blockchain infrastructure in security and user safety, coupled with support from major entities in the financial market, there are positive signs for the growth of this sector. Perhaps, RWAs are just awaiting a regulatory ‘east wind’ to make a significant breakthrough.

It’s uncertain when RWAs will fully enter the practical realm, but once there’s a mass adoption of RWAs, it could unify the traditional finance (TradFi) and DeFi markets like never before, expanding their scale to unprecedented levels. This could be the end game for DeFi, where the distinction between DeFi and TradFi no longer exists.

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