RWA Industry Report: The Integration of TradFi and Decentralized Finance

Foreword

The market value of cryptocurrencies has surpassed one trillion dollars, with Bitcoin and Ethereum accounting for over 50% of the market share. However, the market value of mainstream asset classes and commodities still far exceeds that of cryptocurrencies. Against this backdrop, the "RWA"(Real World Asset, the concept of real-world assets) has begun to gain traction in the crypto space. RWA refers to the tokenization of real-world assets and their introduction to the blockchain, such as commercial real estate, bonds, cars, and almost all assets that can be tokenized. This allows for the storage and transfer of assets without central intermediaries, enabling value to be mapped onto the blockchain for transactional circulation.

Although RWA has great potential for expanding the market cap ceiling of cryptocurrencies, its definition, advantages, and development trends still need to be explored. Some believe that RWA is just market hype and cannot withstand deep scrutiny; others are confident in RWA and optimistic about its future. This article will share perspectives on RWA and analyze its current situation and future.

The core viewpoints are as follows:

• The future development direction of RWA should be the bidirectional integration of the real world and the virtual world: under multiple different jurisdictions and regulatory frameworks, a new financial system using DLT technology should be deployed on the permissioned chain.

• Rational view on RWAization: We need to calm down from the current hype; not all assets are suitable for RWAization. Assets that are unpopular in the real world are also unlikely to be welcomed by the market after being converted to RWA.

• Many countries around the world are actively promoting regulatory frameworks related to blockchain. At the same time, blockchain infrastructure such as cross-chain protocols and oracle services is rapidly improving.

• The principles and challenges faced by RWA projects for different underlying assets are similar, but the specific operating mechanisms have their own focuses. For example, bond tokens typically do not require the same level of liquidity as stock tokens.

1. Background of Asset Tokenization

Asset tokenization is the process of recording the ownership of a specific asset into digital tokens that can be held, bought, and traded on a blockchain. The resulting tokens represent ownership shares of the underlying asset. In theory, any asset can be digitized, whether tangible assets like real estate or intangible assets like company stocks.

Converting assets into digital tokens makes them easier to divide, enables fractional ownership, and allows more people to participate in investments, thereby increasing market liquidity for assets. Digitalization of assets also allows traditional assets to be traded directly on peer-to-peer platforms without intermediaries, bringing greater security and transparency to the market.

Basic Principles of Asset Tokenization:

1. Obtain real-world assets
2. Asset Tokenization on the Blockchain
3. Distributing RWA to on-chain users

RWA is not a new concept. As of 2023, the asset tokenization market size is approximately $600 billion. It is expected to grow at a compound annual growth rate of 40.5% from 2024 to 2032. RWA tokens are the fastest-growing asset class in Decentralized Finance.

As of November 25, 2024, DefiLlama data shows that the TVL of RWA token assets has reached $6.512 billion. The increase in TVL to some extent indicates that the recognition and liquidity of token assets in the Web3 world have improved.

Currently, there are mainly two perspectives on RWA tokenization: the Crypto perspective and the TradFi perspective. This article focuses on RWA from the TradFi perspective.

1. RWA from a Crypto Perspective

The traditional DeFi sector has been striving to achieve yield generation, but the underlying yield mechanisms are only effective when prices rise. Against the backdrop of the crypto winter, the sluggish on-chain activities have led to a decline in yields. The drop in DeFi protocol TVL from a market peak of $180 billion to $50 billion reflects an unsustainable yield model. As yields plummet, the pursuit of "real yields" has intensified, prompting DeFi protocols to integrate RWA tokens as a more stable source of income.

From the perspective of Crypto, RWA can be summarized as the unilateral demand from the Crypto world for the returns of real-world financial assets. The main background is the steady rise in U.S. Treasury yields under the Federal Reserve's interest rate hikes and balance sheet reduction, while the interest rate hikes have drained liquidity from the crypto market, leading to a decline in yields in the DeFi market.

2. RWA from a TradFi perspective

From the perspective of traditional finance ( TradFi ), RWA is a two-way integration between traditional finance and Decentralized Finance ( DeFi ). RWA not only introduces value to the cryptocurrency market but also empowers real assets with the advantages of cryptocurrencies.

For the traditional financial world, DeFi financial services that are automatically executed based on smart contracts are revolutionary financial technology tools. In the TradFi sector, RWA is more focused on how to integrate DeFi technology to achieve asset tokenization, thereby empowering the traditional financial system. Specifically:

• Improve trading efficiency: RWA can transfer multiple stages of traditional IPOs to the blockchain, completing transactions in one go, avoiding cumbersome processes, and not being limited by exchange time constraints.

• Lower financing costs: Through the STO pipeline, RWA can provide financing for industries with lower heat, reduce investment bank fees, and attract projects that struggle to obtain loans.

• Simplified investment threshold: RWA allows users to invest in global stocks, real estate, and other assets with just one account, reducing investment barriers and complexity.

Differentiating the RWA logic is necessary. The underlying logic and implementation paths of RWA vary significantly from different perspectives. In terms of selecting the type of blockchain, the RWA of traditional finance is based on permissioned chains, while the RWA of the crypto world is based on public chains.

In summary, the future development direction of RWA should be the two-way integration of the real world and the virtual world: under the permissioned chain pattern of multiple different jurisdictions and regulatory systems, a new financial system using DLT technology should be established.

2. How does RWA disrupt TradFi?

In the traditional financial system, assets typically exist in the form of paper certificates, which are later converted into digital records held by centralized financial institutions. These records encompass ownership, liabilities, conditions, and contracts, scattered across independently operating different systems or ledgers. The financial system requires extensive post-coordination to reconcile and settle transactions, ensuring consistency of relevant financial data. This traditional system faces numerous challenges:

• Multiple intermediaries lead to high transaction costs
• Settlement time extended, especially for cross-border transactions
• Investment opportunities are limited, with certain asset classes available only to high-net-worth individuals and institutional investors.

Blockchain, as a distributed ledger technology, shows great potential in addressing the efficiency issues of the traditional financial system. It provides a unified shared ledger that directly resolves the information fragmentation caused by multiple independent ledgers, greatly enhancing information transparency, consistency, and real-time updating capabilities. The application of smart contracts further strengthens this advantage, allowing transaction conditions and agreements to be encoded and executed automatically, significantly improving transaction efficiency and reducing settlement time and costs.

For the traditional financial system, the significance of RWA lies in creating digital representations of real-world assets through blockchain, extending the benefits of distributed ledger technology to a wide range of asset classes for exchange and settlement.

To delve deeper into the transformative power of RWA on the TradFi system, here is a more detailed analytical framework:

1. Market accessibility aids in the diversification of investment strategies.

Tokenization allows for partial ownership by splitting high-value assets into tradable tokens, enabling small investors to participate in markets that were previously inaccessible, thereby democratizing investment opportunities.

For example, traditionally illiquid real estate can be sold in fragments, allowing investors from other countries to participate. These assets can be actively traded in the market, enabling investors to convert assets into cash more quickly.

Unlike the specific trading hours of traditional financial markets, tokenized RWA can be traded around the clock on blockchain platforms, providing more cross-time zone trading opportunities and thereby increasing liquidity.

2. Improve liquidity and price discovery capabilities

Tokenization reduces the friction associated with the sale, transfer, and record-keeping of assets, enabling previously illiquid assets to be traded seamlessly at almost zero cost. In traditional financial markets, asset transfers often involve multiple intermediaries, resulting in a complex and time-consuming transaction process. Tokenization leverages the decentralization features of blockchain to simplify this process, allowing buyers and sellers to trade directly and reduce transaction costs.

At the same time, buyers and sellers can trade more easily and price according to new information. This transparency and real-time nature enable market participants to better assess asset values, thus making more informed investment decisions.

3. Improve market efficiency and reduce costs

In human daily life, financial activities, and trade activities, clearing and settlement are ubiquitous. For users, it's just a matter of making a payment for the money to be transferred, but in reality, this simple payment action involves many clearing and settlement processes behind the scenes.

In the traditional financial system, clearing and settlement is a "computational" accounting and confirmation process. Parties reach a consensus through continuous verification and validation, and based on this, asset transfers are carried out. This process requires collaboration among multiple financial sectors and incurs significant labor costs, and may face operational error risks and credit risks.

Blockchain eliminates many intermediaries by adopting distributed ledgers and automated smart contracts, enabling 24/7 payments, instant receipts, easy withdrawals, and meeting the convenient needs of cross-border e-commerce payment settlement services. As assets can be autonomously transferred among parties via smart contracts and stored in an immutable ledger, it has established a globally integrated cross-border payment trust platform at a lower cost, reducing the financial risks associated with cross-border payment fraud.

4. Traceability and programmability

The 2008 financial crisis is a classic case of a global financial disaster triggered by financial derivatives. Financial institutions packaged subprime mortgages into securities and sold them to investors, creating complex financial products that people could not trace back to the underlying real assets. These layered and packaged derivatives were sold to various brokerages and investors, leading to a rapid surge in the leverage ratio of the entire financial system, ultimately triggering a financial tsunami.

If RWA technology had been applied in 2008, investors would have been able to trace the underlying assets of these financial instruments, allowing them to trade based on a full understanding of asset risks. This transparency would fundamentally change the way asset management and trading are conducted. Through blockchain technology, each transaction is recorded on an immutable ledger, providing clear and auditable records of ownership and transfers. This not only significantly reduces the risks of fraud and mismanagement but also enables regulators to more easily track activities, ensuring trust between financial institutions and their clients.

3. RWA Project Classification and Representative Project Operating Mechanism

RWA projects mainly involve RWA infrastructure projects and RWA that belong to a specific category of assets.

The infrastructure projects mainly include:

• Layer 1 blockchain: such as the institution-grade permissioned blockchain Polymesh built specifically for RWA tokens; the MANTRA Chain built on Cosmos SDK allowing users to issue and trade RWA tokens; and the Ondo Bridge enabling native cross-chain RWA token transfers.

• Tokenization platform: such as the decentralized finance platform Centrifuge, which aims to provide financing solutions for small and medium-sized enterprises.

• Identity: Such as SprucelD and Quadrata, which solve the problem of Decentralized Identity.

In theory, all assets can be put on the blockchain and tokenized. Through tokenization, these assets can be divided into smaller fractions, lowering the investment threshold, increasing liquidity, and providing greater transparency and security through blockchain technology, thereby attracting more investors to participate.

1. Institutional-level licensed blockchain project: Polymesh Private

The Polymesh Association announced the launch of Polymesh Private at the 2024 Digital Assets Summit: a brand new complementary version of the public permissioned blockchain Polymesh, bringing enhanced confidentiality and control to its infrastructure built specifically for regulated assets. Polymesh Private is particularly aimed at the institutional finance sector, including banks and large financial institutions. It addresses the issues of