Comprehensive analysis of the opportunities and challenges of the RWA track

Author: Institute of Everything

In the past five years, DeFi has experienced rapid development, especially in 2020-2021, DeFi TVL has grown from hundreds of millions of dollars to hundreds of billions of dollars, known as DeFi Summer in history. During this process, a large amount of funds poured into DeFi, various innovative DeFi applications emerged, and airdrops and subsidies prevailed, creating waves of wealth myths for early participants. During the bear market, DeFi TVL stabilized at around $50 billion.

TVL (total value locked) across multiple Decentralized Finance (DeFi) blockchains from November 2018 to April 24, 2023 (in billion U.S. dollars) 数据来源：

Recently, the RWA track has been hotly discussed, allowing encryption practitioners to see the opportunity to further expand the territory of DeFi. Some jurisdictions friendly to the encryption industry are actively promoting the implementation of RWA, and many well-known traditional institutions, such as Goldman Sachs, Siemens, Hamilton Lane, Bank of China International, and Amazon, are also testing the waters of RWA. In the past three months, almost all tokens related to the RWA concept have risen, some of which have increased by as much as 10 times. Citibank predicts in its research report "Money, Tokens and Games" that in 2030, RWA may bring 5 trillion US dollars of assets to the chain.

In the first half of 2022-2023, TradFi embraces blockchain related events

| | | | --- | --- | | Time| Event| | 5/31/2022 | The Monetary Authority of Singapore (MAS) has announced the launch of Project Guardian, an initiative in partnership with the financial industry to explore the economic potential and value-added use cases of asset tokenization. The pilot will be led by DBS Bank Ltd, JP Morgan and Marketnode. | | 2022/9/24 | Private equity giant KKR tokenized a portion of its $4 billion Health Care Strategic Growth Fund II (“HCSG II”) on the Avalanche blockchain, allowing investors on the chain to invest in this An asset class. | | 2022/12 | UBS Group (UBS) issued 50 million US dollars of tokenized fixed-rate notes on the blockchain licensed by the laws of the United Kingdom and Switzerland, creating a case of blockchain financial compliance applications. | | 2023/1/11 | Goldman Sachs announced that its digital asset platform GS DAP has been officially launched. The platform is based on the Daml smart contract language developed by the software company Digital Asset and developed on the privacy-supporting blockchain Canton. In November 2022, the European Investment Bank (EIB) used the platform to issue a €100 million two-year digital bond. | | 2/1/2023 | According to Polygon's official blog, global asset management company Hamilton Lane's $2.1 billion Equity Opportunities Fund V is open to individual investors through Securitize, a digital securities tokenization platform on the Polygon network. | | 2/14/2023 | Electrical engineering giant Siemens issued its first €60 million digital bond on the Polygon network under the German Electronic Securities Act, which came into force in June 2021, allowing the sale of regional-based bonds. Blockchain debt. | | 2023/6/12 | BOCI, a wholly-owned investment bank under Bank of China Limited, recently announced that it will cooperate with UBS to issue tokenized notes worth RMB 200 million, becoming the first A Chinese-funded financial institution issuing tokenized securities in Hong Kong. |

In fact, what RWA brings to DeFi is not only a huge asset scale, but also a wealth of asset types, including stocks, bonds, real estate, artwork, luxury goods, precious metals, and even carbon credits. There are corresponding projects exploring and trying, some of which are old-fashioned DeFi protocols, such as Maker DAO, AAVE, Compound, Maple, Centrifuge, and more are emerging early-stage projects. Many research reports have been sorted out. Let me repeat.

Assets are the lifeblood of finance. As larger and more types of assets become the basic assets in DeFi, more innovative use cases in DeFi will be stimulated. Some crypto practitioners believe that RWA will become the main driving force for the next round of bull market.

However, some analysts are cautious about RWA. The on-chain of real assets is not a new thing. Since the birth of DeFi, there have been efforts to introduce real-world assets (RWA) on the chain, but these efforts, apart from stablecoins Other than that, the others seem to be all thunder and rain. Similar concepts that were once as hotly discussed as RWA, such as "chain reform", "synthetic assets", "Tokenization", and "STO", have all disappeared in the ever-changing narrative trend. As a result, for a long time, DeFi and TradFi have been two parallel worlds, and most of the assets that DeFi relies on are native assets on the chain.

So how should we objectively view the RWA boom? What exactly is the meaning and value of RWA? Is the time for large-scale RWA on-chain coming? Where is its challenge?

**What is the meaning and value of RWA? **

We mentioned above that RWA will bring a huge asset scale and rich asset types to DeFi, and promote the development of DeFi, but in our opinion, the empowerment of blockchain technology to TradFi is far greater than that of RWA to DeFi Empowerment. Blockchain has some very superior characteristics, which can solve some major drawbacks in traditional finance:

**First, reduce business friction. **Traditional finance can almost be considered a labor-intensive industry. Many important transactions often involve multiple intermediaries and a large amount of paperwork, requiring multiple parties to verify property rights and record the process of property transfer. The essence of the blockchain is a shared ledger, and all relevant parties can access a unique, non-tamperable property ownership status and property transaction records. On the blockchain, the transaction is settled, and the purchase is confirmed. Therefore, the blockchain can greatly reduce transaction costs, improve transaction efficiency, and at the same time eliminate counterparty risks in the transaction process. The International Monetary Fund (IMF) mentioned in the 2022 Global Financial Stability Report that compared with the TradFi system, DeFi's handling of financial markets has brought significant cost savings, mainly reflected in labor savings. A complex intermediary system, often with high operating costs.

**Second, flexibility and composability. **By virtue of the programmability of the blockchain, assets on the chain can be easily split and combined, changing asset forms or creating new asset types. For example, indivisible assets can be divided so that traders with small funds can participate in the transaction, or multiple assets can be combined into one asset, similar to index funds, not only that, but also options, futures, and more complex structured financial transactions. Although a certain degree of flexibility and composability can be achieved through legal contract procedures off-chain, it is far less convenient than on-chain. Compared with legal contracts, smart contracts have the characteristics of automatic execution: the original rights and interests represented by derivative assets created by smart contracts are guaranteed by code; complex transactions created by smart contracts can be executed when the agreed conditions are met. There is no risk of breach of contract, no cost of legal documents, litigation costs and execution costs. What's more attractive is that all the data on the chain is open and can be combined completely without permission. Anyone can freely develop their own products and protocols based on existing products and protocols. Off-chain finance must be realized through a large number of business processes.

**Third, transparency and traceability. **Tokenization of assets is similar to asset securitization, and the operation of asset securitization has a long history in the traditional financial field. Common asset securitization products include MBS and ABS. The former is a security backed by a mortgage, and the latter Others are securities backed by credit card loans and auto loans. MBS and ABS are essentially financial derivatives packaged from mortgage loans. By selling MBS and ABS, banks can earn interest rate differentials on the premise of completely transferring risks. After the success of MBS and ABS, more complex financial products were created, such as CDO, which was packaged and resold layer by layer, and finally in the hands of investors. It may not be clear what the underlying assets are, and only securities sales are left Various selling points peddled by merchants. However, no matter how the tokenized assets are packaged or derived, the process is transparent. Investors can trace the underlying assets and trade on the basis of fully understanding the risks of the assets. DeFi will be more transparent than TradFi, traders can learn more complete information, and can better prevent risk accumulation and systemic crises similar to the "subprime mortgage crisis".

In short, we believe that the blockchain will be an excellent platform for carrying financial services. The automatic execution of smart contracts will enable the financial industry to greatly reduce business friction, eliminate reconciliation costs, and improve the liquidity and composability of assets. According to the joint report "It's Time to Explore Institutional DeFi" co-authored by Oliver Wyman Consulting Forum, DBS Bank, JP Morgan Onyx and SBI, traditional financial institutions will have the following significant benefits in embracing DeFi (see the figure below).

Source: Oliver Wyman Forum, DBS, Onyx by J.P. Morgan, SBI Digital Asset Holdings

From all perspectives, embracing blockchain technology is the inevitable end of the development and evolution of the financial industry. Time will prove that DeFi is an advanced form of the financial system, and asset holders will increasingly hope to hold and trade assets in the form of RWA.

**Is the time for large-scale chaining of RWA coming? **

The reason why previous attempts to put real assets on the chain failed to go out of the circle is mainly due to two factors. One is the unclear or one-size-fits-all regulatory policy, and the other is the immature blockchain infrastructure. But we see What I found is that these two barriers that hinder the implementation of RWA are disappearing.

First of all, some regions have clearly realized the great power of Web3 technology to improve the financial industry, and have begun to actively embrace Web3 technology, especially some regions where the financial industry is the pillar industry, such as Singapore, Switzerland, Hong Kong, and even Some regions have begun to implement central bank digital currency (CBDC), providing a more reliable value anchor than stable coins for the development of RWA.

Secondly, after years of development, the infrastructure in the encryption field has been able to fully support the development of RWA, which mainly includes public chain and cross-chain infrastructure, Token standards, DID technology, ZK technology, etc.

Supervision

Compared with the original assets on the chain, RWA has an inescapable centralization link, which is the custody of off-chain assets. If the off-chain assets are lost, damaged, or stolen, the RWA Token on the chain will become air. In addition, the loan-type agreement also involves the operation of liquidating the assets of the main body under the chain. The contract procedure on the chain cannot perform this step, and must rely on the legal procedure under the chain.

Code is law， but code cannot replace all laws。

In an era of lack of supervision, DeFi can experience a certain period of brutal growth, but to achieve large-scale off-chain asset on-chain, it must be escorted by supervision. The process of asset on-chain must be recognized by the regulator in order to be protected by law and minimize the moral hazard of custodians. At the same time, the transfer of assets on the chain must also be recognized by supervision before the transfer is meaningful.

With the rapid development of the encryption industry, authorities around the world have successively paid attention to and committed to regulating the encryption market, and issued licenses and supervised encryption-related service entities. Some countries or regions, such as South Korea, Switzerland, Japan, the European Union, the United Arab Emirates, and the United Kingdom, have formulated or introduced laws and regulations covering encrypted assets and their related services. Although in most cases, the goal of these regulatory policies is more to prevent economic crimes such as money laundering and to prevent systemic financial risks, objectively provide clear rules for encryption practitioners and provide legal protection for encryption-related services. The space for standardized operations also provides protection for the holding and transfer of encrypted assets. This is a huge benefit for the development of the RWA field.

Public chain and cross-chain infrastructure

With years of expansion efforts, the performance of the public chain has undergone a qualitative leap, and related development tools have become more and more perfect; with the development of technologies such as Layer 2 and parachains, "one-click chain issuance" has become a reality, and, Under the empowerment of shared security, the new chain does not need to pay huge costs and a long time to motivate nodes to join in order to improve its own level of decentralization. Cross-chain technology allows any asset to circulate in multiple ecologies, and be combined and integrated into different scenarios, which allows RWA assets to be fully chained without having to choose a certain ecology.

Token Standard

FT (Fungible Token) and NFT (Non-Fungible Token) are the most basic Token standards, represented by ERC20 and ERC721 respectively. FT represents a fluid asset, which is homogeneous and infinitely divisible, while NFT represents a solid with a specific shape and boundary, which is unique and indivisible. ERC20 once gave birth to the upsurge of 1C0, and the emergence of ERC721 also inspired NFT Sumer. Token standards continue to evolve, and more derivative standards have been born, which can now map almost all things and their relationships in reality. Among them, ERC3525 is especially suitable for expressing financial bills, which will facilitate the chaining of RWA.

The picture is quoted from Spinach Spinach's "From ERC20, 721, 1155 to 3525, detailing RWA's road to Web3 Mass Adoption"

DID TECHNOLOGY

For a long time, all kinds of public chains represented by Ethereum have been an anonymous system with a certain ability to resist supervision. Moreover, some encryption technology believers believe that the genes of the encryption industry are anarchism, and the encryption world and government regulation are incompatible and incompatible.

But we believe that if the crypto industry is to develop more sustainably, it needs to achieve a certain degree of regulation. We are not here to advocate the alliance chain, nor do we think that the public chain system must be completely transformed into a real-name licensing system in order to be compatible with supervision.

In fact, through DID technology, it is completely possible to achieve supervision on the public chain, and it appears as an autonomous option for encrypted users under the premise of protecting user privacy.

According to the Web3 DID scheme proposed by W3C, users can register with the regulatory body with DID to obtain a VC (Verifiable Credentials). If some on-chain services are required by regulatory policies to do KYC for users, when providing services, you can use the user's VC to request verification from the issuer of VC, that is, the regulatory body, and the regulatory body only needs to return a message: " Whether the user is allowed to use the current service", only "yes" or "no", without disclosing the user's complete registration information. Of course, in the W3C DID scheme, the institutions eligible to issue VC are not limited to regulatory bodies, but can be any other issuing institutions, including schools, industry associations, DAO organizations on the chain, etc.

Please note that in this process, the user has the right to choose independently, and the user can choose not to obtain the corresponding VC. However, if a service on the chain requires the user to have a certain VC, and the user does not have it, the service cannot be used. Users can choose to use other services.

This approach not only gives users a choice, but also allows the entity providing on-chain services to accept the supervision of a certain jurisdiction. Regulations such as foreign exchange controls, sanctions lists, and non-exportation of personal information implemented by some jurisdictions can all be enforced on the chain.

ZK technology

ZK technology refers to zero-knowledge proof (Zero-Knowledge) related technologies. The blockchain serves as a public account book, and the transaction information on it can be publicly queried and permanently visible by anyone.

Data privacy is very important to customers in some areas of traditional finance. They are unwilling to expose their positions and transaction history to the public network. Sometimes experienced data analysts can infer investor orders or even off-chain identities from public data. (The author has used Zerion, Parsiq and other tools to track whale account positions, analyze the market, and profit from it.) This situation is unacceptable to many traditional institutions, whose transaction records and customer information are business that they need to keep confidential. data. When ZK technology is used in blockchain, it can realize controllable privacy on the basis of open ledger. Users can selectively publish some information to the authorized subject, and can also declare to the authorized subject that a certain assertion is true, but there is no need to disclose any information.

You can prove to a certain subject that your assets meet a certain threshold, but the specific amount of assets is not transparent. You can also prove that you have made a certain transaction, but the counterparty and amount information of the transaction is not transparent. This not only ensures privacy, but also does not destroy the openness and composability of the blockchain. The application of ZK technology to privacy has made good progress in the field of Web3 and is being more and more widely adopted.

In short, the clarification of government regulatory policies and the improvement of infrastructure are unsealing the development of the RWA track, and the opportunity for large-scale chaining of RWA is ripe. **

**Where are the challenges for RWA? **

Above we have talked about why traditional finance needs to embrace the blockchain, and why the time has come for the development of RWA. Next, we need to objectively analyze the challenges that RWA still faces.

**One is the uncertainty and complexity of regulatory policies. **Although the global trend of regulatory policies for the encryption industry is gradually becoming stricter and clearer, this is a gradual process that cannot be accomplished overnight, and may even take some detours and backtracks during the period. In addition, global regulation is still in the stage of exploration, and unified standards, classifications, and definitions have not yet been formed, although international regulatory agencies such as FATF (Financial Task Force) and IOSCO (National Securities Regulatory Commission Organization) are making efforts , but it is difficult to form a unification in a short period of time, which will hinder the ambition of RWA service providers to face the global market, and will also prevent the advantages of blockchain technology from opening up global liquidity.

**The second is the inertia and historical burden of the traditional financial system. **Traditional finance is self-contained. There are many established rules, orders, and concepts, and it also involves a huge number of stakeholders and intertwined interest relationships. It is difficult to switch to a new system at once. For example, a big country like China and the United States must first consider the stability of the financial order, rather than exploration and innovation, and the enthusiasm for embracing DeFi in regulatory policies will not be too high. Mainland China has adopted a restrained attitude towards the encryption industry, and opened the window in Hong Kong, which is also in line with China's consistent policy strategy of "crossing the river by feeling the stones". The United States still tends to use the framework of the traditional financial system to supervise encrypted assets. It is unlikely that there will be a green light for the crypto industry. We would think that in addition to Singapore, Hong Kong, Switzerland and other regions actively embracing the encryption industry, regions with relatively weak traditional financial systems, such as Africa, Southeast Asia, Latin America, and the Arab world, may have relatively large opportunities.

**The third is the problem of DeFi itself. **So far, there are still relatively serious security issues in the DeFi field, such as code loopholes, price manipulation, MEV, and private key leaks. In 2022, hacking attacks in the DeFi field have caused more than $2 billion in asset losses. Finance is a field that directly deals with money, and the degree of fault tolerance for security will be very low. Many DeFi protocols adopt a decentralized governance mechanism, resulting in no recourse subject, and the losses caused by these security issues may eventually be covered by no one.

**The fourth is the account system problem of Web3. **If a large number of RWAs are on the chain, but the number of players on the chain is insufficient, the development of RWA will still be restricted. The user experience of the blockchain has been widely criticized, not to mention the complicated and incomprehensible account and secret management process, which has dissuaded many ignorant whites. Even many experts have encountered private keys forgotten and lost. Even the miserable experience of being stolen. The existing blockchain account system has greatly hindered large-scale users from entering Web3. Currently, new account technologies such as MPC wallets and contract wallets are developing, but it also requires a process. If the 1 billion users predicted by Citibank to enter the blockchain are to become a reality, the user experience of Web3 accounts must be close to that of Web2.

Summarize

Overall, we are optimistic about the long-term development of RWA, and believe that this is an inevitable trend, and the blockchain is a better financial carrier. But we must also be soberly aware of the short-term challenges RWA faces.

In the short term, we may still see something like this:

Traditional financial institutions may not put their stock business on the blockchain for the time being, but regard the blockchain as an incremental business channel;
Some low-quality assets, even assets with huge custody risks, will try to dump them on the chain, causing a mixed situation in the RWA field;
In view of the fact that regulatory policies are easier to implement on the permissioned chain, RWA will first appear on a large scale in the permissioned chain instead of the public chain.

We expect that the development of RWA will go through a Gartner Hype Cycle, from a short-term explosion period to a bubble period, a return period, and finally a steady growth.