What is a Real-World Asset (RWA) and How Do They Fit Into the Future of Finance?

15 May 2024

Real-world assets have been called both the future of financial markets and their doom. But to even begin to comprehend the issue, we should learn more about what they are.

Real-world assets, also called RWAs, are tokens that represent certain physical assets. It can be property, objects, bonds, or other things. Just like other tokens, these function on the blockchain through smart contracts, and one token can amount to a whole object as well as its part.

Tokenized RWAs make it possible for non-digital objects to become a part of the decentralized financial system. And it’s happening already: As reported by Chainlink, "Tokenized real-world assets have been a growing segment of the DeFi ecosystem, with RWA total value locked sitting at ~$5B in December 2023, according to DefiLlama."

Like any new big thing in the market, seamless work for RWAs is tied to their universal acknowledgment and economic value.

Why RWAs Are Important

Decentralized finances still haven’t become universally accepted, and part of the reason is their existence in the digital world only. However, experienced users have already seen the advantages: They can convert currencies without leaving their houses or paying a bank for a specific account, and more importantly, they can exchange even the smallest portions of a certain asset. There are no counterparties or commissions, and the process is simple and fast.

While this sounds fairly utopian, it’s real, and RWAs are the next link in this chain—the next logical step that’s already been taken.

In June 2019, one company arranged the first tokenization of real estate in France. Soon after, a luxury resort in Aspen raised $18 million by conducting an STO (security token offering). Now, we can easily find platforms offering tokenized assets that can grow in price over time.

One of the benefits of tokenizing illiquid RWAs, such as real estate, is fractionalization. An example of that is a commercial building being divided into hundreds of tokens, each one representing a specific area. The digital tokens are then either transferred or traded through a peer-to-peer system via the blockchain. The process is instantaneous. And just as easily, you can buy several square feet of a house in Florida and send them to your friend in Japan.

As we can see, this whole process offers something nothing else has before: the possibility to make a very specific purchase. Why would you need several square feet in a house you are possibly never going to visit? The answer couldn’t be simpler—these assets, like any other, grow in value. This is especially accurate regarding real estate investments. Financial planners who might be looking for ways to help their clients diversify a portfolio of investments could suggest a real-world addition. By starting with something small, anyone can grow and eventually buy the whole building.

RWAs in the decentralized market increase liquidity, improve transparency, and lead the market to higher efficiency. Yet the main impact might come from RWAs lowering the entrance barriers. While before, it was only possible to join the market with $100,000, now you can start trading and earning with just $1. Additionally, RWAs can serve as collateral for a DeFi loan. As the asset grows in price, your loan is being paid.

Security Concerns

The possibility of implementing such a secure, fast, and very straightforward process will certainly cause a backlash. RWAs challenge the long-standing financial system, where you either have the funds to make a whole purchase or you are left out of the market altogether. But some concerns are still valid.

For instance, the custody of a physical object must be done legally and reliably. With what we know today about the security of the decentralized market, we have to be certain that the asset indeed represents the same object we intend to buy. This is especially important considering that the market has had a controversial experience with assets representing ownership of art before, and many users are still recovering from that.

In addition, there are multiple potential smart contract bugs and vulnerabilities. So, each contract has to be thoroughly audited by a proper third-party auditor company. Fortunately, the auditor market is vast, and it’s possible to find a company that can provide quality security services. Naturally, the best security practices that exist in the decentralized space will become vital to the wide adoption of RWAs.

To achieve security, decentralized practices have to be used along with offline ones. KYC and AML are necessary to the process, so in this case, anonymity is, in fact, your enemy.

And finally, it is not enough to just issue an asset: Market liquidity and demand both need to exist for it to thrive.

A Future For RWAs

RWAs are a second stepping stone to something bigger. If we theorize, eventually, we could be able to have houses and cars represented as digital assets. The process of buying, selling, sharing, or inheriting could be simplified for everyone.

Even shares and jewelry may become not just collateral but actual liquid assets. Besides, exchanging of said assets isn’t the only relevant issue here; storing them safely on the blockchain may end up being just as important.

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