Tagus Bits 'n Bobs Issue 2: Transformation of RWA Tokenisation

31 Jan 2024

Deep Dive: Transformation of Real World Asset Tokenisation

• Digital Tokenisation: The process entails generating a digital representation of an asset on a blockchain. This spans physical items like real estate or art, financial assets such as deposits, equities or bonds, intangible assets like intellectual property, and even identity and data. 

• Tokenisation Yield Boost: Real World Asset (RWA) tokenisation is gaining traction with certain assets boosting yields. Enhanced efficiency, liquidity, and blockchain technology contribute to the appeal, aligning with broader trends in financial innovation.

• US Treasury Tokenisation Takes Off:Growing demand for tokenised US Treasuries in 2023, fuelled by rising US interest rates, outshines keeping funds in non-interest-bearing stablecoins. With an average yield of +5%, these assets offer retail investors fractional ownership and operational efficiency through blockchain settlement. Despite potential Fed rate cuts, they remain an attractive on-chain yield alternative for crypto-native stablecoin holders.

• Tokenising Trillion-Dollar Assets: RWA tokenisation is estimated to centre on a multi-trillion dollar market by 2030, dominated by real estate, debt, and investment funds.

• Tokenisation Trends in Finance: Major institutions like BlackRock, Fidelity, JP Morgan, Société Générale, and authorities like Singapore's MAS are actively adopting blockchain-based tokenised financial instruments, expanding digital asset capabilities, and exploring innovative projects

Unveiling the Potential of Tokenisation: Web3 extends beyond cryptocurrency, encompassing blockchain (a decentralised ledger), smart contracts, and tokenised digital assets, transforming the exchange of ideas, information, and currency. It contrasts with the current, centralised Web 2.0, dominated by major tech companies. In Web3, data and operations are distributed across a network, reducing reliance on centralised authorities and enhancing user control over personal data. The tokenisation of tangible real-world assets, involving digital tokens on the blockchain, is a driving force likely to propel cryptocurrency into widespread acceptance. Positioned as a major disruptor, this innovation has the potential to revolutionise and reshape financial markets.

Significant value is at stake for organisations and innovators in the field of tokenisation. Since its inception in 2017, the tokenisation of digital assets has predominantly revolved around stablecoins — cryptocurrencies pegged to real-world fiat currencies — and NFTs (non-fungible tokens) — distinct digital proofs of ownership that cannot be duplicated, enabling transactions of unique items. However, a noteworthy shift is occurring as tokenisation gains momentum, signifying a significant advancement across financial services, retail, music, gaming, and media. This has the potential to transform, spanning from capital markets to real estate and art. Leveraging blockchain, tokenisation creates a secure, decentralised platform for digital token transactions. Additionally, it enhances privacy and transparency, democratising access to assets and reducing barriers to entry.

Understanding Asset Tokenisation: Process and Types: Tokenisation, the digital representation of underlying assets as well as liabilities on a blockchain, involves creating tokens for diverse assets like real estate, art, equities, bonds, intellectual property, identity, and data. Tokens facilitate the direct exchange and transfer of ownership and titles of value through a digital ledger. Blockchain technology enables the conversion of both tangible and intangible assets into tamper-proof digital tokens, ensuring immutability of their nature, qualities, status, transaction record, and ownership. Tokenisation has, as mentioned previously, therefore extended beyond stablecoin and NFTs. The technology enhances security, transparency, liquidity, cost efficiency, and accessibility therefore to a broad range of assets, from real estate to commodities.

Asset tokenisation follows a systematic procedure with multiple steps. Initially, during the asset sourcing phase, choices are made regarding how to tokenise the asset, taking into account its distinctive features, such as whether it is a money market fund or a carbon credit, and determining its regulatory classification, e.g., as a security or commodity. For instance, according to the Howey test, digital assets designed to signify a promise of future cash flow/profits or partial ownership of a company or property are categorised as investment contracts and, consequently, deemed securities. As a result, real estate tokens may need registration with the U.S. Securities and Exchange Commission, subjecting them to laws and regulations safeguarding investors. The subsequent step, digital asset issuance and custody, involves securing the physical counterpart in a neutral facility and creating a digital representation on a blockchain. Distribution and trading encompass setting up digital wallets for investors, and optionally, creating a less regulated secondary trading venue. Finally, in asset servicing and data reconciliation, continuous maintenance is provided, including regulatory compliance, tax reporting, and addressing corporate actions.Bottom of Form

Factors Driving RWA Tokenisation:Several factors contribute to the growing interest in RWA tokenisation. The current economic cycle, characterised by high interest rates, enhances the economics of tokenisation, providing high yields. Moreover, global regulatory changes reflect a shifting perspective on real-world assets, encouraging the adoption of tokenisation.Tokenisation enhances efficiency and automation in managing RWAs, streamlining processes and facilitating faster transactions. 

Increased liquidity is a notable outcome, as tokenisation broadens market access and allows for fractional ownership, making high-value assets more accessible. Blockchain technology, often employed in tokenisation, ensures transparency, immutability, and security of ownership records. Compliance features address regulatory requirements, and the approach enables diversification of investment portfolios. Tokenisation also reduces transaction costs, attracts new global investors, creates secondary markets, and aligns with the broader trend of technological innovation in the financial sector. Traditional asset fractionalisation, exemplified by entities like Real Estate Investment Trusts (REITs), Exchange Traded Funds (ETFs) boasting $7 trillion in assets (Tagus Bits ‘n Bobs: BTC ETF - Issue 1), and Mutual Funds, has a longstanding presence. However, its emphasis has predominantly been on equity and real estate asset classes. On-chain tokenisation breaks down traditionally illiquid assets, including high-value art and public infrastructure, as well as other assets like US Treasuries, into fractions, expanding investment opportunities to a broader audience. These factors collectively contribute to the growing interest in RWA tokenisation, and likely to be integral to financial markets.

US Treasury Tokenisation Trends: The high-interest U.S. environment has led to increasing demand for the tokenisation of US Treasuries, with tokenised assets surpassing $862 million. In 2023, these assets experienced a staggering 643% increase. With an average yield to maturity of 5.24% and a weighted average maturity of 0.16 years these products effectively mirror the performance of short-term investment horizon of US government yield offerings in traditional finance, e.g. T-Bills and US T. Notes <1 year. Tokenised U.S. Treasuries provide improved accessibility for retail investors, allowing them to partake in fractional ownership of Treasury bonds or bills. Furthermore, blockchain settlement enhances operational efficiency, resulting in nearly instantaneous transaction speeds and reduced fees. Financial settlements typically take two business days (T+2) post-trade to allow parties to arrange documents and funds. Tokenisation's capability for real-time settlements, enabling 24/7 operations, increased liquidity, and fractional ownership has the potential to generate considerable savings for financial firms, particularly in a relatively high-interest-rate environment.

While there are expectations of Fed fund rate cuts later in 2024 and lower US Treasury yields, the persisting inflation volatility is anticipated to endure at higher levels compared to the past decade. This scenario is expected to lead to elevated US terminal (policy) rates and government bond yields, marking a substantial departure from the Zero Interest Rate phenomenon. This paradigm shift is expected to drive continued demand for the tokenisation of US Treasuries. This offers a compelling alternative for crypto-native stablecoin holders, providing a means to earn yield while remaining on the blockchain ('on-chain'). It presents an attractive option compared to existing choices like DeFi lending protocols. The expected expansion of this sector may draw heightened regulatory scrutiny, ultimately contributing positively to establishing credibility for tokenised assets.

Source: Rwa.xyz,Tagus Capital.

Current Developments and Institutional Adoption: Major financial institutions, including BlackRock, Fidelity, and JP Morgan, are actively exploring tokenised financial instruments on blockchain networks. Such institutions and numerous other financial services firms have also substantially expanded their digital asset teams and capabilities over the past few years. 

In 2020, through the establishment of Onyx Digital Assets, JP Morgan has gone further and established a multi-asset tokenisation platform, successfully settling transactions exceeding $900 billion. The trend therefore extends beyond operational uses, with institutions placing tokenised products in the hands of their clients and includes securities, stocks, real estate, and investment funds. The process involves asset sourcing, digital issuance, custody, distribution, trading, and data reconciliation. Société Générale, for example, recently issued a ground breaking digital 3-year green bond on the Ethereum blockchain for public access to carbon footprint details through a smart contract. Governments/authorities are also beginning to examine the potential for real-world asset tokenisation. The Monetary Authority of Singapore (MAS), for example has, via Project Guardian, already initiated a blockchain-based pilot in collaboration with financial entities testing tokenisations and have broadened this initiative to digital infrastructure, enabling cross-border transactions for tokenised assets.

Rising Trends: Tokenising Real-World Financial Assets: Tokenisation has already been embraced by stablecoins, pegged to physical currencies or other financial instruments aimed at maintaining value over the time, and currently amounting to approximately $134 billion in circulation. However, as indicated previously there is potential expansion into other assets.The estimated market value of tokenised assets range from $4 trillion (Citigroup, 2023) up to +$10 trillion (Roland Berger, 2023) by 2030, with real estate, debt, and investment funds dominating the landscape. However, challenges such as regulatory issues, lack of standardisation, and interoperability pose hurdles to widespread development and adoption.

Source: Roland Berger. 

Overcoming Challenges and Transformative Potential: Regulatory ambiguity is a significant hurdle for financial institutions looking to tokenise assets on public blockchains. Some regions, such as the EU and the UK have made progress in creating clear frameworks, while the United States is still a work in progress. To comply with financial regulations on public blockchains and asset tokenisation, issuers often need to incorporate permissions, like Know Your Customer (KYC) and Anti-Money Laundering checks during issuance or transfer, differing from typical DeFi practices.Despite these challenges, progress has been made in addressing regulatory issues and improving interoperability. The implementation of regulatory frameworks such as Markets in Crypto-Assets Regulation (MiCA) establishes consistent market rules for crypto-assets and RWA tokenisation. The emergence of industry solutions also indicate a more conducive environment for the widespread adoption of tokenisation.

The rapid rise in tokenisation of US Treasuries is one example of potential growth of RWA tokenisation. Despite expectations of Fed rate cuts in 2024 and lower US Treasury yields, long-term inflation volatility indicate higher equilibrium of interest rates that then past decade. This paradigm shift is poised to fuel ongoing demand for the tokenisation of US Treasuries, particularly enhancing interest in tokenisation linked to short-term liquidity instruments. This serves as a test bed, highlighting the potential for financial service providers integrating RWA tokenisation to gain a competitive edge. The operational efficiency, driven by continuous data availability and asset programmability, benefits manual-intensive asset classes like corporate bonds. Streamlined processes not only economically serve smaller investors but also democratise access. Enhanced transparency through smart contracts, e.g., exemplified in carbon credit trading, complements the cost-effective and agile nature of open-source blockchain infrastructure.

Real-world asset tokenisation emerges as a transformative and disruptive force, bridging the gap between the virtual and real financial worlds. Tokenisation of real-world assets stands as a pivotal element in financial innovation and poised for a transformative leap in 2024 and beyond. This shift is poised to impact both traditional financial institutions and pioneers in on-chain physical assets. The potential ramifications are substantial, with projected growth reaching into the multi-trillions.