RWA Tokenization At Scale Isn’t Viable, Yet

Everybody is talking about real-world asset (RWA) tokenization these days, and for a good reason. RWA tokenization can finally connect the blockchain with the real world, opening up a wealth of practical applications for decentralized technology. As such, this innovative development is set to finally propel crypto into the mainstream.

However, the current blockchain ecosystem isn’t quite ready to play host to this new mainstream audience. That isn’t to say that the technology isn’t ready – this is not the problem. However, there are lessons to be learned from traditional financial markets before we begin to see billions, or even trillions of real-world assets moving on-chain, primarily when it comes to security, regulation, and identity verification. Without these core principles, RWA tokenization will remain an experimental technology at best.

Scaling up

To achieve RWA tokenization at scale, the companies working on this must refocus their efforts. At the moment, RWA tokenization is being experimented with by a select few large institutional players. The latest news came from banking giant Citi, which brought a Wellington Management-issued private equity fund onto Avalanche’s Spruce subnet. This network was launched last April for institutions looking to test trade execution and settlement on-chain.

Like other banking giants, including JP Morgan and DBS Bank, Citi has been testing the feasibility and potential applications of blockchain technology in the financial sector under Project Guardian, led by the Monetary Authority of Singapore (MAS). But while this collaboration has seen some exciting developments that hint at the potential future success of RWA tokenization, so far that’s primarily all it’s been – experiments and proofs of concept.

While some real-world assets have begun moving on-chain, like US treasuries, so far this has been a small proportion of the total market cap of these asset classes. For example, the total value of tokenized treasuries was under $700 million in November 2023, according to 21.co. This is a tiny fraction of the total US treasury market size, which sits at $26 trillion, based on data from the Securities and Exchange Commission (SEC).

Regulatory hurdles

In order to bring the trillions of dollars currently traded in traditional stocks, equities, real estate, and more onto the blockchain we need to stop talking the talk and focus on the practical aspects of RWA tokenization. First and foremost, this means understanding how RWAs fit into the global regulatory framework.

Like the rest of the decentralized finance (DeFi) ecosystem, RWA tokenization faces a raft of regulatory hurdles. For example, when it comes to real estate tokenization, in theory, this should be subject to the same laws as other property investments. However, different jurisdictions have different legislations to govern real-estate transactions, making it difficult to establish a uniform framework for the global property tokenization market. Solving this fragmentation problem should be a key priority for regulators around the world.

To bring tokenization into the mainstream and really reap the benefits, we need to reassess global regulatory frameworks and adapt them to the modern world of blockchain technology. We require DeFi legislation that is fit for purpose, which must encompass all of its different facets: decentralized governance, privacy, the speed of innovation, and DeFi’s global nature. With a comprehensive framework in place, we can move forward to bring RWA tokenization into the mainstream – not just onto the testnets of a select few institutional giants.

Security in focus

But it’s not just the outside influence of the regulators that will shape the future of RWA tokenization. The blockchain industry must also adapt in order to help trillions of dollars seamlessly transition on-chain.

In part, this will depend on the scalability of the existing blockchain networks. We’re seeing a great deal of development happening in this arena, with Ethereum firmly focused on scalability across its planned developments over the coming years, which should support the expansion of RWAs on the blockchain.

However, we need to see more focus on safety. Rather than simply testing the technology, we must ensure that the blockchain world meets the rigorous standards of traditional financial markets, because this is where the money will be coming from.

Identity verification

This means crypto can no longer afford the bad rep from the hacks and exploits that have plagued the space, resulting in another $1.7 billion in losses in 2023, according to Chainalysis. We believe this is unachievable without a certain level of compromise. As such, the DeFi ecosystem must embrace identity verification in order to minimize these risks and make large-scale RWA tokenization on-chain plausible.

This identity verification process will have to be adapted to the DeFi world in order to maintain the privacy element that is a crucial part of its ethos, but there are ways to get the best of both worlds here. For example, soulbound NFTs and zk-rollups offer solutions that facilitate identity verification in an anonymous fashion, allowing users to transact in a DeFi ecosystem securely without being doxxed.

This enhanced level of security is exactly what we require to facilitate the shift of trillions in mainstream capital on-chain. It will undoubtedly take time for regulatory frameworks to catch up with the huge potential of RWA tokenization, but blockchain technology is perfectly positioned to lead the way – if only we’re willing to build and maintain this bridge between digital and real-world assets.