Overview
Real-world assets (RWAs) are tangible and intangible assets that have monetary value in the actual world. Asset tokenization with the help of advanced blockchain technology converts these RWAs into digital tokens.
But what are RWAs?
Real-world assets or RWAs include physical assets like real estate or gold, intangible or non-physical assets like intellectual properties, and financial assets like derivatives, bonds, or securities.
Blockchain technology in RWA tokenization is a transformative innovation that generates an alternative revenue stream through the decentralized finance (DeFi) economy.
Tokenizing RWAs brings greater liquidity, cost efficiency, transparency, and financial inclusion by reducing investment barriers and eliminating intermediaries of traditional finance.
In this article, we explore the role of blockchain, smart contracts, and token standards in RWA tokenization.
RWA Tokenization in Simple Words
Imagine you want to purchase a small part of Buckingham Palace. Yes, it can be possible with just a few clicks of your phone. Tokenization can make that possible!
Real-world asset tokenization is a unique concept that allows people to purchase physical as well as non-physical items that exist in reality outside the digital world. This is possible through blockchain technology that blurs the distinction between the real and digital world.
Tokenization utilizes the power of blockchain to transform real-world assets into on-chain tokens. Real-world assets that have a value can be tokenized.
Tokens are the digital representation of the assets in the blockchain. Digital tokens backed by traditional assets like RWAs gain value and become tradeable digital assets.
Tokenized RWA is divided into smaller bits or fractions. The fractionalization depends on the choice of the person issuing the token. Each fraction represents a digital token. The token issuer fixes a value for the digital token. The digital tokens are distributed for sale during security token offerings (STOs). The tokenized real-world asset can be sold in fractions to multiple investors or one investor.
Since the value of a digital token is minimal, small investors can purchase fractions of the tokenized RWA depending on the budget.
Fractionalization enhances liquidity. Digital assets can be sold faster with greater efficiency in decentralized marketplaces.
Role of Blockchain Technology in RWA Tokenization
At the core of RWA tokenization, lies the fundamental architecture of blockchain technology.
All transactions and data related to ownership rights, dividend distribution, etc., are recorded in the blockchain’s decentralized ledger that operates across a network of computers. Any new transaction or information recorded in the blockchain creates a new block and is stored permanently on-chain. Each block is interlinked in an orderly manner by a cryptographic code.
Blockchain is a peer-to-peer network (P2P). Once a block is added, it is validated by the subsequent peers through a consensus voting mechanism. With the growth of the blockchain and new blocks added in, the network security strengthens as more blocks validate transactions.
Blockchains can be categorized into:
- Public
- Private
- consortium
Public blockchains are permissionless, open platforms that can be accessed easily. It significantly lowers the cost of operations. Anyone can join a public blockchain.
Private blockchains are restricted and are only open to the stakeholders or the immediate participants of the network.
A consortium or federated blockchain is partly decentralized and selects a group of nodes to validate blocks and audit the blockchain.
The decentralization in blockchain ensures that there is no centralized authority or common point of control. It eliminates intermediaries and improves network transparency and performance. It enhances immutability and cannot be altered by any outside entity.
Key advantages of blockchain integration in RWA tokenization are:
Fractionalization
Tokenization permits fractional shares where the digital asset is broken into smaller bits. Fractionalization fosters financial inclusion, lowers investment barriers, democratizes market entry, and allows asset diversification.
Enhanced security
Immutability guarantees that the ownership and transaction records are not tampered with by outsiders. It eliminates third parties and generates a sense of confidence and trust among stakeholders.
Global accessibility
Blockchain transcends global barriers and can reach investors from the remotest part of the world. People with limited funds and without any bank account can invest. Anyone with internet access and a digital wallet can participate in tokenization.
Improved liquidity
Traditional assets are illiquid in nature. Conventional financial marketplaces are restricted and charge hefty fees from investors. Decentralized secondary markets and exchanges offer instant liquidity and are operational 24/7. This promotes price discovery and allows easy-exits for investors.
Cost-effectiveness
Blockchain automates the tokenization process. Smart contract implementation provides instant settlement of transactions. Distribution of funds and dividends is seamless and less cumbersome. The decentralized tokenization platforms are simple and less expensive compared to their traditional counterparts. Investors have less financial burden and enjoy greater profits from tokenization.
Smart Contracts and RWA Tokenization
Smart contracts are the underlying force that carries out the RWA tokenization process. But what are they?
Smart contracts are self-operating contracts that perform some pre-planned functions based on pre-determined terms. They cost-effectively automate transactions and reduce third-party infiltrations and fraud. They are decentralized applications that:
- Execute functions automatically
- Automatically enforce terms and conditions
- Logically verify and complete tasks based on preset conditions like date and time
- Are tamper-proof and immutable
- Allow participants to take part in voting consensus and management
- Encourage trust and accountability among users
- Remove middlemen and generate cost-efficiency
- Significance of smart contracts in RWA tokenization:
Promotes divisibility
Smart contracts fractionalize and divide RWAs into digital tokens. They aid in token issuance and trade them in tokenization platforms. Fractional shares split the digital assets into multiple tradeable shares.
Creates tokens and transfers ownership rights
Smart contracts govern token issues, supply, and distribution. They execute the automatic transfer of ownership rights.
Regulatory compliance
Smart contracts ensure that all stakeholders follow KYC/AML regulations and other protocols regarding tokenization. These rules can be integrated into the blockchain nodes.
Asset management
The contracts take care of dividend and income distribution, sharing of profits, and governance protocols, and managing the assets for stakeholders.
Dispute resolution
The pre-defined rules outlined by smart contracts help in easy and fast dispute settlements between parties and prevent costly and time-consuming legal battles.
Saves time and cost
The contracts streamline transactions. This saves intermediary fees like brokerage charges, commissions, and lengthy paperwork. Tokenization efficiency is enhanced and manual errors are minimized.
Importance of Token Standards in RWA Tokenization
Token standards in blockchain are the blueprints that outline the key functions, architecture, and properties of digital tokens. They define guidelines for the creation, operation, token issuance, features, and destruction of crypto tokens in a blockchain network.
A token standard within a blockchain network ensures that all the tokens follow the predefined rules and functions. However, it is important to note that tokens following the same token standard can be different in attribution, token supply, usage, and functionalities.
Token standards facilitate standardization and interoperability within a blockchain network. Smart contracts, decentralized applications, and other DeFi products follow these token standards to ensure interoperability and compatibility in the blockchain network.
Smart contracts follow certain token standards to create, deploy, and monitor digital tokens. Every blockchain network has a token standard like an ERC-20. The native tokens, the smart contract, and the crypto wallet must comply with the blockchain’s token standard.
Common token standards:
ERC-20 (Ethereum Request for Comment 20)
It is the Ethereum network’s token standard. It was conceptualized by Fabian Vogelstellar in 2015.
ERC-20 token is one of the most common token standards. They are used to develop fungible tokens. All ERC-20 fungible tokens are interchangeable and can be exchanged with other fungible tokens of the same value.
ERC-721 (Ethereum Request for Comment 721)
ERC-721 was used to create non-fungible tokens (NFTs). ERC-721 tokens have unique characteristics and cannot be exchanged with each other. Due to this rarity, these tokens are used to represent unique assets like expensive artwork, rare paintings, and collectibles.
ERC-1155
ERC-1155 token standard can create different types of tokens. It is a multi-token standard that uses a single smart contract to create both fungible and non-fungible tokens. They can efficiently manage a wide variety of tokens with less gas and transaction fees.
ERC-3643
ERC-3643 is the first, open-sourced, and official tokenization standard built exclusively for RWA tokenization. It is a big step for RWA tokenization as it operates on public blockchains.
Built on the Ethereum blockchain, the token standard lays down the regulatory standards for securities and real-world assets. Following the ERC-3643 token standard, RWAs can be easily validated, audited, and transferred on-chain.
ERC-3643 incorporates Ethereum smart contracts to deploy ownership rights, identity registry, and comply with on-chain guidelines.
Final Take
Blockchain technology and smart contracts have revolutionized RWA tokenization. These inherent technologies have enhanced liquidity, facilitated fractional ownership, and developed financial inclusivity in an otherwise inflexible and illiquid financial market. As the tokenization landscape continues to evolve, there is a growing need for legal standardization for its mainstream accessibility and acceptance in the global finance sector.