Traditional institutions are eager to try, and RWA is finally on fire

Source/kitco

Compiler/Squidward

Real-world asset (RWA) tokenization has become one of the most powerful use cases for blockchain technology globally, as it promises to bring greater efficiency and security to financial markets in the digital age.

To get a deeper look at what’s going on in RWA in 2023, kitco editors spoke with Benjamin Stani, Director of Business Development at Matrixport.

“There has been a big divergence in on-chain and off-chain rates as on-chain yields have compressed and the U.S. Federal Reserve (FED) rates have risen,” Stani said. “RWA may be able to bridge this gap.”

He noted that while the stablecoin market is the cornerstone of the crypto ecosystem, the underutilization of these stablecoins has been a lingering problem, and RWA can solve this problem. This has become a disruptive force in 2023, unlocking the potential of the asset class and fundamentally changing the way value is created, transferred, and stored. ”

The push for “risk-free real-world yields has shifted the industry’s focus to the tokenization of regulated financial instruments”, with Treasury bills, real estate, precious metals, and art seen as the most viable tokenized assets.

The launch of Matrixdock Tokenized Treasury Bills (STBTs) has received a very positive response, raising $123 million in just over five months, and Stani noted that STBT has met this need, driven by the US Federal Reserve’s interest rate hikes, for bonds that want a risk-free rate while avoiding the hassles of traditional trade execution and settlement, and as the industry grows, the same logic applies to other real-world assets.

**As tokenized Treasuries are widely adopted by the industry, exploring other liquid listed securities in a similar format will not make much difference from a conceptual standpoint. In short, RWA can be extended to real estate, corporate bonds and wines. The RWA industry is expected to be a big theme in the digital asset ecosystem in the coming years, adding tens of trillions of dollars to the market. ”

RWA will greatly enrich the size and variety of assets available on-chain, and with the expectation of a continued increase in the risk-free rate, it is expected that in the coming quarters, institutions will adopt tokenized notes due to economic incentives, along with further DeFi innovation in market products. **

While RWA is still in the early stages of the tokenization cycle, there is growing interest from crypto-native as well as traditional financial players.

“There have been some notable developments in the industry, including the successful use of DeFi by the Central Bank of Singapore’s Project Guardian for wholesale funding markets, experimenting with foreign exchange trading and government bond trading, and Deutsche Bank’s testing of a tokenized fund on the Ethereum public network,” Stani said. RWA adoption is rising rapidly. Continued innovation in clearing strategies and smart algorithms is driving this momentum, with significant progress expected by the end of the year. ”

01. Advantages and disadvantages of tokenization

One of the biggest benefits of tokenization is that it democratizes financial markets by eliminating intermediaries, speeding up transactions, and reducing costs, while also opening up investment opportunities that were previously only available to high-net-worth individuals. **

Prior to the birth of RWA, the main limitations of the market focused on the user experience, especially liquidity, and tokenization had the potential to revolutionize the financial landscape, creating new revenue streams and even entirely new markets. We can get a glimpse of the complexity of traditional securitizations provided by PwC with a visualization of the typical mix of external parties and service providers.

Source: PricewaterhouseCoopers

The orange boxes above the dotted line represent the main parties: the debtor (the mortgage borrower), the originator (the lender who created the mortgage), and the investor (the buyer of the pooled mortgage). The core function of securitization is to pool the cash of the underlying debtor, divide it, and distribute the cash to investors.

The cost of each of these steps is cumulative, and the cost is expected to increase by 1% over the entire process of securitization, which may seem insignificant, but even a 0.50% reduction in the mortgage rate of $500,000 can save $2,500 per year, which is a significant expense for most people.

On-chain lending has several key advantages over real-world assets over traditional lending, including greater international accessibility, accessibility to crypto financial instruments, and a more democratic decision-making process. These factors help make lending more inclusive, transparent, and convenient for a wider range of borrowers and lenders, while also promoting stability and reducing risk in the lending ecosystem. As the industry grows, we may see the merger of TradFi and DeFi to create the conditions for a smarter, more programmable global economy.

One of the biggest hurdles to RWA at the moment is regulatory uncertainty. The legal framework is struggling to keep pace with the rapid development of tokenization technology. This is especially evident in the DeFi-integrated RWA infrastructure space, where regulators must confront blockchain scalability issues to accommodate TradFi market capacity. ”

To help overcome this obstacle, Stani recommends a progressive approach to regulation, with a focus on building a comprehensive framework that is fully compatible with DeFi standards. Such frameworks must strictly enforce risk management protocols to enhance transparency and security. The success of Singapore’s groundbreaking stablecoin regulation illustrates the power of clear, strong guidelines. They not only protect investors, but also create an enabling environment for issuers and financial institutions to innovate and explore new investment channels.

The technical part is actually easier to upgrade because there are already viable solutions. The bottleneck is more in terms of regulation and compliance, and we need to be clear about what a security is and how to deal with on-chain property rights off-chain. Some jurisdictions are more progressive than others, and it’s only natural that we’ll see a push for innovation in progressive jurisdictions.

Probably the biggest hurdle is that the internal compliance team wants to overlay the same framework on top of these new asset classes, and it’s clear that a lot of things are less relevant on-chain (e.g. keeping an audit trail) or even unachievable (e.g. reversing transactions).

Current issues related to regulatory compliance have led to delays in the adoption of RWA, but Stani said those hurdles will eventually be overcome, allowing RWA to thrive globally.

02, Conclusion

The demand for deep on-chain liquidity is strong in the future, especially for large protocols. While there are restrictions and licensing requirements for STOs, there will be some flexibility to use securities as the underlying assets for other products. The industry is exploring these possibilities and striving for innovation.

Once RWA has sufficient scale within the industry, the end result will be that TradFi and the crypto world will unite into a single financial sector, which will be amazing unlike the bull market running trend of the past.