Putting Real-World Assets On-Chain
Putting Real-World Assets On-Chain
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With the rise of blockchain technology we saw the introduction of new terminology, and perhaps none of these new words are as all encompassing as the term ‘digital assets’. At first blush, we think of digital assets as blockchain-native currencies, such as bitcoin and ether, and collectibles, such as NFTs. But digital assets are so much more than that. In fact, a digital asset can literally be anything that can be digitized - that is, nearly everything.
One of the most exciting use cases in the digital assets space is found at the intersection of blockchain technology and real-world assets. Real-world assets begin their life off-chain, and encompass those assets most commonly found in traditional finance. Think real estate and car titles, collateralized debt obligations, inventory financing, and carbon credits.
One of the opportunities afforded by blockchain technology is bringing these real-world assets on-chain to create more efficient markets for TradFi assets. In this week’s editorial, Joe King explores this intersection of traditional and decentralized finance. He notes that while he sees “almost daily news of a new use case of technological convergence,” some of the most powerful benefits of bringing these assets on-chain have to do with the nature of the blockchain itself. “Putting real-world assets on the blockchain allows for greater transparency, easy access to liquidity, and fast, cheap transactions.”
Joe sees a world where this intersection is one of the largest economic drivers of the future, “enabling a new generation of financial tools that can unlock financial freedom for all.” Businesses take note, as your website-based inventory financing of today is poised to become your blockchain-based inventory financing protocol of tomorrow.
Putting Real-World Assets on-chain
A Multi-Trillion Dollar Opportunity Is Coming Our Way
Author: Joe King
Key Takeaways
Traditional financial markets can help to bring the over $20 trillion in debt denominated assets onto the blockchain and into the greater decentralized finance ecosystem.
Real-world assets on the blockchain enable greater transparency and capital efficiency, and allow for the fast, cheap transactions we’ve come to expect from DeFi.
The stability of these assets give DeFi protocols like Maker and Aave a way to back stablecoins with stable assets, creating a new world of DeFi and liquidity for both asset originators, credit facilities, and lenders.
Traditional businesses can leverage this technology to gain an economic edge over their competition and fuel faster growth.
Introduction
Since the early days of crypto, the idea of bringing real-world asset (RWA) ownership rights to the blockchain has been a dream of many developers and financiers. In 2017, the first apartment was sold via the blockchain in Ukraine and in the following years more sophisticated assets like “collateralized debt positions,” music and movie royalty payments, payroll advances, and commercial real estate have been “tokenized” and brought onto the blockchain. In this article we will explore the basics of tokenizing a RWA, what it means for both traditional finance and decentralized finance, and demonstrate some use cases that your business can use today to access liquidity, reduce fees, and gain access to this growing sector.
Types of RWA Assets on-chain
What kinds of assets can be tokenized? Anything that can be owned can be tokenized. When you read “tokenization” it boils down to digital ownership rights represented on the blockchain through a token. That can be a unique ownership token represented through an NFT, or a fungible token that works similar to a share in a real estate syndicate or REIT.
Real estate titles as NFTs were the first use case for tokenizing real world assets, but since then the industry has added many new types of tokenized assets such as: Invoice Financing, Mortgages, Fix and Flip Loans (short term real estate financing), Royalty Payment Advances, Auto Financing, Art, and Small and Medium Size Business Financing.
How to Get an Asset onto the Blockchain With invoice Financing
Let us begin by going through the technical details to demonstrate how a RWA gets onto the blockchain in the first place. Many companies and protocols are building tools and methods to “tokenize” assets, but for our example we are going to demonstrate how Centrifuge gets assets onto the blockchain and how those assets are valued. We chose Centrifuge as they are currently leading the blockchain-enabled RWA origination movement and have integrations with two of the most battle-tested DeFi protocols: Aave and MakerDAO.
In our example of “invoice financing” a company we will call “Big Car Inc.” orders millions of tires from another company we will call “Tire LLC”. Tire LLC needs financing to purchase the rubber, electricity to run the plant, and capital to pay the employees who produce the tires. Tire LLC. sends the invoice to Centrifuge who in turn verifies all the particulars (price, delivery date, amount payable, credit worthiness of both parties). Once Centrifuge, Tire LLC, and Big Car Inc. are all in agreement the document is signed through a cryptographic hash, anchored to the blockchain, and then Tire LLC mints the invoice on-chain as an NFT that represents all the information verified. This NFT can now be used as collateral and capital can be borrowed against this asset.
What Is the Benefit of Tokenizing RWA?
Invoice financing is a common practice in traditional finance, as companies need capital to fulfill incoming orders, make payroll, pay rent, and continue operations. Typical invoice payment times can vary from 30 to 120 days to obtain payment after the order is delivered (that is not counting the amount of time needed to produce the product and fill the order).
To help businesses bridge the gap from order to payment, banks lend capital against the invoices they have in turn for interest, which can be quite high for a small or medium size enterprise (SME). SME financing can have rates higher than 15% to borrow capital while a top 2,000 company like Google can access capital for less than 1%. The difference in these rates is not commensurate with default rates as the SME industry has a less than 2% default rate on loans of this kind. Because of these high rates and low risk, the opportunity to bring these assets into the liquid world of decentralized finance is an attractive opportunity for lenders and borrowers alike. Fees for lenders in the RWA space on MakerDAO and Aave are between 4%-10%, and borrowers can get interest rates as low as 5% and upwards of 12% to access capital.
Bringing Real Estate On-Chain
If you have ever purchased a home, investment property, or a piece of commercial real estate, you know the painstaking process of filling out paperwork, dealing with multiple intermediary agencies like banks, title companies, and underwriters, along with the myriad fees charged by all of these intermediaries.
What if we could use the ease and security of the blockchain to facilitate these types of transactions as well as unlock new functionality while simultaneously lowering counterparty risks? While it may sound too good to be true, the future is here and being tested by a variety of companies. Tokenized real estate unlocks a host of new features that can open up these markets to individuals and companies that have been left out of this ever-growing market.
Transparency and Ease of Blockchains
Imagine buying a property at 3am on a Sunday from the comfort of your own home. This is the future blockchain-enabled real estate is bringing to the table.
Currently real estate relies on multiple human intermediaries to complete a transaction that can take weeks if not months to effectuate. Thanks to the composability of smart contracts, the required facts and figures such as market value, ownership (past and present), and lien status are all verifiable instantaneously through smart contracts, allowing 24/7 transactions without all of the traditional title transfers, title insurance, real estate agent fees, appraisers, and underwriters.
Secondary Market Liquidity
Real estate is often touted as a vehicle for the wealthy to park capital that keeps pace with inflation and can produce a dividend in the form of rent payments. However, real estate is an illiquid asset and accessing capital locked in a property can be an expensive and cumbersome process.
With tokenized real estate, borrowing against a piece of property can be simple with DeFi marketplaces such as MakerDAO, Aave, and Compound. Perhaps you are part of a real estate syndication or group investment and have a financial emergency where you need to liquidate the asset; with tokenized real estate, secondary markets are created where these tokens can be traded to another investor looking to gain exposure to your type of asset.
Even more nuanced investment choices can be made in these markets. Perhaps you invested in growth markets where the value of the property was going up quickly, but rents were low; now as an older investor you would prefer the safety of a more stable market with the cash flows of a higher rental rate. You could use these secondary markets to change the composition of your portfolio to better adapt to your individual investment goals.
New Opportunities
Using a smart contract, tokenization fractionalizes ownership of the asset. This is similar to the crowd funding model or to bundling multiple real estate assets into one pool, such as a real estate investment trust (REIT). For example, as a small retail investor I want exposure to commercial real estate in the city of Austin, TX. I only have $10,000, which is well short of owning my own property, and no real estate investment syndication will let me in on the deal for less than $100,000, meaning I have no way to access this market. With asset tokenization, ownership in a property can be split as large or as small as needed to allow investors the opportunity to unlock these capital markets. Similar to REITs, these tokens can be bundled into larger “vaults,” which could give investors access to a variety of investment strategies in asset class or location such as:
Commercial Real Estate in Austin, TX
Large Apartments in Fast Growing Cities
Green Energy Projects in Emerging Economies
Women-Owned Rental Real Estate
Vineyards in Europe
Public-Private Affordable Housing
The tokenization model enables asset organizations and fund managers to create a variety of new investment vehicles that can allow for more targeted investments, such as in underserved segments of the real estate market.
Getting DeFi Liquidity with MakerDAO
MakerDAO is the oldest and most battle-tested decentralized finance protocol in existence, and they continue to innovate and build new ways to democratize finance. Maker Vaults are an over-collateralized lending protocol, essentially you lock up an asset (typically crypto currency) and you can borrow DAI (a dollar-backed stablecoin) in the amount the vault will allow depending on the asset deposited (typically 50%-80% of the underlying value). Due to the overcollateralized nature of these loans, they are typically very stable and if the underlying collateral ever reaches the amount borrowed, the assets are automatically liquidated to repay the loan plus a liquidation fee. The Maker Vaults work the same with RWA as they do with crypto assets, allowing fund managers to lock up an investment type as collateral and to borrow against that asset.
Why Tokenizing Assets Will Change the Game
The cross section of traditional finance and decentralized finance continues to evolve. With what seems like almost daily news of a new use case of technological convergence, we are witnessing everything from carbon credits on-chain to tokenized ownership of commercial real estate.
Centrifuge and MakerDAO are continuing to work together to maintain and grow a robust marketplace for lenders and borrowers alike to gain exposure to the fast, secure, and transparent system DeFi offers users. Putting real-world assets on the blockchain enables greater transparency, easy access to liquidity, and fast, cheap transactions, while enabling a new generation of financial tools that can unlock financial freedom for all.
Joe King is a tokenomics designer and DeFi strategist with Bankless Consulting, where he helps clients build token models, incentive structures, and go-to-market strategies for DeFi protocols. A contributor to Tokenomics DAO, The Token Engineering Academy, and The Crypto Oracle Collective, when Joe King is not at his desk you can spy him in the sky flying his Paraglider around the Appalachian Mountains.
🎙️ Early Podcast
A Podcast About Web3 Business from Bankless Consulting
EARLY Ep5: Tune in to the latest episode with Chuck from Bankless Consulting as they explore the potential of web3 and blockchain technology to drive social impact. Chuck is passionate about social impact practice as a step towards building blockchain technology for real-world use cases. He is a founding member of Bankless Consulting, a digital nomad, and a writer.
Web3 Business Developments
Curated News on Recent Blockchain Adoption and Innovation
Making Ethereum Wallets Smarter Is the Next Challenge—and Visa Is Among Those Working on It
Author: Liam J. Kelly
🔑Insights: The Ethereum network is about to get a massive UX upgrade with the announcement of account abstraction, or EIP-4337. Account abstraction enables smart wallets that are easier to use, smarter, and safer. Some of the key benefits include:
Great flexibility by being able to batch transactions into one click.
Improved features like recurring payments, “pull payments”, and social recovery of lost private keys.
Programmable, smart wallets don’t require any intervention.
“If you play games, you probably wouldn't want to sign a transaction every five seconds, every time you are killing a player, winning new updates, and then paying for the transaction. With account abstraction, you can program what we call a ‘session key’ and say, ‘hey, I will let that game sign for me for the next hour.’”
– Itamar Lesuisse, Cofounder and CEO Argent
Blockchain, NFTs, And The Future Of The Perishables Supply Chain
Author: Alex Swart
🔑Insights: Supply chain leaders are exploring AI and blockchain technology to solve issues in the perishables supply chain, such as decreasing food waste, increasing transparency and traceability, and optimizing shipping routes. NFTs could be a natural complement to blockchain solutions, and while their adoption is still uncertain, companies that adopt future-facing technologies like blockchain and smart contracts can see decreased liabilities, quicker time to payment, and reliable traceability. Smart supply chains optimized with AI and blockchain technology would offer several advantages, including:
AI-powered predictive analytics optimizes shipping routes and matches trading partners
Increased transparency through traceability and quality inspections
Reduced errors and increased efficiency through automation
Real-time tracking of inventory-based transactions across retailers, suppliers, and distributors
Smart contract automation streamlines workflows, decreases liabilities, and increases resiliency, while enhancing security and reducing the risk of fraud or counterfeiting.
Tokenized Real Estate: Crypto Hungry for Real-world Assets
Author: Shalini Nagarajan
🔑Insights: Tokenized real estate is introducing greater liquidity and access to investment strategies previously limited to high net-worth individuals. While we are still a few years away from blockchain-powered real estate, some companies are already allowing users to invest in fractions of properties. Tokenized real estate can provide potential advantages and uses:
Reduced paperwork: Smart contracts can reduce the need for paperwork, making buying and selling real estate more efficient.
Cost savings: Tokenization can cut down on the cost, time, and effort involved in buying property.
Fractional ownership: Fractional ownership allows investors to participate with as little as a few hundred dollars, offering exposure to high-value assets at lower costs.
Global investment opportunities: Tokenized real estate allows investors from other countries to access equities originated in the US.
Rental income: Investors who buy fractionalized tokens can receive rental income from the property they co-own in the real world.
World’s Largest Asset Manager BlackRock Is Exploring ‘Tokenization of Stocks’
Author: Justinas Baltrusaitis
🔑Insights: The largest asset management company in the world believes that the operational potential of blockchain technology offers exciting growth opportunities for businesses. In their annual letter to investors, BlackRock highlighted how tokenization of real-world assets will revolutionize asset management and offer dramatic advantages, including:
Digital payments can advance financial inclusion and decrease fees.
Tokenized assets could drive capital efficiency in markets, shorten value chains, and improve costs and access for investors.
Despite elevated risks and a need for regulation, BlackRock is optimistic about the potential of digital assets.
“At BlackRock we continue to explore the digital assets ecosystem, especially areas most relevant to our clients such as permissioned blockchains and tokenization of stocks and bonds.”
– Larry Fink, Chairman and CEO of BlackRock.
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Thank you!
Hey,
Thanks for an interesting read, we're also really excited about the prospect of real-world asset tokenisation and are seeing a lot more financial institutions taking the plunge with this, such as HSBC and in our client activities. One concern we have with tokenisation is fractionalisation - for instance, putting a piece of real estate on chain may ultimately lead to the lack of pure ownership of the real estate because everybody has a piece of the pie, and therefore deter people from tokenising their own asset. Do you have any view on this?