RWA Discussion: Underlying Assets, Business Structure, and Development Path
RWA: Assets, Business, and Development
Recently, there has been increasing discussion in the market about real world assets (RWAs), with some viewpoints suggesting that RWAs will trigger the next bull market. Some entrepreneurs have also adjusted their focus to RWA-related tracks, hoping to accelerate business growth with the support of the gradually heating up narrative.
RWAs are assets from traditional markets that are mapped to the blockchain in the form of tokens for Web3.0 users to buy and sell. RWA tokens have the right to receive returns on assets. A few years ago, the scope of STOs was mainly focused on corporate bond financing, but the scope of RWA is now broader: it is not limited to primary market of traditional assets, and any assets circulating in the primary and secondary markets can be mapped to the blockchain through tokenization, allowing Web3.0 users to participate in investment. Therefore, the narrative of RWA contains a wide variety of asset types and a wide range of yield ranges.
RWA is gradually attracting attention from the market, possibly for several reasons: first, the cryptocurrency market currently lacks low-risk U-denominated assets, and with the wave of interest rate hikes in traditional financial markets, risk-free rates in major economies have risen to 4% or even higher, which is attractive enough for investors in the cryptocurrency native market. Corresponding to this phenomenon is the entry of many traditional funds into the cryptocurrency market during the bull market period from 2020 to 2021, earning low-risk profits through arbitrage and other strategies. By introducing low-risk, high-yield products from the traditional market through RWA, it may be welcomed by some investors; second, the cryptocurrency market is not currently in a bull market, and there is a lack of sufficient narratives even in the cryptocurrency native market. RWA is one of the few tracks that has solid revenue support and may achieve explosive business growth; finally, RWA is one of the bridges connecting the traditional market and the cryptocurrency market, and through RWA, there is also an opportunity to attract incremental users from the traditional market, injecting new liquidity, which is undoubtedly a positive development for the blockchain industry.
However, some RWA projects that have been seen so far have not seen a rapid increase in business indicators such as TVL, perhaps the market has overestimated its short-term expectations for RWA. For an RWA project, it is necessary to consider the following dimensions:
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Underlying assets. This is the most crucial issue in the RWA track. Choosing the right underlying assets can greatly help the subsequent management.
Standardization of underlying assets. Due to the different “heterogeneity” of different underlying assets, the difficulty of standardizing underlying assets is also different. The stronger the heterogeneity of the asset, the higher the standardization requirements and the more complex the process.
Off-chain partner institutions and cooperation forms. High-quality off-chain partner institutions can not only fulfill their obligations smoothly, but also fully release the value of underlying assets.
Risk management. The maintenance of underlying assets, the on-chain of assets, and the distribution of income all involve risk management. If it is a debt-type asset, it also involves risk management of asset liquidation, collection, and other links after the debtor defaults.
Underlying assets are the most core elements.
In the current RWA track, underlying assets are mainly divided into the following categories:
Bond-type assets, mainly short-term US Treasury bonds or bond ETFs. Typical representatives include USDT and USDC of stablecoins. Some lending projects, such as Aave and Maple Finance, have also joined this camp. US Treasury bonds/Treasury bond ETFs are currently the largest proportion of RWA;
Gold, a typical representative is BlockingX Gold. Still under the narrative of “stablecoins”, but the development is slow and the market demand is weak;
Real estate RWA, typical representatives are RealT, LABS Group, etc. Similar to packaging real estate into REITs and then putting them on the chain. The source of real estate for this type of project is extensive, and the project team will often choose their own city as the main source of assets;
Loan-type assets. Typical types such as USDT, Polytrade, etc. The types of assets are relatively diverse, including personal housing mortgage loans, corporate loans, structured financing tools, car mortgage loans, etc.;
Equity-type assets, typical projects include Backed Finance, Sologenic, etc. The trading of this type of asset seeks real existence, but is greatly restricted by legal and other issues. A key development direction of native cryptographic “synthetic assets” is the listed and circulating stocks, which highly overlap with this field;
Other, including farms, works of art, and other types of assets with a large scale (large individual asset amounts) but a low degree of standardization.
When considering what assets to use as underlying assets, five dimensions need to be considered: liquidity, standardization, principal safety, scalability, and yield. From these five dimensions, we can roughly outline the attributes of the above assets.
From the perspective of underlying assets, debt-related assets currently seem to be the most worthwhile category to explore, and based on their own positioning, they can seek differentiated routes: anchoring fiat-backed stablecoins, encrypted market Yu’ebao, etc. Although the stablecoin race anchored to fiat currency is already dominated by a few giants, and the main projects have formed ecological cooperation with a large number of projects, there is still room for exploration in the “encrypted market Yu’ebao” and other races.
For real estate assets, although the REITs scheme is already very mature, if the project team decides to choose assets, conduct regional and property diversification management, it will undoubtedly increase a lot of costs: for example, in project maintenance, if the regional distribution is too scattered, The number of people involved in property management will increase, and the procurement costs and personnel transportation costs in property maintenance and other aspects will also need to increase. In the process of reviewing projects, I have encountered project teams who hope to control the value of a single property within 100,000 US dollars, distributed in more than 5 countries, and not be restricted to residential and commercial properties. Although it may achieve sufficient diversification, it is still difficult to disclose information and manage property. It is also difficult to achieve rapid growth of underlying assets in the future.
Currently, I do not recommend overly focusing on “other” types of underlying assets, the most important reason being liquidity and standardization. For example, for agricultural-related underlying assets, due to the high degree of non-standardization, this adds a lot of difficulty in determining the quality of underlying assets. Take a single farmland as an example. The quality of the crops produced will also vary. The warehousing, transportation, and sales processes are also relatively specialized. To ensure that the income from agricultural assets is ultimately delivered to investors, it is necessary to deeply cultivate the industry for many years. The production capacity cycle fluctuations and weather factors facing economic crops are also difficult to predict. Ultimately, there are great difficulties in realizing them.
If the project party finds assets and packages assets by themselves, the growth of the project itself will also be greatly affected, and such projects will have greater difficulty in achieving rapid growth.
As for underlying assets, using bond assets as a core direction and using REITs assets as a way to increase revenue may be a more practical and feasible direction.
If there were major issues regarding how to put RWA on the chain a few years ago, this has now formed a clearer path under the exploration of leading projects such as MakerDAO.
First of all, to achieve convenience in putting RWA on the chain, an RWA Foundation architecture can be established. Under this architecture, MakerDAO can manage multiple RWAs through RWA Foundation, and new RWAs can be initiated directly by RWA Foundation loading SPVs (Special Purpose Vehicles).
Secondly, for individual SPVs, a management mode can be adopted similar to the asset-backed securitization (ABS) financing method supported by asset-backed securities:
In order to ensure the safety of funds, MakerDAO chooses to invest in priority assets, and other investors can become subordinated investors. For other project parties, the risk level of holding assets can be determined based on the risk preferences of the target user group.
Unlike traditional asset securitization steps, there is no settlement or fund custodian role in the single SPV of MakerDAO, but a tokenized issuance platform has been added. After the regulatory space becomes clearer in the future, settlement and fund custodianship may still be necessary participants for RWA.
Risk management for RWA mainly consists of three dimensions:
1. Risk management of underlying assets. The lower the standardization level of the asset, the higher the required risk management ability. Compared to forest and farm assets, government bonds have a higher degree of standardization, better asset liquidity, and stronger price discovery ability. Therefore, it is easier to manage government bonds. However, even for the same type of asset, the level of difficulty in management may differ in different regions and countries. For example, in some developing countries, the level of digitization is low, and debt-type assets may still exist in paper form. This requires the project party to find a place to store the bonds that cannot be destroyed during the holding period of large bonds. Assets that exist in paper form also have a high possibility of being “bait and switch”, and such events have occurred in many regions with large cases.
For risk management of underlying assets, the most basic thing is to ensure that the underlying assets are real and effective during the project period, followed by ensuring that the value of the underlying assets will not be lost due to human factors. Thirdly, it should be ensured that the underlying assets can be realized at a fair market price, and finally, it should be ensured that the income and principal can be safely delivered to investors. This type of risk has a high degree of overlap with the attributes of traditional assets and there are risk management measures that can be referred to.
2. Risk management on the chain. Because it involves data on the chain, if the off-chain institutions do not receive sufficient management, there may be a situation of false reporting of data. Similar negative cases often occur in the traditional financial field, such as in the fields of commercial bills, supply finance, bulk commodities, etc., where there have been huge false claims. Even with real-time monitoring through sensors, fixed delivery locations and other methods, it is still impossible to completely avoid risks.
For the RWA industry, which is still in its infancy, I believe that similar situations will occur. Moreover, there are currently no corresponding regulatory rules, and the cost of illegal activities is too low, so the risk of data fraud on the chain cannot be underestimated.
3. Cooperation risk management. This type of risk still tends to be traditional, but the problem is that there are currently no regulatory rules for RWA. For example, in the custody link, what kind of custody institution is compliant? In the audit link, can the current accounting and financial standards accurately and completely reflect the characteristics of RWA? In the process of project operation, if there is a risk event, what kind of risk disposal method and process can better protect investors? These questions still do not have very accurate answers. Therefore, partners still have the opportunity to do evil.
Current User Structure and User Needs
As mentioned in the previous “Prospects for the Native Bond Market in the Encryption World”, due to the extremely strong volatility and cyclicity of the encryption market, relatively low-risk and risk-averse investors find it difficult to obtain sustained and stable returns in the market. In such a market, a large number of users also show strong risk preferences:
In the survey report released by teams such as dex.blue in 2020, half of the surveyed cryptocurrency market users invested 50% or more of their entire savings in the cryptocurrency market; Pew Research and Binance also released survey reports, respectively Mentioned that the current users in the cryptocurrency market are young people. In this market structure, the risk appetite of cryptocurrency market investors will be higher than that of traditional market investors.
In the current market dominated by “arbitrageurs” and high-risk investors, its volatility also exhibits similar characteristics: K33 Reseach’s research shows that from early 2017 to October 2022, Bitcoin’s volatility was higher than that of NASDAQ and the S&P 500 for most of the time, and only when the market was extremely quiet did the volatility of the US stock market have a chance to surpass Bitcoin.
The two main types of investors in the crypto market may have different demands for returns: for arbitrageurs, low-risk investment opportunities are easier to obtain, and these types of trading opportunities, such as the Bitcoin perpetual contract funding rate, have an annualized rate of return between 15% and 20% since the product was introduced. This figure is already much higher than the long-term rate of return of 5% for the global stock market and higher than the long-term rate of return of various types of bonds. For high-risk investors, their expected returns are even higher than those of arbitrage investors.
Therefore, even if stocks are tokenized, it may be difficult to meet the user structure and expected return levels of the current market. In the short term, the risk-return ratio of a large number of RWA products is relatively awkward.
Regulation: Perhaps a Potential Opportunity
In early June of this year, the US SEC announced that multiple tokens, including BNB, BUSD, and MATIC, were defined as securities, causing market concerns about regulation, and corresponding targets also showed significant declines.
If the SEC’s regulatory measures are recognized by other G20 or more countries, and more tokens are listed as securities and included in the traditional regulatory framework, future token issuances on the chain may also be included in the regulatory scope. From current regulatory policies, we see a similar trend: whether it is the United States, Japan, or European Union countries, regulatory measures for stablecoins are beginning to move closer to traditional banks, and perhaps future regulation of tokens will also draw on securities regulation to some extent.
If such a situation arises, some practitioners in the traditional financial industry will be more confident in putting assets on the chain: the benefit of this is that the assets are local but can absorb global liquidity. This idea has been recognized by some RWA project entrepreneurs: although they are limited by geographical factors, they can obtain global investors with blockchain. For these practitioners, asset securitization under supervision will bring two benefits: 1. With the tentacles of obtaining global liquidity, the capital end will not be affected by geographical factors, which may melt into cheaper money; 2. Because it may find investors with lower yield requirements than the local, the project’s selection range increases.
At the same time, regulatory measures on the user side are also advancing: KYC. Cryptographic projects that are native only require wallets to access, but some start-up projects financed in the primary market already require KYC assistance to determine whether users are qualified investors. Some projects that introduce RWA, such as Maple Finance, also regard KYC as an indispensable process in the process of obtaining customers. If the KYC process is gradually implemented in more new projects, then a more clear supervision and KYC coexisting blockchain industry may bring an additional benefit: more ordinary investors can enter the market with more confidence.
This type of user’s risk preference prefers familiar assets, and there is also a certain interest in new cryptographic native assets. At this time, RWA can serve as an important investment direction for this more common type of investor.
The Possible Development Path of RWA
In the short term, RWA brings three benefits to cryptocurrency investors:
1. Low-risk investment targets denominated in fiat currency: The risk-free interest rate level of major economies led by the United States has reached a level of more than 3%, which is significantly higher than the borrowing interest rates in various U-based lending agreements in the cryptocurrency market. Without the need for cyclic leverage, it brings extremely low-risk investment opportunities to investors. Currently, projects such as Ondo Finance, Maple Finance, and MakerDAO have launched investment projects based on US Treasury bond yields, which are extremely attractive to investors settled in fiat currency. In this track, perhaps a “Yu’ebao” project in the cryptocurrency market will appear.
2. Risk diversification of assets: Taking Bitcoin as an example, the correlation with gold and US stocks also fluctuates to varying degrees in different market stages.
Even in the big year driven by macro factors after 2020, different asset categories still have a certain degree of diversification advantage.
For configuration investors, mixing native cryptographic assets with various types of RWA can achieve greater diversification of asset risks.
3. A means for investors in developing countries to cope with fluctuations in their own currency values: In some developing countries, such as Argentina, Turkey, etc., inflation is at a high level throughout the year. RWA can assist investors in these areas to a certain extent Hedge their own currency fluctuations and achieve global asset allocation.
From the above three dimensions, RWA that can be widely accepted in the short and medium term is more likely to be the main economic entity government bond RWA with high returns and low risks caused by interest rate hikes.
In the long run, as the regulatory framework becomes clearer and more popular investors gradually enter the crypto market, and the operation of the crypto industry becomes more convenient, RWA has the opportunity to replicate the prosperity of China’s Internet finance explosion 10 years ago:
1. RWA assets based on blockchain provide unprecedented “accessibility” to global retail investors: RWA, as the asset that retail investors are most familiar with, may become the main chain investment target for non-Web3 natives. For them, the borderless property and permissionless access and operation of on-chain assets open the door to investing and using more extensive global assets. Conversely, for entrepreneurs in the field, this also provides them with unprecedented user breadth, scale, and extremely low customer acquisition costs. The rapid development and widespread use of USDT and USDC as “on-chain dollars” have preliminarily verified this trend.
2. RWA assets may give rise to new DeFi business models: LSD has stimulated the rapid development of LSD-Fi as a new underlying asset. In addition to the existing business models such as asset management, spot trading, stablecoins, etc. being revalued, there are also directions that have appeared in the past but have not received attention, such as fluctuations in yields. If RWA becomes an important type of underlying asset, the introduction of new and large off-chain profits may give birth to new DeFi business models. In the future, RWA can also form a hybrid asset with native encrypted assets and strategy portfolios, allowing more users who are willing to explore native encrypted assets to understand them in a more familiar way. From this perspective, the next RWA+DeFi project with ultra-high TVL may be the “on-chain Yu’ebao”.
3. The game between the industry and regulation will eventually have an answer, and practitioners can seek methods to obtain compliant customers: Whether in Western countries or in Hong Kong in the East, regulation is gradually landing. The growth of the cryptocurrency industry to a scale of $10 trillion in the future will not be ignored by regulation. With the gradual clarification of regulatory policies, we can see that some regions can land businesses that were previously impossible: stablecoins can now be issued through compliant channels in Hong Kong, and the blockchain industry is being explored in the Middle East. Combined with traditional industries.
In the long run, one of the important factors for the booming development of the cryptocurrency industry is sufficient liquidity. With the landing of regulation, RWA led by fiat-backed stablecoins will inevitably grow rapidly. Especially under the stimulus of the next round of global liquidity easing, new players who enter the market may be able to replicate the road to ultra-high growth of USDT if they have strong support in ecology and channels, etc.