Exploring RWA: Underlying Assets, Business Structures, and Development Paths

Since the beginning of the year, there has been an increasing market discussion about RWAs (real world assets). Some believe that RWAs could trigger the next bull market. Accordingly, some entrepreneurs have shifted their focus to the RWA sector, hoping to leverage the growing narrative to rapidly boost their businesses. RWAs involve tokenizing traditional market assets and bringing them onto the blockchain for Web3.0 users to buy and sell. These tokens carry the rights to the asset’s revenues. While a few years ago, Security Token Offerings (STOs) mainly focused on corporate bond financing, the scope of RWAs has now expanded significantly. It’s not limited to traditional assets’ primary markets; any asset that circulates in both primary and secondary markets can be tokenized and brought onto the blockchain, allowing Web3.0 users to participate in investment. Therefore, the narrative around RWAs encompasses a rich variety of asset types and a broad range of yield rates.

The growing market interest in RWAs can be attributed to several reasons: First, the current crypto market lacks low-risk assets based on universal (U) value, and with interest rate hikes, the risk-free rates in major economies have risen to 4% or even higher, which is attractive for native crypto investors. Correspondingly, during the 2020-2021 bull market, many traditional funds entered the crypto market, earning low-risk returns through strategies like arbitrage. Introducing traditional market products with low risk and high returns through RWAs could appeal to some investors. Second, the crypto market is not currently in a bull phase, and even within the native crypto market, there’s a lack of compelling narratives. RWA is one of the few sectors with solid revenue support, which could potentially experience explosive business growth. Lastly, RWAs serve as a bridge between traditional and crypto markets, potentially attracting traditional market users and injecting new liquidity, which is undoubtedly beneficial for the development of the blockchain industry.

However, looking at some current RWA projects, their business indicators, such as Total Value Locked (TVL), have not grown rapidly, suggesting that the market might have overly high short-term expectations for RWAs. For an RWA project, several key dimensions need to be considered:

1. Underlying Assets. This is the most crucial issue in the RWA (Real World Assets) track. Choosing the right underlying assets greatly aids in subsequent management and other aspects.
2. Standardization of Underlying Assets. The difficulty in standardizing underlying assets varies due to the different levels of “heterogeneity” among them. Assets with stronger heterogeneity require higher standardization demands, and the process becomes more complex.
3. Off-chain Collaborative Institutions and Forms of Cooperation. High-quality off-chain collaborative institutions can not only fulfill their obligations smoothly but also fully unleash the value of the underlying assets.
4. Risk Management. The maintenance of underlying assets, asset tokenization, profit distribution, and other processes all involve risk management. For debt-type assets, this also includes managing the risks in asset liquidation and collection in the event of debtor default.

I. Underlying Assets

Underlying assets are the most crucial element in the field.

In the current RWA (Real World Assets) track, underlying assets are primarily categorized into the following types:

1. Bond assets, mainly short-term U.S. Treasuries or bond ETFs. Typical representatives include stablecoins like USDT and USDC. Some lending projects, such as Aave and Maple Finance, have also joined this category. Government bonds/bond ETFs currently have the largest share in RWAs.

2. Gold, with PAX Gold being a typical example. It still falls under the broader narrative of “stablecoins,” but its development is slow, and market demand is weak.

3. Real estate RWAs, represented by entities such as RealT and LABS Group. This approach is similar to packaging real estate into REITs (Real Estate Investment Trusts) and then putting them on the blockchain. The real estate for these types of projects comes from a wide range of sources, with the project teams often choosing their own cities as the primary source of assets.

4. Loan assets, with typical types being USDT, Polytrade, etc. These assets vary widely, including personal residential mortgage loans, business loans, structured finance instruments, and auto mortgage loans.

5. Equity assets, with typical projects including Backed Finance and Sologenic. The trading of these assets seeks to be tied to real-world entities, but is greatly limited by legal and other issues. An important direction for the development of crypto-native “synthetic assets” is publicly traded stocks, which highly overlaps with this area.

6. Others, including larger-scale assets (in terms of individual asset value) like farms and artworks, but with a lower degree of standardization.

Deciding which assets to use as underlying assets requires considering five dimensions: liquidity, standardization, principal security, scalability, and yield rate. From these five dimensions, we can broadly define the attributes of the aforementioned assets.

From the perspective of underlying assets, debt-based assets currently seem to be the most worthwhile category to explore. These assets can seek a differentiated approach based on their positioning, such as anchoring fiat currency stablecoins, and products similar to “crypto market Yu’E Bao”. Although the race for fiat-anchored stablecoins is currently dominated by a few major players, and the main projects have already formed ecological partnerships with numerous other projects, the field like “crypto market Yu’E Bao” still remains largely untapped.

Regarding real estate assets, although REITs (Real Estate Investment Trusts) are a mature solution, if the project team decides to select assets themselves and manage regional and property diversification, it undoubtedly adds significant costs. For instance, in terms of project maintenance, if the regions are too scattered, the number of people involved in property management will increase, as will the procurement costs for property maintenance and personnel transportation. During my experience of reviewing projects, I have encountered teams aiming to control the value of individual properties within $100,000, distributed across more than five countries, and not limited to residential and commercial properties. Although this achieves sufficient diversification, it poses significant challenges in information disclosure and property management. The rapid growth of underlying assets in the future also faces difficulties.

Currently, I do not recommend overly focusing on “other” types of underlying assets. The primary reasons are liquidity and standardization. For example, underlying assets related to agriculture, due to their high degree of non-standardization, add considerable difficulty in determining the quality of the underlying assets. Take an individual farm as an example; the quality of the crops produced can vary, and the storage, transportation, and sales processes are relatively specialized. Delivering the returns from agricultural assets to investors requires many years of deep cultivation in the industry. The cyclical fluctuations in production capacity and the impact of weather factors on cash crops are also difficult to predict. The final realization of these assets also presents significant challenges.

If a project party searches for assets and packages them independently, the growth potential of the project itself can be greatly affected, making rapid growth more challenging for these types of projects.

In terms of underlying assets, focusing on debt-based assets as the core direction and using REITs-like assets as a means to enhance returns might be a more practical and feasible approach.

II. Business Architecture

If in the past few years there were significant challenges in tokenizing real-world assets (RWA) on the blockchain, the situation has now changed. Thanks to the explorations of leading projects like MakerDAO, a clearer path has emerged.

Firstly, to facilitate the tokenization of RWAs, it’s feasible to establish an RWA Foundation structure. Under this framework, MakerDAO can manage multiple RWAs through the RWA Foundation. The incorporation of new RWAs can be directly initiated by the RWA Foundation by launching a Special Purpose Vehicle (SPV).

Source: https://forum.makerdao.com/t/pre-mip-discussion-rwa-foundations/9510

For individual SPVs (Special Purpose Vehicles), a management model similar to that of ABS (Asset Backed Securitization) projects can be adopted, where the financing is secured by the assets owned by the project.

Source: https://forum.makerdao.com/t/poll-rwa-working-group-covenant-structure/4836

MakerDAO, prioritizing the safety of funds, opts to invest in senior assets, allowing other investors to become holders of subordinate shares. For other project parties, the risk level of the assets held can be determined based on the risk preferences of the target user group.

Unlike traditional asset securitization steps, in MakerDAO’s individual SPVs, there are no roles for settlement and fund custodians, but a tokenization issuance platform is added. In the future, as regulatory clarity improves, settlement and fund custody might still be essential participants in RWA (Real World Assets).

III. Risk Management

The risk management of RWA primarily encompasses three dimensions:

1. Risk management of underlying assets. The lower the standardization of assets, the greater the need for risk management capacity. Compared to timberland and farms, government bonds have higher standardization, better asset liquidity, and stronger price discovery capabilities. Therefore, managing government bonds is less challenging. However, even for the same type of asset, management difficulties can vary across different regions and countries. For instance, in some developing countries with lower levels of digitalization, debt assets might still exist in paper form. This necessitates finding a secure location to store these large-volume bonds without damaging them. Paper-based assets are also more prone to fraud, such as bait-and-switch scams, which have occurred in numerous large-scale cases in various regions.

In summary, fundamental to the risk management of underlying assets is ensuring their authenticity and effectiveness throughout the project’s duration. Secondly, it’s crucial to protect the asset’s value from man-made losses. Thirdly, it’s essential to ensure that the underlying assets can be liquidated at a fair market price. Finally, it’s vital to guarantee that returns and principal are safely and smoothly delivered to investors. These types of risks largely overlap with those of traditional assets, offering referenceable risk management measures.

1. Risk management of on-chain data. Involving data on the blockchain, there’s a potential for falsifying data if off-chain institutions are inadequately managed. Similar negative incidents frequently occur in traditional finance, such as in commercial paper, supply chain finance, and bulk commodities, where significant fraud has been committed. Even methods like real-time sensor monitoring and fixed delivery locations can’t completely eliminate risk.

For the still-nascent RWA industry, similar incidents are likely to occur, especially since there’s a lack of specific regulatory guidelines, making the cost of illegal activities relatively low. Therefore, the risk of data fabrication on the blockchain should not be underestimated.

1. Partner risk management. This type of risk still leans towards traditional, but the problem lies in the absence of specific regulatory guidelines for RWA. For instance, what type of custody institutions are compliant in the custody link? In the auditing stage, can current accounting and financial norms accurately and completely reflect the characteristics of RWA? During project operation, if a risk event occurs, what risk disposal methods and processes can better protect investors? These questions still lack precise answers. Thus, there remains an opportunity for malfeasance by partners.

IV. Current User Structure and Demands in the Cryptocurrency Market

As previously mentioned in “Prospects of the ‘Native Bond Market’ in the Crypto World,” due to the high volatility and cyclicality of the cryptocurrency market, investors with a preference for low-risk and conservative risk profiles find it challenging to achieve consistent and stable returns. In such a market, many users exhibit a strong preference for risk:

According to a survey report released by dex.blue and other teams in 2020, half of the surveyed cryptocurrency market users have invested more than 50% of their total savings in the crypto market. Separate reports by Pew Research and Binance have also noted a higher proportion of young people among cryptocurrency market users. In this market structure, the risk preference of crypto market investors is higher than that of traditional market investors.

Source: https://medium.com/dexdotblue/defi-usage-survey-the-results-insights-b3481275019b

In the current market, dominated by arbitrageurs and high-risk investors, the volatility also presents similar characteristics: Research by K33 Research shows that from early 2017 to October 2022, Bitcoin’s volatility was higher than that of the Nasdaq and S&P 500 for most of the time, with U.S. stock market volatility only occasionally exceeding Bitcoin’s during extremely sluggish market periods.

Source: https://k33.com/research/archive/articles/volatility-near-6-year-lows

Source: https://k33.com/research/archive/articles/volatility-near-6-year-lows

The two main investor groups in the crypto market might have different yield requirements: For arbitrageurs, “low-risk” investment opportunities are more accessible. For instance, the annualized return rate for Bitcoin perpetual contract funding rate trades has been between 15% and 20% since their inception, a figure significantly higher than the long-term return rate of 5% for the global stock market and higher than the long-term return rates of various types of bonds. High-risk investors, on the other hand, seek returns much higher than those of arbitrageurs.

Therefore, even tokenizing stocks may find it challenging to meet the current market’s user structure and their expected level of returns. In the short term, the risk-return ratio of many RWA (Real World Asset) products seems awkwardly positioned.

V. Regulation: Potentially an Opportunity

In early June this year, the U.S. Securities and Exchange Commission (SEC) announced that several tokens, including BNB, BUSD, and MATIC, would be classified as securities. This declaration raised market concerns about regulation, leading to a noticeable decline in related assets.

If the SEC’s regulatory measures gain recognition from other G20 countries or more, and more tokens are categorized as securities and incorporated into traditional regulatory frameworks, future token issuances on the blockchain might also fall under regulation. Current policies from various regions, such as the United States, Japan, and European Union countries, show a trend towards aligning the regulation of stablecoins with traditional banking practices. It’s conceivable that future token regulations might similarly draw from securities regulation to some extent.

If this scenario unfolds, professionals in traditional finance might feel more confident about moving assets onto the blockchain. The advantage here is that assets are local, yet they can attract global liquidity. This concept has already been embraced by some Real World Asset (RWA) project entrepreneurs. Although limited by geography, with blockchain, they can access global investors. For these professionals, regulated asset tokenization offers two benefits: 1. The ability to tap into global liquidity without geographic constraints, potentially accessing cheaper funds; 2. The opportunity to reach investors with lower return requirements than local ones, increasing project options.

Meanwhile, regulatory measures for users are also advancing: Know Your Customer (KYC). Crypto-native projects only require a wallet for access, but some startups raising funds in primary markets now need KYC to verify qualified investors. Projects incorporating RWAs, like Maple Finance, consider KYC an essential part of customer acquisition. If KYC becomes more prevalent in new projects, a blockchain industry with clearer regulations coexisting with KYC might offer an added benefit: More ordinary investors can enter the market with confidence.

These investors tend to prefer familiar assets but also show some interest in emerging crypto-native assets. Here, RWAs can serve as a significant investment focus for these more mainstream investors.

VI. Possible Development Paths for RWA

In the short term, RWA offers three main benefits to investors in the crypto industry:

1. Low-risk investment options denominated in fiat currency: Currently, the risk-free interest rates in major economies led by the United States have reached levels above 3%, significantly higher than the lending rates in various US dollar-denominated lending protocols in the crypto market. This provides investors with extremely low-risk investment opportunities without the need for additional leverage. Projects like Ondo Finance, Maple Finance, and MakerDAO have launched investment projects based on U.S. Treasury yields, which are highly attractive to investors who settle in fiat currencies. In this area, a project akin to China’s “Yu’e Bao” in the crypto market may emerge.

来源：https://fred.stlouisfed.org/series/FEDFUNDS

1. Diversification of asset risks: Taking Bitcoin as an example, its correlation with gold and U.S. stocks has varied at different market stages.

Source: https://www.theblock.co/data/crypto-markets/prices/btc-pearson-correlation-30d

Even in the years after 2020, driven by macroeconomic factors, there remains a degree of diversification advantage among different asset classes. For portfolio investors, mixing crypto-native assets with various types of RWA can achieve greater risk diversification.

Source: https://www.swanglobalinvestments.com/the-correlation-conundrum/

1. A tool for investors in developing countries to hedge against their national currency fluctuations: In some developing countries, like Argentina and Turkey, where inflation is perennially high, RWA can help investors hedge against local currency fluctuations and achieve global asset allocation.

From these three dimensions, RWAs that are likely to be widely accepted in the medium to short term are those that currently offer high yields and low risks due to interest rate hikes in major economies.

In the long term, with clearer regulatory frameworks, more mainstream investors entering the crypto market, and easier operations within the crypto industry, RWA has the potential to replicate the boom experienced by China’s internet finance a decade ago:

1. Blockchain-based RWA assets offer unprecedented “accessibility” for global mainstream investors: RWAs, being the most familiar assets to mainstream investors, could become their primary on-chain investment targets. For them, the borderless nature and permissionless access and operation of on-chain assets open up a world of global assets for investment and use. Conversely, for entrepreneurs in the field, this provides 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 validated this trend.

2. RWA assets could give rise to new DeFi business models: LSD as a new underlying asset has stimulated the rapid development of LSD-Fi. In this area, not only are past paradigms like asset management, spot trading, and stablecoins revisited, but also directions that were previously overlooked, such as yield volatility. If RWA becomes an important class of underlying assets, the introduction of new and massive off-chain yields could breed new DeFi business models. In the future, RWA can also be combined with crypto-native assets and strategies to form hybrid assets, allowing more users who are willing to explore crypto-native assets to understand them in a more familiar way. From this perspective, the next project with ultra-high TVL in RWA+DeFi might be the “on-chain Yu’e Bao”.

3. The industry’s struggle with regulation will eventually find an answer, and practitioners will find compliant customer acquisition methods: Whether in Western countries or in Hong Kong in the East, regulatory clarity is a major trend. As the crypto industry grows to a size of $10 trillion, regulators will not ignore it. With progressively clearer regulatory policies, we can see that some regions can implement previously unfeasible businesses: stablecoins can now be issued through compliant channels in Hong Kong, and the Middle East is exploring ways to combine the blockchain industry with traditional industries.

In the long run, one of the key factors in the robust growth of the crypto industry is ample liquidity. As regulations are implemented, fiat-collateralized stablecoins and other RWAs will inevitably grow rapidly. Especially under the next round of global liquidity easing, if new players in the market can have strong ecosystem and channel support, compliant fiat-collateralized stablecoins may also replicate USDT’s rapid growth path.

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