Headwinds for RWAs

The last couple of days have been promising in terms of financial institutions championing tokenized Real-World Assets in the media. The CEO of BlackRock, Larry Fink, said in an interview, “ETFs are step one in the technological revolution in the financial markets. Step two is going to be the tokenization of every financial asset.” On top of that, Franklin Templeton handed the reins of their X account to their digital asset team, who posted the following:

One thing is clear, institutions are interested! In my previous post, I highlighted the tailwinds propelling Real World Assets (RWAs) forward, spotlighting both intrinsic strengths and favorable external factors. But, as we peer into 2024, it's important to also acknowledge the headwinds this promising industry faces. These challenges not only require our attention but will chart the course for the strategic growth of RWAs.

Navigating Complicated Legal Structures

The core of tokenization is to establish the bridge between traditional and on-chain finance, enabling on-chain ownership to reflect real-world asset possession while ensuring a robust legal framework for its protection. This can be a complicated process of legal stipulations, which varies wildly across borders. This process isn't just about converting assets into tokens, but weaving through a tapestry of compliance and tax considerations to safeguard stakeholder rights and maintain a delicate equilibrium amidst diverse legal norms. Oversights here can lead to regulatory entanglements and disputes, which emphasizes the need for a nuanced understanding of the legal terrain. This process can be not only financially demanding, with costs ranging from hundreds of thousands to millions of dollars, but also time-consuming. I have yet to hear of anyone getting it done in less than three months. 

Part of the legal complexities come from the diversity of jurisdictions and their nature, including Luxembourg, Liechtenstein, Switzerland, Ireland and Cayman Islands to name a few. These structural implementations have various characteristics, ranging from totally off-chain, hybrid, to fully on-chain. The spectrum of tokenization is a concept that RWA.xyz has done a great job of going into more detail in their report.

Sailing Through Regulatory Fog

The nascent RWA market is sailing through a fog of regulatory ambiguity, facing a large amount of uncertainty due to unclear regulations. Without consistent global guidelines, both investors and issuers are dealing with unpredictability. This lack of clarity not only discourages investment and slows down innovation, but also brings potential legal risks that could cause serious problems for businesses. In this constantly changing regulatory environment, it's important to stay alert and proactive in adapting to new rules. 

Stablecoins play a big role in the RWA industry, and companies like Circle are actively working towards clear regulation, their CEO, Jeremy Allaire, recently shared in an article on CNBC that he believes 2024 will be the year that the U.S. passes concrete laws for the stablecoin industry. There are also pro-crypto governments like Hong Kong who have already made progress, with their government proposing a stablecoin licensing and regulatory regime, you can read about it in more detail in this article by King & Wood Mallesons. Other examples include the EU, UK, and Japan.

Yearning For Liquidity To Arrive

In the RWA market, liquidity often appears as a mirage – enticing yet elusive. Many potential LPs are interested, but most of them choose to watch closely, on the sideline. In a bear market, investors lump RWAs and crypto together, and keep their wallets closed. Then in a bull market, most chase more speculative assets where the upside could be higher, and thus steer past RWAs. To be clear, I believe RWAs will attract liquidity from traditional finance, but that it'll take time. There are a couple of reasons right now for investors to stay put, from the illiquid nature of some RWAs such as real estate and art, to regulatory and legal challenges. The reality is that for most RWAs, only the trailblazer investors are providing liquidity right now, others are waiting for more confirmation. In 2024, we will see projects with hundreds of millions in investments, but not billions, yet. 

Scaffolding The Essential Infrastructure

As much as I would like to claim that we have everything figured out about RWAs, I have to acknowledge that we are still in the early innings. Having secure and well-functioning smart contracts is essential, but it is far from sufficient. Many protocols are still opaque to the investors. People are investing in RWAs through an on-chain vehicle, and it requires a significant lift of confidence to believe that they indeed have the claimed ownership of the assets when something goes wrong. Development in both legal and technology is needed to build a clear and guaranteed linkage between on-chain and off-chain. 

Further, risk underwriting and management are the bread and butter for any credit products in traditional finance. We have witnessed some important lessons by some of the RWA pioneers with defaults that occurred, which made it clear that we need to establish the right infrastructure in various areas like underwriting, asset valuation, ongoing risk monitoring and management, legal compliance, and operational transparency. Constructing this infrastructure lays the foundation for a new era in finance, one that combines the security of traditional assets with the power of blockchain technology.

A Journey To Educate The Market

The journey to widespread adoption of RWAs is hindered by limited understanding in the wider financial market, plus the challenging reputation of cryptocurrency brought on by scandals like FTX. RWAs, which we view as fundamentally different (I discuss this more in my post on Tailwinds for RWAs), need to undergo a thorough process of education. For example, with the success of T-bills in 2023, many people assumed T-bills are all there is when it comes to RWAs, but in reality, T-bills are a small slice of the pie (I will cover different RWA asset classes in the next post). From conversations I’ve had with other RWA players like Sid Powell, CEO of Maple Finance, the sentiment is shared that it takes an army to educate the market. It requires explaining the complexities, outlining the benefits, and creating an environment where trust and knowledge meet. This will pave the way for a future where RWAs are not only well-understood but also recognized as vital elements of a stable and prosperous financial system.

While on the topic of RWA education, I’m planning to continue exploring the topic more in these blog posts throughout 2024, so be sure to follow us on X or LinkedIn to stay up to date. Other educational resources I recommend to get started include The State of Tokenization by 21.co, Citi’s Money, Token and Games Report, and BCG’s Relevance of On-chain Asset Tokenization.

To conclude, my optimism for the future of RWAs is strong. I see it as an evolving industry that is able to overcome the headwinds discussed in this post. With the obstacles in mind, there is no better quote to summarize my view on RWAs and its future than Bill Gates’ quote, “Most people overestimate what they can do in one year and underestimate what they can do in ten years.” I do not expect the world to be tokenized in 2024, but in ten years, I will go with Larry Fink’s statement, “The next generation for markets, the next generation for securities, will be tokenization of securities.” The path ahead may be filled with obstacles, but these challenges will only improve our strategies, enhance our ability to predict future trends, and strengthen our determination.

Note: Special thanks to Zané van Greuning for her insightful contributions. 

Disclaimer: This blog post is for informational purposes only and should not be construed as investment advice.

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