The Emerging World of RWA

Blockchian tech has opened the world to real world assets (RWA), one of crypto's killer use cases.

Since the 1990s, it has become increasingly evident that software is eating the world. Said differently, the ability of bits and bytes to transform how information is stored, sent, and received has enabled virtually every industry to be disrupted in one capacity or another. While some have been disrupted sooner than others, the rise of blockchain technology has allowed traditional finance to be disrupted for the first time in history.

More specifically, blockchain technology has opened the world to real world assets (RWA), or the tokenization of assets that exist in the real world that can serve as collateral in Decentralized Finance (DeFi). Under this new paradigm, new markets will surface while existing markets will become larger, more efficient, and transparent thanks to the autonomy and openness of blockchain technology. However, as we see it, the world has yet to realize that RWA represents a $32T opportunity come 2031 and could become the largest and most useful application in crypto.

In this report, we take a deep look into real world assets, their usefulness, why they matter, their expected growth, key players, the opportunities at hand, and potential headwinds. Unfortunately, the vast majority of the general public has yet to truly understand the potential of RWA and their future. But after reading this report, anyone can expect to understand better why RWA will become the largest crypto sector and why it’ll bridge the gap between crypto and traditional finance.

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So, What Are RWA?

Simply put, real world assets (RWA) are assets that exist in the world that are represented and entitle ownership on a blockchain by way of a digital token. Amongst all, by digitally representing assets via an open-source, trustless blockchain that can securely record, store, manage, and transmit all transactions, efficiencies can be realized, and markets can be created. Furthermore, in a world where asset ownership, transfer, and sale is ripe with inefficiencies, human error, and fraud, RWA presents a unique opportunity for these assets to be better used, stored, and tracked.

It’s worth noting that RWA is exclusive to the tokenization and integration of physical assets into the DeFi ecosystem, as well as the tokenization of yields from productive assets that are used in the economy, such as capital markets type assets that come from credit facilities, corporate borrow/lending, revenue-based financing, mortgages, and more.

One of the most obvious opportunities within the world of RWA is real estate, which is a $3.7T market as of 2021. However, real estate ownership, sale, and collateralization have long been based on rules and regulations that a judge or court has determined. As a result, the market has been built on top of financial institutions and government enterprises with substantial influence and control. On top of that, real estate is one of the most fragmented and inefficient markets thanks partly to intermediaries that belabor asset exchanges and introduce additional costs.

By bringing real estate assets on-chain, many of the tasks involved in a transaction can be autonomous and unrestricted. Also, a record of ownership and transfer can be seamlessly and affordably recorded, thereby eliminating the possibility of fraud and human error. In turn, it becomes cheaper, easier, faster, and more accessible to buy, sell, trade, and cross-collateralize real estate, among other things. For instance, a business operating in the commercial real estate industry looking to issue debt to expand its operations can tokenize its bond offering and take out a fixed-rate loan from a pool of lenders or stablecoin issuer.

But as previously mentioned, real estate isn’t the only real world asset that can be tokenized on the blockchain. RWA includes, but is not limited to, real estate, emerging markets, revenue-based financing, trade finance, insurance, synthetics, treasuries, agriculture, ReFi, infrastructure finance, portfolio management, and collectibles. ‎ ‎

Why Does RWA Matter In DeFi?

With financial services and, more importantly, the multi-decade-old asset securitization process having yet to be disrupted, the advent of RWA introduces a plethora of benefits for several multi-trillion dollar asset classes. Unfortunately, financial markets currently have larger than necessary borrowing costs due to third parties that sit in the middle of the securitization process, such as investment banks, rating agencies, trustees, and more. Not to mention, many market participants and businesses are restricted to their local jurisdiction because international financing is restricted to a select few. In both instances, individuals and the broader economy are worse off.

For this very reason, the technological advantages of RWA and set to not only disrupt traditional finance but meaningfully accelerate the adoption of DeFi and, as a result, bridge the gap between traditional finance and cryptoassets. The benefits of RWA include the following:

Increased Transparency: With assets tracked on-chain, anyone can identify who owns which asset, when it was last traded, who bought/sold said asset, and how it has been used.

Reduced Costs: Because assets can be autonomously transferred between parties by way of a smart contract and stored on an immutable ledger, there is little need for an intermediary to take a cut. Not to mention, instant transfer means counter-parties can reach settlement in a timely manner.

Improved Liquidity, Market Efficiency, & Price Discovery: By reducing the frictions associated with asset sales, transfers, and record-keeping, assets that were once illiquid can seamlessly exchange hands at nearly zero cost. As a result, these assets become more liquid, and markets become more efficient since it’s easier for buyers and sellers to trade hands and price in new, relevant information.

New Markets & Participants: The tokenization of assets on-chain allows once illiquid assets to move across DeFi seamlessly, new markets, financial products, and offerings can be born. With RWAs being highly composable, new and existing market participants can access uncorrelated, stable returns that otherwise wouldn’t exist/be available.

Enhanced Capital Efficiency: With RWA, market participants can enhance the capital efficiency of their assets by posting them as collateral to access capital much faster and more cheaply than going through a traditional financial institution. These same participants also can set the conditions of a loan agreement and decide when to issue debt.

The benefits of RWA are rather obvious, and the sector’s future certainly appears to be, at the moment, brighter than most others. But while it may seem that the broader market has yet to wake up to the reality that RWA presents a unique opportunity that could disrupt markets, institutional investors are becoming increasingly more aware of their potential. For instance, a recent study conducted by BNY Mellon showed that tokenized products are popular among institutional investors. After polling 271 institutional investors, BNY Mellion found that more than 90% of the respondents said they would be interested in putting their money into tokenized products. Survey results noted, “91% of respondents expressed interest in investing in tokenized products. Benefits of tokenization include removing friction from the transfer of value (84%) and increasing access for mass affluent and retail investors (86%). Every asset manager surveyed with more than $1 trillion assets under management (AUM) is interested in investing in tokenized products.”

But while some market participants remain optimistic over the tokenization of real world assets, others have sprung into action. That is to say, the potential future adoption by crypto-native and traditional financial market participants has been validated by many large participants coming to market to capitalize on what they see as a major technological advancement and disruption. Some of the more noteworthy developments to date include the following:

Apr. 2019: Societe Generale, one of France’s largest financial services groups, issues €112M worth of bonds on Ethereum. Approximately 100M OFH tokens were minted to represent covered bonds with a 5-year maturity and a 12-month extension period.

May 2020: Societe Generale issues a second covered bond Security Token issuance worth €40M and settled in Central Bank Digital Currency (CBDC) issued by Banque de France.

Jul. 2020: MakerDAO, the decentralized autonomous organization behind the Maker protocol, approves its first credit facility loan with New Silver.

Jan. 2021: MakerDAO approves its second-ever credit facility loan with Fortunafi.

Apr. 2021: Societe Generale launches the first structured product as a Security Token on the Tezos Blockchain.The European Investment Bank, the lending arm of the European Union, issued €100M in 2-year digital notes on Ethereum.

Jun. 2021: MakerDAO partners with Centrifuge, a DeFi protocol bringing structured credit onto the blockchain, to onboard Centrifuge’s DROP tokens as collateral, including tokenized freight invoices & trade financing solutions through ConsolFreight’s CF-DROP token, rented farm properties through Peoples Company’s Series 1 P1-DROP token, trade credit through The Harbor Trade Credit’s HTC-DROP token, revenue-based financing through Fortunafi’s FFT1-DROP token, and real estate-backed loans through New Silver’s NS2DRP token.

Sept. 2021: Cryptoasset manager Arca partnered with Securitize to launch a tokenized U.S. Treasury fund on Ethereum that is structured like a mutual fund and adheres to the same regulation.

Dec. 2021: Digital asset banking platform SEBA issues a gold-backed stablecoin (SGT). Token holders are eligible to redeem their tokens for gold at any point.

June 2022: MakerDAO allocates $400M and $100M worth of DAI into U.S. short-term treasuries and investment-grade corporate bonds, respectively.

Oct. 2022: Vera Labs, the company behind the Vera DeFi protocol that enables rentals, lending, and buy-now-pay-later for NFTs on any blockchain, signed an exclusive agreement with Lux Partners to bring precious metals and resources on-chain. The partnership started with Vera Labs helping Lux Partners issue uranium-backed NFTs.

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Sizing Up The Opportunity

Despite RWA being a relatively small part of crypto, adoption has started to gain traction over the past few years. Adoption has been remarkable over the past two years, with total value locked (TVL) climbing from roughly $20M to more than $360M. However, as impressive as the growth has been, we believe RWA adoption is just getting started.

We believe that come 2031, RWA will represent a $32T opportunity. Our estimate is largely considerate of the average annual growth rate of global wealth, as well as the adoption rate of the internet. Given the nature of RWA, we predict that a share of the global wealth, both illiquid and liquid assets, will be tokenized over the next decade. We also assume that RWA adoption will follow in the same footsteps as the internet.

If we break our estimate down further, we find that since 2000, global wealth has been growing, on average, by 6.5%.12 Given unprecedented dovish monetary policy over the past several decades, coupled with ongoing geopolitical issues and macroeconomic headwinds, we conservatively extrapolate out 2021’s global wealth of $463.6T by an average annual growth rate of 3.25% for 10 years - resulting in an implied global wealth of $638.3T in 2031.

Assuming that RWA adoption grows at the same pace as the internet, given that significant technological innovation built on top of the internet experience the same kind of exponential growth, RWA will have achieved a penetration rate of 5% come 2031. With global wealth at $638T in 2031, we’ll find that a 5% penetration equates to $32T.

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How RWA Gains Momentum

Clearly, the opportunity for RWA is one of, if not the largest, opportunity in all of crypto. But while ripe with opportunity, we have yet to see RWA adoption take-off. Although there are several headwinds for RWA, as we outline later in this report, it’s worth noting that the biggest challenge for RWA isn’t just originating and underwriting RWA on-chain in a legally compliant manner, but much like central banks, providing balance sheet liquidity. As shown below, we define this segment of RWA as Layer 4 of The RWA DeFi Stack. Though one could argue that Layer 1 is the most important layer since it dictates the viability and usefulness of all other layers, which range from securitizing and tranching RWA NFTs, providing peer-to-peer (P2P) liquidity and offering balance sheet liquidity, RWA will not be able to gain mass adoption without a protocol that can act as a cross-chain financial ecosystem that provides balance sheet liquidity.

To date, RWA have been able to get to where they are thanks to a handful of market participants competing in Layers 1, 2, and 3 of The RWA DeFi Stack. But as we see it, RWA will experience its next leg of growth from the expansion of new opportunities in Layer 4. As of today, Maker protocol is the de facto leader in Layer 4 of The RWA DeFi Stack. However, we anticipate several new protocols to come to market and compete in that segment, thereby advancing the development and adoption of RWA.

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Industry Players

Despite still being so early to RWA, several market players have emerged over the past few years that are looking to take a bite out of what will be the largest opportunity in all of crypto. Although each is unique in terms of its offerings, target demographic, risk management, and liquidity sourcing, all are focused on accelerating the adoption of RWA and unlocking new efficiencies, opportunities, and markets.

The RWA sector can be segmented into collateralized lending (asset-backed lending to financial institutions) and uncollateralized lending (primarily non-recourse lending to market makers as of today). In our view, RWA growth will largely come from collateralized lending for the foreseeable future. This is because the idiosyncratic risks, market structure, and tech design unique to crypto makes uncollateralized lending riskier than uncollateralized lending in traditional financial markets. Though this may change, we believe uncollateralized lending is not an aspect of RWA that will see outsized demand, particularly given recent events showcasing the perils of uncollateralized lending. For example, on Dec. 3, 2022, Maple Finance cut ties with Orthogonal Trading due to the alleged misrepresentation of finances after FTX’s collapse. The move came after creditor M11 Credit issued a default notice to Orthogonal Trading for $36M of loans.

Collateralized Lending

CentrifugeBuilt on top of Parity Substrate in Apr. 2020, Centrifuge is a DeFi platform that facilitates the decentralized financing of real-world assets through an on-chain securitization process. All real world assets deployed on Centrifuge are fully collateralized, and liquidity providers have legal recourse in the event of default. The platform is asset-class agnostic and has pools for assets including, but not limited to, mortgages, invoices, micro-lending, and consumer finance. At its core, Centrifuge is concentrated on lowering the cost of capital to borrowers via greater transparency and access to liquidity by way of its on-chain securitization, tokenization, privacy, governance, and liquidity integration. Debt on the Centrifuge protocol is tranched into senior (DROP) and junior (TIN) tokens. Centrifuge’s native token (CFG) is used as an on-chain governance mechanism that empowers holders to manage the development of the Centrifuge Protocol.

Deployed On: Ethereum, Polkadot
Key Borrowers: 1754 Factory, Branch, Cauris, Fortunafi, Harbor Trade, New Silver, REIF
Total Value Locked (TVL): $80M
Native Token: CFG

Credix FinanceAvailable in Brazil and soon elsewhere in emerging markets, Credix Finance is a decentralized credit marketplace that connects banks and hedge funds with credit fintechs and non-bank lenders seeking to raise capital. The protocol handles the underwriting, meaning institutional investors can access higher lending rates with less risk. Loan originators can borrow USDC using their off-chain loan book as collateral. On Nov. 1, 2022, Credix Finance announced a $150M stablecoin credit pool to digital lending platform Clave to originate loans to businesses and consumers in Latin America.

Deployed On: Solana
Key Borrowers: A55, Adiante, Clave, Divibank, Tecredi
Total Value Locked (TVL): $26M
Native Token: N/A

GoldfinchAlthough initially targeting emerging market lending, Goldfinch has become a global, decentralized credit protocol concentrated on bringing the world’s credit activity on-chain and improving access to capital through unsecured lending. Goldfinch seeks to minimize the riskiness associated with unsecured lending by leveraging a coordination protocol to assess risks and allocate capital. The protocol was created so potential borrowers can demonstrate their creditworthiness based on the collective assessment of other participants instead of over-collateralizing their loans with cryptoassets. Protocol backers, or investors who supply USDC to Borrower Pools, are tasked with monitoring the health of pools and providing liquidity. Because their liquidity is lost in the event of default, incentives are aligned to incentivize Borrower Pools to monitor accordingly.

Deployed On: Ethereum
Key Borrowers: Addem Capital, Almavest, Aspire, Cauris, Divibank, Lend Eat,
QuickCheck, Stratos, Tugende
Total Value Locked (TVL): $102M
Native Token: GFI

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Uncollateralized Lending

ClearpoolLaunched in Mar. 2022 on Ethereum, Clearpool is a permissionless marketplace for unsecured institutional liquidity. The protocol attempts to feed liquidity into capital markets for borrowers and lenders utilizing crypto while providing a return for investors hunting moderate yield. Institutions interested in borrowing on the Clearpool protocol must complete a KYC review, pass real-time risk scoring measures, and be willing to stake solely in CPOOL. Clearpool also offers permissionless pools where capital can be lent directly to whitelisted institutions (with a zero lock-up period) by connecting a Metamask wallet. To manage risk, Clearpool has created and deployed an on-chain risk management system to enable lenders to monitor, manage, and hedge unsecured lending in real time.

Deployed On: Ethereum, Polygon
Key Borrowers: Auros, Wintermute
Total Value Locked (TVL): $7M
Native Token: CPOOL

Maple FinanceSince 2021, Maple has offered under-collateralized lending for permission KYC loans to institutions. Although under-collateralized, Maple Finance users can loan funds out to key industry players with longstanding, reputable reputations and are well-capitalized. Maple's protocol is governed by holders of MPL and xMPL, who can earn a share of revenue fees and use tokens to provide liquidity to Lending Pools for an additional yield. Aside from lending and/or borrowing, users can become pool delegates to manage a liquidity pool. Delegates are responsible for negotiating loan terms with borrowers, performing diligence, and liquidating collateral in the event of a default. Delegates are also in charge of evaluating a Borrower's reputation, expertise, and performance and reaching an agreement with borrowers regarding the loan's interest rate and collateral ratio. Upon completion, Pool Delegates fund the loans from their managed Pool.

Deployed On: Ethereum
Key Borrowers: M11 Credit & Orthogonal Trading
Total Value Locked (TVL): $104M
Native Token: MPL, xMPL

RibbonRibbon is a crypto-structured products platform that combines derivatives, lending, and its proprietary on-chain options exchange to be a one-stop solution for users who seek to improve a portfolio's risk-return profile. Although not as RWA-centric as other industry players, Ribbon launched its unsecured lending offering in October 2022. Ribbon Lend allows platform users to generate higher yields via unsecured lending to institutions that have been evaluated for their creditworthiness by Credor, an end-to-end lending solution facilitating credit by validating real-time risk metrics through zero-knowledge proofs to protect and validate sensitive information. Ribbon’s native RBN token is a governance token and can be used to vote on the platform's future.

Deployed On: Ethereum
Key Borrowers: Folkvang, Wintermute
Total Value Locked (TVL): $18M
Native Token: RBN

TrueFiBuilt on Ethereum and Optimism, TrueFi is a credit protocol concentrated on unsecured real-world and crypto-native lending. The protocol is powered by on-chain credit scores and governed by holders of their native TRU token. Currently, most of the lending on TrueFi is to industry market makers and investment funds pursuing a market-neutral arbitrage strategy. The protocol was founded on the belief that on-chain, collateral-free lending will ultimately exceed DeFi’s existing collateralized lending market since uncollateralized lending provides an opportunity for lenders to earn higher long-term returns and for borrowers to improve their capital efficiency.

Deployed On: Ethereum
Key Borrowers: Cauris Finance, END Capital, NeoFi, WOO X, USDC.homes
Total Value Locked (TVL): $29M
Native Token: TRU

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Opportunities & Headwinds

As obvious as it may be that RWA has the potential to disrupt asset classes worldwide, many opportunities exist within the world of RWA that could ultimately separate the industry leaders from the laggards. However, we understand that by capitalizing on the opportunities listed below, the market benefits from a more refined and competitive industry. Some of these opportunities include:

Redefining the securitization process from the ground up enables assets to move on-chain, be created on-chain, minimize friction points, reduce costs, and remove the need for human intervention.

Acting as the bridge for traditional institutional investors who are not crypto-native entities and have little experience with what is set to be a new technology stack for TradFi.

Creating a RWA-backed stablecoin that is sufficiently decentralized, stable, capital efficient, and backed by the highest quality collateral on-chain.

Building and deploying a RWA borrow/lending protocol that is sufficiently decentralized yet designed from the ground up to have the proper governance needed to adapt to changing market conditions and industry developments.

Standardizing a Proof-of-Reserves audit whereby RWA market participants can see in real time a protocol's assets, liabilities, and equity such that the general public can be reassured that protocols are well-capitalized and functioning as promised.

Though the future of RWA is undoubtedly bright, there are many headwinds and challenges that the industry will have to overcome to be as disruptive as possible. Some of these challenges may be tougher and take longer to overcome than others, but we believe only some of them could ultimately threaten the potential of RWA. As we see it, it is only a matter of time before RWA eats traditional finance. Therefore, it's still worth being cognizant of these potential roadblocks to understand what stands in the way of mass adoption. Some of these challenges include, but are not limited to, the following:

For most regions of the world, regulators have yet to provide guidance specific to RWA. It’s for this reason that there is a risk that regulatory actions negatively affect existing RWA players and/or the industry’s potential.

Settling collateral in the event of default needs to be more efficient and is largely untested. Until liquidations occur on-chain, RWA will be burdened by the off-chain settlement process.

Although information can be shared on-chain and routinely updated for zero cost, there remains the risk of fraudulent accounting. Therefore, new industry standards, be it Proof of Reserves or 3rd party auditing, must exist to ensure no fraudulent activity in RWA. Otherwise, the adoption and success of RWA could be impaired by bad actors.

The need for KYC for certain jurisdictions may limit the industry’s growth rate, as some market participants may not be eligible or have no interest in completing KYC.

High-volume, cash-flowing assets brought on-chain will require a well-capitalized 3rd party to facilitate the transfer of funds while servicing the on-chain assets. Otherwise, reliance on a handful of small start-ups limits the reach, scale, and usefulness of RWA.

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Conclusion

More often than not, it's in retrospect that what was once an idea was truly a sleeping giant. However, the evidence supporting the idea that real world assets are a multi-trillion dollar opportunity is unprecedented. Moreover, as we've shown, RWA is set to be the next frontier of crypto thanks to its underlying technology, the inefficiencies of traditional financial markets, and the broader trends of what continues to be an increasingly digital world. Undoubtedly, the mass adoption of RWA has its challenges. But the opportunities at hand will surely drive new and existing market participants to overcome said challenges and bring RWA mainstream.

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Disclaimer: The information contained herein is general information, intended for educational purposes only, and is not intended to constitute legal, tax, accounting, or investment advice. Information, opinions and views are solely of Fortunafi and none of the information contained should be used as the basis for an investment decisions. To ensure suitability, contact a licensed investment professional when making any investment decisions and do your own research.