Real World Assets (RWA): In-Depth Market Analysis | Notum

Introduction

RWA (Real World Assets) are assets from the “real”, off-chain world that have been tokenized for using them in the DeFi ecosystem.

Tokenization refers to the process of converting ownership of tangible (cars, real estate, gold) and intangible (stocks, bonds) assets into digital tokens (i.e. on-chain). Basically, any real-world thing that has a monetary value can be represented as an RWA:

Examples of using RWA in DeFi:

• As a real estate owner, I can get a loan in stablecoins against the security of my house;
• As an investor, I can finance business development from the real sector at a certain percentage;
• As an investor, I can trade tokenized ETFs or other financial instruments, etc.

Asset tokenization allows the transfer and storage of digital property rights on the blockchain, which in turn opens up a number of advantages for market participants.

RWA Advantages

Reducing Marginal Cost

The level of capital efficiency in DeFi is significantly higher than in traditional finance, TradFi. This is achieved by reducing the number of intermediaries involved in financial and economic relations. For example, in TradFi there are intermediaries such as banks, brokers, dealers, etc., who charge fees for providing a certain level of guarantees and control. In turn, blockchain technology, and related smart contracts, offer a decentralized solution to the trust problem, which directly affects the final cost of products and services.

So, according to the International Monetary Fund, DeFi has the lowest marginal costs compared to traditional financial institutions. 

• AE - Advanced Economy (Developed markets).
• EM - Emerging Markets (Developing markets).

It proves that RWA, being an integral part of DeFi, opens up access to cost-effective financial products. For example, obtaining a loan secured by real estate will be cheaper directly from the lender than from a bank. Thus, the owner can tokenize his property as an NFT, and take a loan at a better interest rate against the security of this NFT.

Getting access to high-value assets

Asset tokenization opens up opportunities for the so-called fragmentation of property rights - i.e. fragmentation of these rights into many parts. This in turn leads to fractional ownership of the property. Investors share all the profits and losses that ownership incurs.

To illustrate the benefits of property fractionation, here is an example of a house for sale by RealT.

So, let's say, there is a house in Panama that costs $585,580. The house is owned by some LLC. This legal entity issues 11,500 shares at $50.92 each. All shares are tokenized, that is, they are transferred to the blockchain and put up for sale. Each share is converted into an ERC-20 token. Since the main purpose of an LLC is to own specific property, then owning real estate tokens is effectively the same as owning property. An agreement is concluded with a service company that provides real estate management services e.g. renting real estate, cleaning premises, etc. The property itself is for rent. The profit generated from the lease is distributed proportionally among its owners, holders of RWA tokens. Thus, an investor can become a co-owner of a house in Panama for $50.92 and get passive income from renting it out. 

Assets’ liquidity increase

This advantage is a consequence of the factionalization of asset rights. Real estate, factories, and steamships are extremely illiquid assets. Selling an asset worth $1 million can be problematic while selling 1/10, 1/100, 1/1000 of this asset is much easier.

At the same time, it’s quite easy to sell or transfer rights. To sell a share in an apartment, you do not need notaries, waiting in lines, visiting various offices, etc. Instead, it is enough to send tokens from your wallet to the future owner’s one.

Transparency of owning an asset

Asset tokenization leads RWAs to create a transparent, open, and secure environment where ownership is recorded on a blockchain. This reduces the risk of a counterparty, and possible fraud, and increases the security of owning this type of asset.

Alternative channels of passive income

The profitability that investors receive in the majority of DeFi protocols directly depends on the on-chain activity of market participants. So, for example, liquidity providers will earn more if the demand for loans will be increased on lending platforms or if more traders will make exchanges on DEXs. At the same time, on-chain activity directly depends on the current phase of the market. 

RWAs can be seen as a hedging instrument against declining potential returns on DeFi investments during a bear market. RWA investors get exposure to real-world assets with sources of profitability that, in fact, do not depend on the current state of the crypto market.

It is worth noting that all of the above advantages of asset tokenization serve as the basis for creating fundamentally new markets that operate 24/7, without any restrictions or censorship.

RWA Segmentation

RWA projects can be segmented into different types. For example, Jack Chong and a number of other researchers provide the following classification of the RWA sector:

The most famous form of RWA is stablecoins. At their core, stablecoins reproduce the value of the underlying asset (first of all, US dollars), which means they are a kind of “bridge” between DeFi and TradFi. That is why they can formally be considered RWA.

According to DefiLlama, the market capitalization of stablecoins is $125B which is 10% of the total cryptocurrency market. 

87% of the stablecoin market is fiat-backed stablecoins USDT and USDC. Binance, in turn, divides RWA projects into 3 categories:

• Equities projects;
• Real Assets projects;
• Fixed income projects.

Equities/Real Assets Projects

Projects in this category reflect the value of the associated assets (e.g. commodities). Many of these assets are traded on public exchanges, which means they are subject to a high level of regulation. It is precisely because of the high regulatory requirements for trading these kinds of assets that they are not very widespread in the form of RWA. An example is the Backed project, which is engaged in the tokenization of various assets. For example, Backed has a product “Backed CSPX Core S&P 500” (ticker: bCSPX). bCSPX is an ERC-20 token that tracks the price of the iShares Core S&P 500 UCITS ETF USD. Thus, bCSPX is an RWA asset based on the US stock market index.

Fixed-Income Projects

In fact, fixed-income projects are tokenized debt capital markets. They are divided into public and private. At the same time, private debt capital markets are divided into secured and unsecured.

Public Debt

The public debt markets are mainly US Treasuries. At the same time, this market itself is estimated at $665 million. The main players in the market are Franklin Templeton, Ondo Finance, and Matrixdock.

Private Credit

In order to understand how the private debt tokenized capital market works, it is necessary to understand how RWA-lending protocols work.

At their core, protocols of this type allow users to borrow against RWA. Although there are protocols that allow borrowing with small or no collateral at all. These protocols act as a link between the borrower and lenders. On the one hand, there are DeFi users who want to provide their stablecoins to the protocol at a certain percentage; on the other hand, there are users who want to get a loan in these stablecoins using an RWA asset as collateral.

In many ways, the mechanics of how RWA lending platforms work are similar to traditional lending options such as AAVE, Compound, etc. The main difference between them is that in RWA landing protocols a separate Vault (storage) is created for each borrower. Thus, lenders provide liquidity to a specific Vault, and these Vaults themselves are separated from each other.

Another difference is that on traditional DeFi lending platforms, credit pools are managed by smart contracts, while the key metrics of these credit pools are determined by voting. 

At the same time, in RWA lending platforms, a separate manager is allocated for each Vault, who is responsible for providing funds to borrowers. There are different options for how this control might look. For example, in Maple Finance, there are so-called pool delegates who are responsible for checking borrowers, as well as determining the terms of the loan and the liquidation procedure in case of default by the borrower. At GoldFinch, instead of having separate custodians for each pool, there are legal agreements that govern what happens to collateral assets in the event of a loan default.

It is also worth noting that traditional DeFi lending platforms, as a rule, use ERC-20 tokens as collateral, which are fungible and liquid. This means that such protocols can be managed automatically, at the level of smart contracts. It’s different with RWA. Firstly, there is a huge variety of these RWAs, and secondly, they are less liquid and have a lot of individual parameters such as the profile of a particular borrower. That’s why every credit pool acts as a separate isolated storage.

In turn, these features also lead to a liquidation order that is different from the usual liquidations on DeFi lending platforms. So, in many traditional lending services, protocols set a certain LTV (Loan-to-Value) coefficient, which is the ratio of the loan value to the collateral value. Once the LTV limit is reached, the process of liquidating the collateral is launched by selling it on the open market. In this case, the body of the loan and accrued interest for the period are accrued to the lender, the balance is returned to the borrower. 

Thus, the lender returns his investment, and the borrower leaves the loan amount, but loses the collateral. In fact, for the borrower, this situation is tantamount to selling cryptocurrency at the market rate. However, some lending platforms charge the borrower a penalty for meeting the margin requirement.

When the LTV’s max is reached, the process of liquidating the collateral is launched by selling it on the open market. In this case, the loan body and the interest for the period are accrued to the lender. The balance is returned to the borrower. Thus, the lender returns his investment, and the borrower has the loan amount, but loses the collateral. In fact, for the borrower, this situation means selling cryptocurrency at the market rate. However, some lending platforms charge the borrower a penalty for meeting the margin requirement. 

In the case of RWA lending platforms, liquidation decisions are made based on the borrower making payments on the loan. Each vault has its own configuration of credit metrics: interest rate, frequency and amount of payments, etc. In the event that the borrower ceases to fulfill its obligations, the liquidation process is launched.

Another difference is that in RWA lending platforms, the manager of a specific vault communicates with the borrower in order to determine the probability of fulfilling obligations and possible rescheduling of payments. At the same time, RWA cannot be sold as an ERC-20 token on the exchange, so liquidation mechanisms for such protocols also have their own characteristics. 

Part of the RWA lending protocols have specially created funds to cover outstanding loans. For example, TrueFi has a special SAFU (Secure Asset Fund for Users) fund for this purpose. Other protocols have funds that do not cover defaults directly but ensure assets as a priority against losses caused by borrower defaults. For example, GoldFinch has a so-called “Junior Tranche”, a fund financed by deposits from lenders willing to take on more risk in exchange for higher APY.

If a default happens, creditors are deprived of the opportunity to withdraw the investments deposited in the vault. That’s implemented for bypassing the situation when some creditors have time to withdraw their deposit, while others don’t. The vault itself is frozen, and after that, the RWA collateral is sold (usually off-chain). Then the proceeds will be distributed proportionally among the creditors.

Let’s have a look at the dynamics of the private tokenized debt market. According to rwa.xyz:

• Total Loans Value* = $4 429 835 837;
• Active Loans Value* = $552 016 680;
• Current Average APR = 10,61%;
• Total Loans = 1 651.

*Total Loans Value stands for all the loans issued since the launch, including repaid loans.

*Active Loans Value stands for loans that have not yet been repaid.

For example, if I took out a loan for $1 million, repaid it, and then took out another loan in the amount of $1 million, then Active Loans Value = $1 million, and Total Loans Value = $2 million.

The average interest rate that borrowers must pay on these RWA-backed loans is 9-9.75%. This is higher than the average rate for business loans in traditional banks, which is in the range of 5.26 - 11.32%.

Basically, RWA loans are in demand among developing countries, since the national currency in these countries is subject to high inflation. At the same time, obtaining a loan in stablecoins allows you to increase the horizon and quality of planning.

On rwa.xyz you can find the list of all available RWA-Vaults, as well as the conditions that they offer for lenders.

Overview of the Protocols 

Let's take a brief look at the main players in the sector. This section does not aim to dive deep into the nuances of each of the protocols or conduct a full-fledged competitive analysis. Below is a brief description of some of the protocols to get acquainted with them.

Ondo Finance

Ondo Finance is a decentralized investment bank.  Ondo is specialized in the tokenization of financial products such as the U.S. Treasuries, corporate bonds, etc., and the provision of loans using stablecoins. The profit of the protocol is formed by 0.15% of the annual management fee.

Before giving users access to trade their products, they must go through KYC / AML procedures. To date, Ondo Finance offers the following tokenized bonds to investors:

• Ondo Money Market Funds (OMMF): invests in US government bonds and short-term debt instruments for capital preservation with a yield of 4.5%;
• Ondo Short-Term US Government Bond Fund (OUSG): invests in short-term US government bond ETFs (iShares Short Treasury Bond ETF - link). As of the date of this report, it has an APY of 5.13%.
• Ondo Short-Term Investment Grade Fund (OSTB): an actively managed ETF (e.g. PIMCO Enhanced Short Maturity - link), with liquidity (a small part of the portfolio is in USDC and USD). At the moment of writing, it had 5.38% APY.
• Ondo High Yield Corporate Bond Fund (OHYG): invests in high-yield corporate bonds such as iShares iBoxx $High Yield Corporate Bond ETF - link. At the time of this report, it has a 7.76% APY.

Ondo Finance Dune Dashboard

Goldfinch

Goldfinch is a protocol that allows companies to access crypto loans backed by RWA assets. Goldfinch uses Soul Bound Tokens (SBTs), which are non-transferable NFTs, to store the borrower's online identity and KYC/KYB data. SBT tokens function as credit scores.

Let’s say there is a borrower who wants to get a loan. To do this, he needs to create a credit pool, set the interest rate, the purpose of the loan, the procedure for repaying the debt, etc. Then, this application goes to the Auditors for consideration, and if the application is approved, the pool will be “filled” with funds from Lenders and Liquidity Providers. The credit pool itself consists of 2 parts: “Junior Tranche” and “Senior Pool”.

The lender (or Backer) is the one who provides liquidity in the Junior Tranche to a separate pool of the Borrower. Junior Tranche is also called “First-loss capital” - i.e. capital that will bear the loss in the first place in the event of default by the borrower.

Liquidity Provider (or LP)is a participant who provides capital to the Senior Pool. One of the main differences between Lenders and Liquidity Providers is the level of risk they take on and thus the level of APY they receive.

Auditor is engaged in the assessment/verification of borrowers. Anyone can become an auditor by staking a certain amount of $GFI - the project's native token.

Dune Goldfinch Dashboard

RWA: Perspectives and Challenges

According to DefiLlama, the RWA sector ranks 10th in the category rankings for total project TVL. As of the date of writing, the sector's TVL RWA is $960 million.

In turn, the entire cryptocurrency sector is estimated at $1.2 trillion. At the same time, according to Sifma: 

• the fixed income market is estimated at $127 trillion; 
• the real estate market is $362 trillion; 
• the gold market is $11 trillion. 

This suggests that there is potentially huge headroom for the RWA sector for even further expansion.

According to a Boston Consulting Group report, in 2030 the RWA market will be valued at $16 trillion, which will be 10% of global GDP.

It should be noted that at the current moment, RWA also has a number of disadvantages, such as:

• Regulatory uncertainty

Since asset tokenization is a relatively new phenomenon, there is still some regulatory uncertainty around it. This can create problems for both investors and issuers, as they may not be sure how to comply with the rules and exactly what rules apply to tokenization.

• Counterparty risk

While tokenization may reduce the need for intermediaries, it may also add new forms of counterparty risk. By itself, the tokenization of an asset cannot take place without the participation of third parties, since there is no direct connection between the on-chain and off-chain worlds.

Closing Thoughts 

RWA is the bridge between TradFi and DeFi. Many largest banks have already started integrating their financial products into the DeFi ecosystem. For example, Goldman Sachs issued a €100 million digital bond to the European Investment Bank using a private blockchain. Hamilton Lane announced its intention to launch tokenized funds.

Protocols such as MakerDAO and AAVE are already deeply integrated with RWA. MakerDAO has formed a committee to carry out the research and administrative work required to release DAI under the RWA. In addition, over 50% of MakerDAO's revenue is generated by RWA assets.

According to a Celent survey from 2022 — 91% of institutional investors have claimed their interest in investing in tokenized assets.

RWA assets have a number of advantages that open up new opportunities for the market - liquidity fragmentation, an increase in the liquidity of obviously illiquid assets, cost reduction, etc. All this shows that RWA is a fundamental narrative that is based not on speculation but on solving real problems.

Disclaimer: Notum does not provide any investment, tax, legal, or accounting advice. This article is written for informational purposes only. Cryptocurrency is subject to market risk. Please do your own research and trade with caution.