December 2023

Tokenizing Real World Assets

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One theme that has come to prominence this year is the tokenization of real-world assets, also known as “RWA”.  Declining yields in the decentralized finance (DeFi) space have pushed crypto natives towards earning yield through traditional financial products.

To cater to this, there has been an explosion in the issuance of capital market products on-chain, such as tokenized US Treasuries, real estate, and loans to real-world businesses. This month we will dive into what is being done in the RWA space, who the key players are and provide an outlook for where things are headed.

RWA is not a new theme and the idea of “tokenizing” assets arguably pre-dates blockchain technology. Traditional finance instruments such as Real Estate Investment Trusts (REITs) for real estate and Exchange Traded Funds (ETFs) for commodities have been around since the 1990s and have transformed physically limited asset classes into widely accessible and investable products. These products are distributed through centralized issuers, limiting both the demand for these products and how easily they can be created.

When blockchain technology arrived in the 2010s, it became easier for tokenization to take place, with public blockchains providing an immutable record of account that can be mutually verifiable. In the early days of Bitcoin, there were initiatives such as Colored Coins which attempted to tokenize real-world assets, although fell far short of institutional standards. In 2014, the company Tether introduced the first US dollar-backed stablecoin USDT. This became the first significant token that is pegged to the value of fiat currency, a real-world asset. In less than a decade, it has become one of the most successful companies of all time, with profitability that boggles the mind. It is reported that the company could earn more than BlackRock this year, with an estimated USD6bn of net income. Truly remarkable.

The launch of Ethereum in 2015, with smart contract capability, made tokenization easier and more sophisticated, although regulatory challenges remained in the early days. These early days were also so lucrative from a crypto asset appreciation perspective, that few investors were looking for the stable yields that real-world assets could offer. From 2020 onwards Ethereum became the home of a burgeoning DeFi ecosystem, with most of the yields and products remaining tied to digital assets themselves.

In 2022, with total value locked on DeFi approaching USD200bn, traditional finance players started to pay attention to the market that they were missing out on. These TradFi institutions realized the market potential for tokenizing assets and over the last few years have started laying the groundwork on both the regulatory and technological front, to bring RWA mainstream.

Introducing RWA to the digital asset space has benefits on both the demand side and the supply side. On the demand side, there are around USD130bn of outstanding USD stablecoins in the digital asset ecosystem. Tether, the clear market leader, has over USD90bn of outstanding USDT and Circle has USD24bn of outstanding USDC. Holders of these tokens do not receive yield. In 2020 and 2021, this was not much of an issue for crypto natives as interest rates were low and DeFi yields were high. Holders could put their stablecoins to work on platforms such as Compound and Aave and earn yield well above government interest rates and the “risk free rate of return”.

Over the course of 2022 and the digital asset bear market, DeFi yields have come down substantially.  At the same time, interest rates have been rising, meaning that crypto-natives have become interested in using their on-chain assets to access yields that are outside of the digital assets space. There is demand for people holding USD stablecoins to earn US Treasury yields while remaining on-chain. This is the key demand driver for RWA, with crypto asset holders looking to earn yield in non-crypto products. Tokenized treasuries stand at USD800m today and private credit stands at USD570m. Significant growth potential lies ahead, especially considering that there is USD130bn outstanding supply of stablecoins that are not earning holders any yield. It is reasonable to assume that some portion of this stablecoin market would be interested in holding RWA tokens, such as US Treasuries, earning a 5%+ yield.

On the supply side, traditional asset issuers can access a new market of crypto buyers. Tokenization represents a new distribution channel, the only difference being that the client holds assets on a blockchain rather than in a brokerage account. Tokenized treasuries are gaining traction, but this is just the start. Once the infrastructure rails are in place, a new roster of tokenized fund products will hit the market and are likely to gain traction as interest rates start to fall.

There are several key players in the RWA space today. When it comes to offering tokenized treasuries, some of the market leaders include:

  • Franklin Templeton: the institution boasts the largest on-chain fund that is tokenized on the Stellar blockchain. The filing with the SEC states that the fund’s off-chain ledger supersedes the blockchain in case of disputes.
  • Ondo Finance: a stablecoin that wraps a US Treasury bill ETF and passes the interest on to holders. This service is only available to qualified purchasers and the token can only be transferred between whitelisted addresses.
  • Maple Finance: a platform for credit professionals to manage lending businesses, while attracting capital from crypto natives. Maple’s “Cash Management” product has become one of its most popular products and is backed by US Treasuries.

Other large DeFi players are making use of RWA, without offering them directly to customers. For example, the largest DeFi protocol, MakerDAO, now makes over 60% of its revenue from lending out its stablecoin to real-world borrowers. The protocol has deployed USD2.5bn into US Treasuries, which led to profits of over USD90m last year.

While many RWA projects are looking to tokenize assets onto specific chains, such as Ethereum, there are some base layer chains that are looking to “protocolize” the RWA theme itself. Canto (part of our Digital Asset Fund portfolio) is one such Cosmos chain that has doubled down on the RWA thesis. Created in 2022, Canto originally focused more generally on being an experimental chain for DeFi applications with the objective of promoting Free Public Infrastructure. While there was early excitement around the chain, it struggled to attract deep liquidity, stemming from the fact that bridging assets to Canto was slow and clunky. Not being secured by Ethereum as an L2 also limited its appeal, as most DeFi activity and stablecoin assets are on Ethereum.

Earlier this year, Canto transitioned to Canto 2.0, partnering with Polygon Labs to establish an L2 on Ethereum alongside its Cosmos chain. The new L2 is targeting real-world asset integration and what the team calls “NeoFinance”. As part of this drive, Canto has created primitives that include the Canto DEX, the Canto Lending Market and the $NOTE stablecoin, which is backed by USDC and USDT. Canto has tokenized T-Bills on its chain and is attracting users through a carry trade. Using the Canto Lending Market, users can borrow $NOTE against T-Bill tokens. They can then buy more T-Bill tokens with the $NOTE that they are borrowing. In this way, Canto users can get leveraged exposure to T-Bills. With current interest rates at over 5%, Canto users have been able to leverage APR up to 35%.

Another of our portfolio companies that is making it easier to tokenize assets is WalletKit, an investment in our Titan Fund. The focus of WalletKit is to make it incredibly easy for web2 developers to integrate web3 into their applications, which includes incorporating wallets and making it simple for developers to deploy custom tokens. This highlights the evolution of the tokenization process. What started as a complex and cumbersome procedure with Bitcoin Coloured Coins, is now so easy that it can done in minutes through WalletKit’s no code solution and deployed to multiple blockchains.

It has been almost 10 years since Tether first tokenized the USD. In that time, we have seen two market cycles play out and a slow and steady march of institutions moving toward the digital asset space. The growth of the RWA theme is emblematic of the digital asset space growing up. It illustrates that crypto holders are becoming interested in traditional financial products that produce yield, rather than just in speculating on token prices. It also demonstrates that large financial institutions are taking the digital asset market seriously enough to be issuing tokenized products.

Through our digital asset funds, we have exposure to layer-1 protocols that will house much of the RWA infrastructure of the future. These are ecosystems like Ethereum, Solana and Cosmos. We also have more specific investments through platforms like Canto that are focusing on the RWA theme. On the equity side, our Titan Fund will invest in companies that are operating in the tokenization space, with companies like WalletKit making it easy for web developers to integrate tokens and wallets into their applications. We are excited about the inevitable convergence between the real world and the digital, enabled by immutable ledgers and blockchain technology.