According to a report by leading investment bank Jeffries Group, the NFT market capitalization is expected to exceed USD $80 billion by 2025, more than doubling in value from today. While much of this can be attributed to the non-fungible profile pictures we know and love, a grow...
While much of this can be attributed to the non-fungible profile pictures we know and love, a growing use case for NFTs is the tokenization of Real-World-Assets, or RWAs.
As the digitization of RWAs such as stocks, collectibles, and Real Estate grow in popularity, it’s imperative that we understand both the benefits and risks associated with it.
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How Does RWA Tokenization Work?
At the most basic level, RWA tokenization involves taking an asset and creating a digital twin of it on the blockchain. This can be done in one of two ways – either through the creation of a synthetic version of the asset, or through the ownership and tokenization of an underlying asset.
Let me explain.
Method 1: Synthetic Tokens
Method 2: Tokenizing an Underlying Asset
In this case, Real Estate is tokenized so that it can be bought and sold on the blockchain.
By tokenizing the property into ERC-20 tokens, CitaDAO also fractionalizes it, allowing holders to own a portion of the underlying Real Estate for as little as $1.
Yield (rental income) generated is then used to buy back and burn ERC-20 tokens that represents the underlying property, incentivizing liquidity through fees while theoretically increase the value of the token.
Unlike Synthetic Tokens, these token prices are decided by the free market, instead of on-chain oracles.
Why Do We Need RWA Tokenization?
Beyond Real Estate and commodities, they highlighted mutual funds, carbon credits, and bonds as industries prime for disruption.
But why?
Tokenization comes with a slew of benefits, including lower management fees, the ability to invest regardless of geography, and fractionalization.
Risks of Tokenization
While there are immense benefits to be gained from the tokenization of Real World Assets, it’s not all sunshine and roses in the world of Web3.
For example, what if you tokenize an entire building as an NFT, and your wallet gets hacked? Does legal ownership now transfer to the hacker?
While the abovementioned situation remains a fringe example, let’s consider something else – liquidity crunches.
We’ve seen the disastrous effects low liquidity can have on pegged or even algorithmically-pegged assets during volatile market conditions.
When prices start to fall, users rush to sell their positions, compounding the effect.
This is usually offset by arbitrage opportunities, where an entity is able to redeem the underlying asset and sell it for it’s real value. Using the profits, he can once again purchase the de-pegged asset and repeat the process ad-infinitum, essentially “closing the loop” and causing it’s price to stabilize.
A less extreme example would be the Grayscale Bitcoin Trust ($GBTC).
Shares of $GBTC can be acquired through depositing Bitcoin with Grayscale. Due to this mechanism, the total market capitalization of $GBTC should therefore the value of all Bitcoin deposited with the trust.
While shares of $GBTC initially traded at a premium to Net Asset Value (NAV), they started to trade at a discount toward the end of the 2021 bull run.
As the market continued to decline, the discount to NAV only steepened as uncertainty loomed over Grayscale, and $GBTC holders liquidated their positions.
Protecting Against Liquidity Crunches With CitaDAO
While fungible assets like Bitcoin can easily be redeemed to “close the loop”, it becomes a lot harder for non-fungible assets like Real Estate.
After all, how do you redeem 1/100th of a condominium unit?
The buyout system helps to solve a few major issues present with current tokenized assets:
- Redemption of non-fungible assets
- Incentivizes holders to not sell under NAV
- Reduces costs for redemption, as opposed to buying 100% of circulating supply
This serves to prevent lowball offers from potential buyers, while allowing RET holders a say in the underlying property.
Once the soft-cap is met, the unit will be tokenized in the form of an ERC-20 token. Should the soft cap not be reached, all participants will have their committed amount refunded.
Closing Thoughts
RWAs will be pivotal to the growth of DeFi, and Web3 as a whole.
During the bear market, these aspects of crypto have shined, with “Real Yield” narratives taking the place of inflationary tokens and more speculative assets.
The bond market, for example, is valued at $46 trillion in the US alone, compared to crypto’s approximately $1T market capitalization.
However, the risks associated with smart contracts and tokenization should not be underplayed. Instead, they should be the most important consideration when a project is looking to tokenize a Real World Asset.
“[Editor’s Note: This article does not represent financial advice. Please do your research before investing.]
Featured Image Credit: ChainDebrief