In the sphere of finance, we stand on the precipice of an astounding, all-encompassing metamorphosis, rendered plausible by the emergent field of decentralized finance. A closer examination will unveil how this trend is steadily extending its reach beyond the confines of the cryptographic sphere, assimilating conventional financial structures that, in turn, show no opposition to tokenization. Discourse and speculation around the disintegration of boundaries between the two are on the upswing. The quandary, therefore, is why the decentralized finance sector appears to have hit its theoretical nadir? When shall the financial revolution transpire, and what part will Real World Assets play in this grand narrative?The difference between a DeFi and a TradFiDecentralized finance (DeFi) encompasses the financial mechanisms constructed atop blockchain networks.From the annals of history, it is evident that traditional financial systems (TradFi) have perennially evolved within a framework of certain control, regulations, and an interplay with the service sphere, thereby broadening the spectrum of participants involved in financial dealings. Real-world asset transactions are frequently characterized by the involvement of third-party entities such as banks and intermediaries, among others. This provides a modicum of security and conventional stability, yet the trade-off is the inefficiency of transactions and a decrease in their simplicity and convenience. The very raison d&#39;être of decentralized financial systems is to attenuate or entirely eliminate these intrinsic limitations of TradFi.If the internet has instituted a superior standard for the exchange of text, images, and multimedia, DeFi is set to create a more enhanced standard for the exchange of assets.How Tokenized Real World Assets Work?Real World Assets, or &#34;RWAs&#34;, are assets that have a physical existence but are tokenized and transitioned online for utilization within the DeFi sphere.The procedure necessitates the selection of an appropriate asset, which could include:- Real estate - Automobiles - Enterprises - Precious metals such as gold - Government bonds - And other types of tangible and intangible assetsThe next step is to transpose, or tokenize, the asset from the tangible realm to the blockchain network, mirroring current practices, albeit on paper and in traditional registries.<img src="https://academy-public.coinmarketcap.com/srd-optimized-uploads/bdbb23286c3d466a8e78812778934c98.png" />Tokenization can be conceptualized in three stages:IdentificationReal assets that are to be incorporated into DeFi must first be identified in the offline world: detailing what the asset is, its condition and price, proprietors, ownership documentation, etc.Integration into the network/tokenizationAt this juncture, the information accrued during the identification stage is inscribed onto the blockchain, supplemented by legally mandated data and the deployment of oracles — protocols that will mirror the true value of the asset according to external sources.RWA Management ProtocolA protocol is established to oversee all processes associated with the disposition of the asset.Although RWAs in sectors such as real estate are in existence, for instance, the RealT company in the U.S., their popularity and demand are currently underwhelming. In contrast, the domain of private lending built within the DeFi sphere is gaining traction, even becoming a trend for the current year.Lending ProtocolsThere are several protocols that constitute the RWA private lending markets. These can be bifurcated into two groups: those offering asset-backed (or secured) private credit or unsecured private credit.Asset-backed private credit protocols, such as Centrifuge, Goldfinch, or Credix, foster private credit markets by utilizing a methodology typical of DeFi. In the likeness of other cryptocurrency loan/credit protocols, the borrower selects a cryptoasset to borrow, provides collateral, and remits interest to liquidity providers. The primary point of departure between cryptocurrency loan/credit protocols and RWA asset-backed private loan protocols is that the collateral employed is not a cryptocurrency, but a real-world asset such as real estate or another type of RWA.By permitting borrowers to secure their loans with tangible assets rather than cryptocurrencies, asset-backed protocols have broadened access to cryptocurrency capital for most companies and organizations globally, especially those located in African nations. DeFi&#39;s asset-backed protocols have proven notably beneficial for borrowers lacking access to traditional financial markets.Conversely, there exist other protocols or companies that do not mandate RWAs as collateral but instead analyze the creditworthiness of prospective borrowers in both the Web2 and Web3 spheres. Specifically, the new Masa Finance protocol warrants mention. After collating all pertinent user information, access is granted to a select list of DeFi applications on the web that the user is approved to access and interact with.Albeit bearing semblance to another conventional financial entity akin to a bank or lending institution, it is worth acknowledging that such protocols advance towards the popularization and evolution of DeFi. Herein, certain bureaucratic procedures, workforce maintenance costs, geographical site accessibility, et al., are eschewed.Individually, it behooves us to emphasize the following protocols that confidently champion the use of RWA in DeFi.MakerDAOAn Ethereum-based collateralized debt platform, MakerDAO, has arguably made the most strides in terms of RWA adoption.MakerDAO empowers borrowers to deposit collateral assets into &#34;vaults&#34; (smart contracts), enabling them to borrow in DAI stablecoin. Provided the collateral value remains above a certain threshold, the borrower maintains complete control over their collateral. Conversely, if the collateral value decreases and becomes undersecured, the vaults automatically liquidate the collateral through an auction process, ensuring the loan repayment in a mutually beneficial manner.To date, more than $680 million has been concentrated in such vaults. Interestingly, about $500 million is collateralized in the form of U.S. Treasury bonds managed by Monetalis, and a distinct vault accumulates the assets of Société Générale, which borrowed $7 million from MakerDAO in a position backed by €40 million in AAA-rated tokenized bonds.CentrifugeThis structured credit protocol of DeFi, Centrifuge, emulates the structured loan process from TradFi to DeFi and leverages the resulting securities as collateral, facilitating borrowers to secure cryptocurrency-denominated debt.Centrifuge has facilitated the creation of debt pools backed by structured credit assets such as pooled mortgages, microloans, consumer lending, and others. Centrifuge aggregates all of its varied debt offerings into a decentralized marketplace for RWA pools, dubbed Tinlake. Fundamentally, Centrifuge&#39;s protocol can be viewed as a comprehensive solution for tokenizing structured credit and loan origination.Centrifuge&#39;s noteworthy attribute is its pioneer status in incorporating transcription into its contracts. Tranching in TradFi enables investors to access diverse types of risk and return on the same asset class. In the event of default, the senior tranches are compensated first; hence, they embody less risk and lower returns than the junior tranches.GoldfinchThis protocol, Goldfinch, assists businesses, predominantly in emerging markets, in accessing cryptocurrency lending without necessitating cryptocurrency collateral. Instead, the loans are secured by RWAs. Consequently, Goldfinch enables practically any business to procure cryptocurrency loans. A cryptocurrency-denominated loan can be immensely advantageous to businesses in emerging markets if their native country lacks adequate financial infrastructure or if their home currency is susceptible to depreciation.Goldfinch has currently disbursed over $120 million in RWA-based loans to businesses in emerging markets.Goldfinch employs a unique method of vetting businesses that can become borrowers on their platform. The so-called &#34;auditors&#34; are users of the Goldfinch platform who stake Goldfinch&#39;s proprietary token, GFI, enabling them to vote on whether a borrower can open a credit line on Goldfinch.<img src="https://academy-public.coinmarketcap.com/srd-optimized-uploads/e13b0ae975724afa8c928892bcf998ec.jpg" />These enterprises are performing well in the market, yet they inhabit such a minuscule market segment that they are incapable of effecting a fundamental change in the approach to tokenizing tangible assets.As illustrated in the TVL graph below from Defilama, the total amount of locked funds in the DeFi sector is just over $50 billion, and a mere couple of billion of that sum is tokenized RWAs.Consider this: tangible assets constitute a significant fraction of global financial value. The value of global real estate in 2020 was a staggering $326.5 trillion, and the gold market capitalization stood at $12.39 trillion. Thus, the tokenization of RWAs amounting to even a few billion dollars is virtually indiscernible..What is the problem with tokenization?It is an innovative technology, whose implementation necessitates legal adoption and, consequently, regulatory innovation for this financial instrument. Regulatory challenges have also emerged as a trend in 2023 and signify that there exists no unified approach to the adoption and regulation of cryptocurrency worldwide: we witness the measures of the SEC, which has no inclination to adapt the outdated legislation, juxtaposed with the actions of the Hong Kong regulator, which provides a different control system, more congenial to the Web3 world.1. The governance of real world assets may prove intricate due to disparities in legislative constructs across nations. Such assets could fall under the jurisdiction of diverse regulators, thereby rendering the tokenization process and regulatory compliance convoluted.However, it must be acknowledged that regulation and oversight are inalienable prerogatives of sovereign states and subsidiary institutions that none would voluntarily relinquish.2. Difficulties arise not solely within the legal sphere but also in the confluence of the cryptocurrency realm with the tangible world, particularly concerning the mechanisms of enforcement and liquidation of positions collateralized by real world assets. The procedure isn&#39;t as swift as the liquidation of cryptocurrency assets and necessitates the institution of suitable procedures and mechanisms.In the event of borrower default or breach of contractual obligations, it may be challenging for RWA token holders to enforce their rights and reclaim the pledge. This could necessitate complex legal procedures and litigation.3. Tokenizing RWA necessitates precise asset appraisal and validation. This could be a protracted and expensive process, especially for specific asset types such as real estate or debt instruments.4. The integration of RWAs into the blockchain milieu requires the development of technically advanced solutions to connect traditional assets to digital tokens. This could pose a barrier to the widespread adoption of real world asset tokenization. Here, careful consideration needs to be devoted to the customization of RWA and Oracle protocols. Technological evolution demands identity verification in both the Web2 and Web3 worlds, and such projects are either nascent or in their early developmental stages, thus failing to provide a quality, reliable, and secure product for all users.5. Despite the fact that the DeFi sector has been evolving for several years, its comprehension and technologies remain subpar. Many market participants, including investors and businesses, may not be adequately cognizant of the opportunities and benefits proffered by tokenizing real-world assets. Propagating knowledge about DeFi and attracting fresh participants to the market necessitate substantial educational and awareness efforts.The halcyon days of easy DeFi returns are bygone, and the industry has now reached a juncture where DeFi yields are almost commensurate with TradFi yields. Given the lower risk embodied by the TradFi market, DeFi participants have commenced their exodus from DeFi, channeling their capital towards the TradFi market for superior risk-reward.Despite these hurdles and limitations, the tokenization of real world assets furnishes considerable opportunities for DeFi, such as tapping into new capital sources, diversifying risk, and forging novel investment opportunities.Unquestionably, real world assets within the traditional financial industry are prodigious. However, these assets are scarcely utilized within the DeFi world. This offers a prospect to amalgamate tangible assets into the DeFi industry, augment available liquidity, and present DeFi participants with a novel asset class they can leverage to generate investment returns.It is RWAs that hold the potential for an astounding and transformative impact on the DeFi sector presently and in the imminent future, fostering greater interoperability with external markets and bridging the chasm between decentralized and traditional financial systems.The primary impetus behind the migration of real world assets to the blockchain is the belief that, in the long run, DeFi will offer asset owners unique opportunities and market efficiencies unattainable within traditional financial systems.The successful evolution of this trend necessitates surmounting the aforementioned obstacles and fostering collaboration amongst regulators, developers, and market participants.<img src="https://academy-public.coinmarketcap.com/srd-optimized-uploads/0e51d46736804d0587776f235e2bc7b6.png" />The article was prepared by Listing.Help. If you are interested in learning about cryptocurrencies and exchanges, then we invite you to visit <a href="https://listing.help/blog" rel="noopener noreferrer nofollow">our blog</a>, where you will find many related articles.

What are Real World Assets in Crypto? Why do we need RWA?

Sergei Khitrov

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