This article conducts an in-depth discussion and analysis of the current situation and future of RWA.
Written by: Spinach Spinach, Research Director of Ample FinTech; Annabella: CMO of zCloak Network
The most eye-catching issue in the blockchain field in 2023 is undoubtedly the tokenization of real world assets (Real World Asset Tokenization, RWA). This concept has not only caused heated discussion in the Web3 world, but has also been highly valued by traditional financial institutions and government regulatory agencies in many countries, and is regarded as a strategic development direction . For example, authoritative financial institutions such as Citibank, JPMorgan Chase and the Boston Consulting Group have successively released their own tokenization research reports and actively promoted related pilot projects.
At the same time, the Hong Kong Monetary Authority clearly stated in its 2023 annual report that tokenization will play a key role in Hong Kong's financial future. In addition, the Monetary Authority of Singapore, together with the Financial Services Agency of Japan, JPMorgan Chase, DBS Bank and many other financial giants, have jointly launched an initiative called " Project Guardian" to deeply tap the huge potential of asset tokenization.
Although the topic of RWA is in full swing, according to the author's observation, there are differences in the industry's understanding of RWA , and discussions surrounding its feasibility and prospects are also quite controversial. On the one hand, some people believe that RWA is just market hype and cannot withstand in-depth discussion; on the other hand, there are also people who are full of confidence in RWA and optimistic about its future. At the same time, articles analyzing different perspectives on RWA have sprung up.
The author hopes to share his cognitive perspective on RWA through this article and conduct a more in-depth discussion and analysis of the current situation and future of RWA.
Limited to personal knowledge, the contents of this article are all personal opinions. If you have any questions, please point them out for discussion.
Word count: This research report exceeds 28,000 words and covers a wide range of topics. Please read it patiently.
Core ideas:
- Crypto's RWA logic mainly revolves around how to transfer the income rights of assets that generate income (such as the income rights of U.S. debt, fixed income, stocks and other assets) to the chain, and put off-chain assets on the chain to mortgage loans to obtain on-chain assets. liquidity and moving various real-world assets onto the chain for trading (such as sand, minerals, real estate, gold, etc.), which reflects the crypto world’s unilateral demand for real-world assets. In terms of compliance, There are many obstacles.
- The future key development direction of Real World Asset Tokenization will be a set of DeFi technologies based on the Permission Chain promoted by traditional financial institutions, regulatory agencies, central banks and other authoritative institutions. A new financial system , and what is needed to realize this system is a computational system (blockchain technology) + non-computational system (such as legal system) + on-chain identity system and privacy protection technology + on-chain legal currency (CBDC, public currency) Certified deposits, legal stablecoins) + complete infrastructure (low-threshold wallets, oracles, cross-chain technology, etc.).
- Blockchain is the first technical means to effectively support the digitization of contracts after the development of computers and networks. Therefore, it can be said that the blockchain is essentially a platform for digital contracts, and the contract is the basic expression form of assets , and the token is the digital carrier of the assets after the contract is formed. The blockchain therefore becomes the digital expression/pass of assets. Certified expression, that is, the ideal infrastructure for digital assets/tokenized assets.
- As a distributed system jointly maintained by multiple parties, blockchain supports the creation, verification, storage, circulation and execution of digital contracts and other related operations, solving the problem of transmitting trust. And as a "computational system", blockchain can satisfy human beings' demands for "repeatable processes and testable results. " Therefore, DeFi has become a "computational" innovation in the financial system, replacing the "computational" innovation in financial activities. For the "computational" part , automatic execution can reduce costs and increase efficiency while also achieving programmability. However, the "non-computational" part, which is the part based on human cognition, cannot be replaced by blockchain. Therefore, The current DeFi system does not cover credit, and unsecured lending based on credit has not yet been implemented in the current DeFi system. The reasons for this include the current lack of an identity system that expresses "relationship identity" in the blockchain and the lack of a legal system to protect both parties. rights and interests.
- For the traditional financial system, the significance of Real World Asset Tokenization is to create digital representations of real world assets (such as stocks, financial derivatives, currencies, equity, etc.) on the blockchain to distribute The benefits of formal ledger technology extend to enable exchange and settlement across a wide range of asset classes.
- Financial institutions further improve efficiency by adopting DeFi technology, using smart contracts to replace the "calculation" links in traditional finance, automatically executing various financial transactions according to predetermined rules and conditions, and enhancing programmability. This not only reduces labor costs, but in certain situations, it can give enterprises new possibilities, especially providing innovative solutions to financing problems for small and medium-sized enterprises (SMSE), which opens a very rich door for the financial system. The door to potential.
- With the increasing attention and recognition of blockchain and tokenization technology in the traditional financial field and governments of various countries, and the continuous improvement of blockchain infrastructure technology, blockchain is moving towards integrating with the traditional world architecture and solving real-world problems. On the road to real pain points in application scenarios, we provide practical solutions to actual scenarios, rather than being limited to a "parallel world" that is separated from the real world.
- In the future permissioned chain structure with multiple different jurisdictions and regulatory systems, cross-chain technology is particularly important to solve the problems of interoperability and liquidity fragmentation. In the future, on-chain tokenized assets will exist on public blockchains and regulated permissioned chains operated by financial institutions. Through cross-chain protocols similar to CCIP, tokenized assets on any blockchain can be Connect to achieve interoperability and achieve interoperability among thousands of chains.
- Currently, many countries around the world are actively promoting blockchain-related legal and regulatory frameworks. At the same time, blockchain infrastructure, such as wallets, cross-chain protocols, oracles, various middleware, etc., are being rapidly improved, and the central bank’s digital currency CBDC is also constantly being implemented and can express more complex assets. Types of token standards are also constantly emerging, such as ERC-3525. Coupled with the development of privacy protection technology, especially the continued development of zero-knowledge proof technology, and the increasing maturity of on-chain identity systems, we seem to be in the midst of a large-scale adoption of blockchain technology. on the eve of application.
Table of contents
1. Introduction to the background of asset tokenization
- RWA from the perspective of Crypto
- RWA from the perspective of TradFi
2. Starting from the first principles of blockchain, what problems does blockchain solve?
- Blockchain is the ideal infrastructure for tokenized expression of assets
- Blockchain meets humankind’s demands for “computability”
- DeFi is a “computational” financial innovation
3. Asset Tokenization: Transformative Effect on the Traditional Financial System
- Establish a credible global payment platform, reduce costs and increase efficiency
- Programmability and transparency
4. What else is needed to realize asset tokenization Mass Adoption?
- Complete legal system guarantee and permission chain
- Identity system and privacy protection
- On-chain fiat currency
- Oracles and cross-chain protocols
- Low threshold wallet
5. Future prospects
1. Introduction to the background of asset tokenization
Asset tokenization refers to the process of expressing assets in the form of tokens on a programmable blockchain platform. Generally, assets that can be tokenized are divided into tangible assets (real estate, collectibles, etc.) and intangible assets. Assets (financial assets, carbon points, etc.) , this technology of transferring assets recorded on the traditional ledger system to a shared programmable ledger platform [1] is a disruptive innovation for the traditional financial system, and even Financial and monetary systems that will affect the future of the entire human race.
First of all, the author would like to mention an observed phenomenon: "There are two groups with completely different views on RWA asset tokenization." The author calls them Crypto's RWA and TradFi's RWA, and the RWA described in this article is RWA from a TradFi perspective.
RWA from the perspective of Crypto
First, let’s talk about Crypto’s RWA: The author of Crypto’s RWA calls it the Crypto world’s unilateral demand for the return rate on real-world financial assets . The main background is that under the background of the Federal Reserve’s continuous increase in interest rates and shrinkage of its balance sheet, high interest rates have a significant impact. The valuation of the risk market and the shrinkage of balance sheets have greatly drained the liquidity of the crypto market, causing the yield rate of the DeFi market to continue to decline. At this time, the risk-free yield rate of U.S. bonds, which is as high as about 5%, has become the most popular item in the crypto market, among which it is the most popular. Nothing is more remarkable than MakerDAO’s massive purchase of U.S. debt this year. As of September 20, 2023, MakerDAO has purchased more than 2.9 billion U.S. debt and other real-world assets.
Data source: https://dune.com/steakhouse/makerdao
The significance of MakerDAO's purchase of US dollar treasury bonds is that DAI can use the ability of external credit to diversify the assets it supports , and the long-term additional income brought by US treasury bonds can help DAI stabilize its own exchange rate, increase the flexibility of issuance, and balance its assets and liabilities. Incorporating U.S. Treasury bonds into the table can reduce DAI's dependence on USDC and reduce single-point risks [2]. Not only that, because all the income from U.S. debt will flow into MakerDAO’s treasury, MakerDAO has recently increased the demand for DAI by sharing part of the income from its U.S. debt and raising the interest rate of DAI to 8% [3].
MakerDAO's approach is obviously not replicable for all projects. With the skyrocketing price of MRK tokens and the market's rising sentiment towards the RWA concept, in addition to some larger-scale RWA public chain projects that follow the compliance route, various RWA Concept projects emerge in an endless stream, and various real-world assets are being moved to the blockchain for tokenization and sale , including some outrageous assets, resulting in a mixed bag in the entire RWA track.
In the author’s opinion, Crypto’s RWA logic mainly revolves around how to transfer the income rights of income-generating assets (such as U.S. bonds, fixed income, stocks and other assets) to the chain and put off-chain assets on the chain for mortgage Loans obtain the liquidity of assets on the chain and move various real-life assets to the chain for trading (such as sand, minerals, real estate, gold, etc.).
Therefore, we can find that Crypto’s RWA reflects the crypto world’s unilateral demand for real-world assets, which still has many obstacles in terms of compliance. MakerDAO’s approach is actually that the MakerDAO team deposits and withdraws funds through compliance channels (such as Coinbase, Circle) and purchase U.S. Treasury bonds through formal channels to obtain their proceeds, rather than selling these proceeds on the chain. It is worth noting that the so-called RWA U.S. debt actually on the chain is not the U.S. Treasury bond itself, but its income rights, and this process also involves the step of converting the legal currency income generated by the U.S. Treasury bonds into on-chain assets, which increases the complexity of the operation. Complexity and friction costs.
The rapid rise of the RWA concept cannot only be attributed to MakerDAO. In fact, a research report titled "Money, Tokens and Games" released by Citibank from the traditional financial world also caused a strong response in the industry. This report revealed the strong interest of many traditional financial institutions in RWA, and also stimulated the enthusiasm of a large number of speculators in the market. They have spread the news that major financial institutions are about to join this field, thus further increasing market expectations and speculation.
RWA from the perspective of TradFi
If you look at RWA from the perspective of Crypto, it mainly expresses the unilateral demand of the crypto world for the return on assets of the traditional financial world. If we look at this logic from the perspective of traditional finance, the size of the crypto market is basically miniscule compared to the multi-trillion-scale market of traditional finance, whether it is U.S. debt or any other financial asset. If it is for an additional sales channel on the blockchain, it is not necessary. From the visual market size comparison chart below, we can see the size difference between the encryption market and the traditional financial market.
So from the perspective of traditional finance (TradFi), RWA is a two-way journey between traditional finance and decentralized finance (DeFi). For the traditional financial world, DeFi financial services based on automatic execution of smart contracts are an innovative financial technology tool. RWA in the traditional financial field is more concerned about how to combine DeFi technology to realize the tokenization of assets to empower the traditional financial system, reduce costs, improve efficiency, and solve the pain points of traditional finance. The focus is on the benefits that tokenization brings to the traditional financial system, rather than just finding a new channel to sell assets.
The author believes that it is necessary to distinguish the logic of RWA. Because RWA from different perspectives has very different underlying logic and implementation paths. First of all, when it comes to choosing the type of blockchain, the two have different implementation paths. RWA in traditional finance is based on the permission chain (Permission Chain), while RWA in the crypto world is based on the public chain (Public Chain).
Since the public chain has the characteristics of no access requirements, decentralization, and anonymity, crypto-finance RWA projects will not only face greater compliance obstacles, but also users will not have legal rights protection when encountering adverse events such as RUG. , not to mention that the rampant hacking activities have high requirements on users’ security awareness, so the public chain may not be suitable for the issuance and trading of tokens on a large number of real-world assets.
The permission chain based on traditional financial RWA provides basic prerequisites for legal compliance in different countries and regions. At the same time, performing KYC on the chain and establishing an on-chain identity system are necessary prerequisites for realizing RWA. Owning assets under the premise of legal system protection Institutions can legally issue/trade tokenized assets. The difference from Crypto's RWA is that the assets issued by on-chain institutions can be native on-chain assets instead of being mapped to assets that already exist off the chain. This The potential for change brought by RWA for financial assets on the native chain will be huge.
To summarize the core point of this article, I believe that the future key development direction of Real World Asset Tokenization will be established on a permissioned chain, promoted by authoritative institutions such as traditional financial institutions, regulatory agencies, and central banks. A new financial system using DeFi technology. To realize this system, we need a computational system (blockchain technology) + non-computational system (such as legal system) + on-chain identity system (DID, VC) + chain Onboard legal currency (CBDC, tokenized deposits, legal stablecoins) + complete infrastructure (low-threshold wallets, oracles, cross-chain technology, etc.) .
The following content of this article will start from the first principles of blockchain, lead readers to elaborate on the principles of each link mentioned by the author, and cite practical application cases to support the author's views.
2. Starting from the first principles of blockchain, what problems does blockchain solve?
Blockchain is the ideal infrastructure for tokenized expression of assets
Before discussing the first principles of blockchain, we need to have a clear understanding of the essence of blockchain. Teacher Meng Yan said in "What are Digital Assets?" "[4] has a very comprehensive discussion on the definition of digital assets and the essence of blockchain. The article mentions: Writing and paper as a technology are considered to be one of the most important inventions of mankind and have a profound impact on human civilization. An immeasurable boost, its impact is likely to exceed that of all other technologies combined. Their application scenarios are mainly concentrated in the two application areas of information dissemination and supporting contracts/instructions.
In the application field of information dissemination, through written records, knowledge and information can be copied, edited, and disseminated at low cost, which promotes the widespread transmission of knowledge and the popularization of ideas. In the application fields that support contracts/instructions, text can also record and convey various instructions . For example, ancient emperors sent military orders and intelligence through documents, the bureaucracy conveyed instructions through text, and commercial activities can also form contracts through text to record agreement matters. Form consensus and even legal provisions, and preserve evidence to facilitate future supervision and arbitration.
There are clear differences between these two application scenarios. In the field of information dissemination, people are pursuing the convenience of low-cost, lossless copying and editing; while in the transmission of contracts and instructions, authenticity, non-repudiation and non-tampering are regarded as more important attributes. In order to meet these needs, people have developed a variety of sophisticated anti-counterfeiting printing technologies, and handwritten signatures and other verification methods are still widely used to ensure the reliability of information.
When the Internet was born and humans entered the digital age, the Internet, as a modern information transmission system, greatly met the needs of information dissemination scenarios. The Internet can realize fast, low-cost, lossless and convenient transmission of information, providing unprecedented possibilities for the sharing of global knowledge and information. At this time, the transmission and sharing of information has become easier and faster than ever before. Whether it is academic knowledge or daily information, it can be quickly spread and shared around the world, greatly promoting the progress and development of human society.
However, the Internet has encountered difficulties when dealing with contract/command systems, especially in scenarios involving authority and trust, such as corporate operations, government decision-making, and military command, where the credibility of information becomes crucial. In these situations, relying solely on information transmitted through the Internet may lead to significant risks and losses due to insufficient credibility. This is because the Internet mainly develops around the first application scenario of information dissemination, emphasizing the rapid, extensive and convenient transmission of information, but often ignores the authenticity and accuracy of information.
In this context, people try to make up for this shortcoming through centralized decision-making and trusting third parties, which has become the main means to achieve trusted information transmission. However, a centralized power structure can lead to the concentration and abuse of power, making information transfer opaque and unfair. Trusting the intervention of a third party may bring more security risks and trust crises, because the third party itself may also become an untrustworthy information source.
Therefore, the emergence of blockchain technology provides a new solution for processing contracts and instruction systems. Blockchain, as a decentralized, transparent and non-tamperable distributed ledger, can ensure the authenticity and reliability of information, which means that people no longer need to rely on centralized institutions or third parties to establish trust. This innovative technology brings new perspectives and solutions to the problem of information transmission in contracts and instruction systems, allowing the authenticity, integrity and consistency of information to be guaranteed without the need for centralized verification.
If the Internet is the digital upgrade of text-paper technology in the information dissemination scenario, then the blockchain is undoubtedly supporting the digital upgrade of text-paper technology in the contract/instruction scenario. Therefore, we can comprehensively identify the blockchain as a distributed system jointly maintained by multiple parties, which supports the creation, verification, storage, circulation and execution of digital contracts and other related operations. It can be said that blockchain is the first technical means to effectively support the digitization of contracts after the development of computers and networks. Therefore, since the blockchain is essentially a platform for digital contracts, and the contract is the basic expression of assets [4], and the token is the digital carrier of the assets after the contract is formed, the blockchain has therefore become the digital expression of assets. / Tokenized expression, that is, digital assets/ The ideal infrastructure for tokenized assets.
Image source: https://www.defidaonews.com/article/653729
Blockchain meets humankind’s demands for “computability”
Blockchain provides humans with an infrastructure that can tokenize assets, and smart contracts are the most basic form of digital asset expression, and Ethereum’s Turing completeness provides smart contracts with the ability to express a variety of Different types of asset forms have led to the emergence of token standards such as Fungible Tokens (FT), Non-Fungible Tokens (NFT), and Semi-Fungible Tokens (SFT).
Some people may ask, why can only blockchain realize the digital expression of assets? Because the blockchain solves the problem of "computability" without being manipulated, that is, " the process can be repeated and the results can be verified", the author also considers "the process can be repeated and the results can be verified" as a block chain. The first principle of the chain, because the operating mechanism of the blockchain is based on this: when a node records a transaction, many other nodes will re-execute the recording process (the process is repeatable); if the declared result is verified by the node itself If the results are consistent, then it will be regarded as a "fait accompli" in the blockchain world and be permanently recorded [5].
When we look at what problems blockchain can solve, breaking the problem down into "computational systems" and "non-computational systems" will help us gain a clearer insight into the essence. The problems that blockchain can solve are "computational systems". "System" issues are matters based on "the process can be repeated and the results can be tested" , while "non-computational systems" include those matters that cannot achieve "the process is repeatable and the results can be tested", such as those recognized by others. Affecting matters. Because if human cognition, thinking and judgment are all "processes repeatable and results testable", then aren't humans just a group of robots that only respond to the same stimulus?
Since ancient times, humans have always had the computational pursuit of “repeatable processes and testable results.” However, due to the insufficient development of science and technology, humans can only use their bodies and cognition to simulate this "calculation" process. For example, counting stones or recording with knots are the most primitive methods. In ancient China, the Chinese invented arithmetic. Tools such as the abacus and the abacus met the growing demand for "calculation" at that time. However, due to human errors, humans were not able to achieve "repeatable processes and testable results." But with the birth of computers, the process of "repeatable processes and testable results" can be solidified in the computer program. With the continuous iterative upgrade of tools that meet the requirements of "computability", human productivity has been qualitatively improved. The leap has become an important driving force for the development of science, technology and society.
However, in a centralized "computational system" like the Internet, when people's subjective consciousness interferes with this "computational system", it will invalidate the "repeatable process and testable results". For example, hackers can By tampering with the program to produce different output results, it affects the reliability and authenticity of information transmission, thus hindering the transmission and construction of trust.
With the birth of the blockchain, a new tool that meets the demands of "computing" was born. That is, when the computing system of the blockchain is decentralized, it becomes more difficult for human subjective consciousness to control the computing system. Interference , for example, if a hacker wants to tamper with the output of a smart contract, the hacker may need to control more than 50% of the nodes in the blockchain to tamper with it, and this kind of attack is often not proportional to the cost and benefit, so in the blockchain Under non-extreme circumstances, it can well satisfy human beings' demands for "computability".
DeFi is a “computational” financial innovation
Since the advent of Ethereum and smart contracts, blockchain has occupied a pivotal position in the financial field with its inherent financial attributes , making finance one of its most important application scenarios. Therefore, decentralized finance (DeFi) emerged as the times require and has become the most widely used scenario in the blockchain field.
DeFi is a new financial model that relies on distributed ledger technology to provide various financial services, such as lending, investing, or exchanging crypto assets, without relying on traditional centralized financial institutions. The DeFi protocol implements these financial services with a set of smart contracts, which are programs that program traditional financial operation logic to automatically execute. Therefore, DeFi users do not interact with another party when trading, but with these programs that can pool the assets of other DeFi users in order to maintain control of their funds [6].
Blockchain is a "computational system". We can regard DeFi, a financial system composed of smart contracts, as a "computational" innovation in the financial field. Smart contracts can replace the "computational" aspects of traditional finance. Some links , such as those in financial activities that rely on manual or mechanical steps to "obtain a deterministic result by repeating a process," such as clearing, settlement, transfers, and some repetitive tasks that do not rely on human cognition. In short, DeFi enables all manual and time-consuming steps in traditional financial activities to be executed by smart contracts, thereby significantly reducing the transaction costs of financial activities, eliminating settlement delays, and achieving automated execution and programmability. .
The corresponding concept of "computational system" is "non-computational system", which is human cognition. Blockchain is a purely computational system that can only solve computational problems but not cognitive problems. , the cognitive system can be understood as the credit system in the financial system, such as the credit evaluation and risk control system in credit. Although they have the same information such as work income and bank flow, different banks may have different opinions on the specific amount of credit that should be granted. There are different judgments.
For example, the same customer may have a $10,000 line of credit at one bank and $20,000 at another bank. This difference is not based on a repeatable and verifiable calculation process, but is deeply affected by human cognition, experience and subjective judgment. Each bank has its own risk control system, but in specific credit decisions, human cognitive factors still play a decisive role. This kind of cognitive-level decision-making has the characteristics of being unrepeatable and not fully verifiable, because they incorporate human subjectivity and interpretation of non-black and white right and wrong issues.
Or maybe it’s a debt relationship. Can the debt problem be solved by putting the debt contract on the chain and automating the repayment steps? To explore this question, we first need to analyze the debt itself. Debt is not just a contract or a form, it is a relationship based on mutual knowledge and trust between people. In essence, the establishment of a debt relationship does not only rely on the formation of a contract, it relies more on human cognition.
Blockchain technology can put the "ontology" of the debt contract on the chain, and set rules for the contract through programming to automate the repayment process and debt transfer. This process is predictable and verifiable because it relies on fixed rules to ensure "repeatability of the process and verifiability of the results." However, the operation of this system does not involve the human cognitive level.
Although the "ontology" of the debt contract has been objectively confirmed and guaranteed technically, the formation, change and even termination of the debt relationship are based on human cognition. This kind of cognition cannot be programmed or chained. Human cognition is not a "repeatable and testable" process. It may change with changes in the environment, emotions, and information. When the debtor's perception changes, they may choose not to fulfill their debt, which is the so-called "default". Therefore, on-chain cannot solve the problem of default, because this is a cognitive problem rather than a computational problem.
Someone may ask, can’t DeFi’s lending agreement solve the problem of borrower default through smart contract liquidation? Isn’t the act of borrowing and lending on DeFi an act of a credit system? Jake Chervisnky, Compound’s general counsel, once published an article discussing: The DeFi lending agreement itself does not exist as a loan, but an interest rate agreement [7]. Simply put, DeFi lending itself does not generate any credit, and most DeFi lending protocols rely on the same basic mechanism to function: over-collateralization and liquidation. That is, if a borrower wants to borrow money, he first needs to pledge collateral that exceeds the borrowing amount. For example, if he pledges 100 yuan of ETH and borrows 65 yuan of USDT, this kind of loan is essentially a kind of "calculation leverage" and does not generate any credit. , the borrower does not rely on any promise of future payment, trust or reputation.
To briefly summarize, blockchain, as a distributed system jointly maintained by multiple parties, supports the creation, verification, storage, circulation and execution of digital contracts and other related operations, solving the problem of transmitting trust. And as a "computational system", blockchain can satisfy human beings' demands for "repeatable processes and testable results. " Therefore, DeFi has become a "computational" innovation in the financial system, replacing the "computational" innovation in financial activities. For the "computational" part , automatic execution can reduce costs and increase efficiency while also achieving programmability. However, the "non-computational" part, which is the part based on human cognition, cannot be replaced by blockchain. Therefore, The current DeFi system does not cover credit, and unsecured lending based on credit has not yet been implemented in the current DeFi system. The reasons for this include the current lack of an identity system that expresses "relationship identity" in the blockchain and the lack of a legal system to protect both parties. rights and interests.
3. How disruptive is asset tokenization to traditional finance?
Financial services are based on trust and empowered by information. This trust relies on financial intermediaries maintaining the integrity of records covering aspects such as ownership, liabilities, conditions and covenants. These records are often dispersed in different systems or ledgers that operate independently. These institutions maintain and verify financial data so that people can The ability to trust the accuracy and completeness of this data.
Because each intermediary holds a different piece of the puzzle, the financial system requires a great deal of post-event coordination to reconcile and settle transactions ensuring that all relevant financial data is consistent. This is an extremely complex and time-consuming process. For example, in the context of cross-border transactions, the process is particularly complex due to the need to comply with different regulations and standards in various countries, as well as the involvement of multiple different financial institutions and platforms, making the transaction settlement cycle often longer, usually taking one to four days. In order to settle, this process increases the cost of transactions and reduces transaction efficiency [8].
Blockchain, as a distributed ledger technology, shows great potential in solving efficiency problems prevalent in the traditional financial system. By providing a unified and shared ledger, it directly solves the problem of information fragmentation caused by multiple independent ledgers, and greatly improves the transparency, consistency and real-time update capabilities of information. The application of smart contracts further enhances this advantage, allowing transaction conditions and contracts to be encoded and automatically executed when specific conditions are met, significantly improving transaction efficiency and reducing settlement time and costs, especially when dealing with complex multi-party or cross-border transactions. In the context of border transactions.
Therefore, asset tokenization (Tokenization) is increasingly accepted by traditional finance. According to a survey report by the Bank of New York Mellon, 97% of the 271 financial institutions it interviewed It is believed that tokenization will bring a new revolution to asset management [9], which fully reflects the potential of blockchain in the financial field.
Image source: https://www.bnymellon.com/content/dam/bnymellon/documents/pdf/insights/migration-digital-assets-survey.pdf
Therefore, for the traditional financial system, the significance of Real World Asset Tokenization is to create digital representations of real world assets (such as stocks, financial derivatives, currencies, equity, etc.) on the blockchain , extending the benefits of distributed ledger technology to enable exchange and settlement across a wide range of asset classes.
Financial institutions further improve efficiency by adopting DeFi technology, using smart contracts to replace the "calculation" links in traditional finance , automatically executing various financial transactions according to predetermined rules and conditions, and enhancing programmability. This not only reduces labor costs, but in certain situations, it can give enterprises new possibilities, especially providing innovative solutions to financing problems for small and medium-sized enterprises (SMSE), which opens a very rich door for the financial system. The door to potential.
In order to deeply explore the potential transformative power of tokenization on the financial system, this article will present readers with a more in-depth analysis framework:
Establish a credible global payment platform, reduce costs and increase efficiency
In all aspects of human daily life, financial activities, and trade activities, clearing and settlement are everywhere and have become a key link in maintaining economic flow. Although these two processes are very common in life, they are often not paid attention to by the public. However, they are the forces behind ensuring the smooth progress of transactions.
In our daily activities such as shopping, paying wages, and sharing bills, the process of clearing and settlement is involved. When we usually share expenses with friends, we are also carrying out a simplified clearing and settlement process - calculating the amount payable by each person, making transfers, etc. Or when we use Alipay or WeChat for electronic payment, the payment platform has to go through a series of clearing processes to confirm that the payment is accurately transferred from our account to the merchant's account. For users, it is just The money is transferred after a payment action, but in fact, there are many clearing and settlement processes involved behind the simple payment action (as shown in the figure below [10]).
Image source: https://www.woshipm.com/pd/654045.html
According to the Committee on Payment and Settlement Systems (CPSS) definition of clearing and settlement, CPSS defines a clearing system as a set of procedural arrangements that enable financial institutions to submit and exchange data and documents related to the transfer of funds or securities. It all starts by establishing a "net position" for the transaction participants, that is, offsetting the debts of both parties. This step is called "netting" [11].
Subsequent clearing refers to the process of exchanging, negotiating and confirming payment instructions or securities transfer instructions, which occurs before settlement. Settlement refers to the process in which the seller transfers securities or other financial instruments to the buyer, and the buyer transfers funds to the seller. It is the final step of the entire transaction. The settlement system ensures that the transfer of funds and financial instruments proceeds smoothly.
Simply put, clearing is the sending, receiving, and verification of payment instructions by both parties and reaching a final consensus on the assets to be paid. Settlement is the transfer of assets based on the clearing results. Let us explain this process in depth through an example. :
Clearing
Imagine you and your friends are having dinner at a restaurant and decide to split the bill. Everyone declared the amount of their consumption, and then jointly calculated the amount that each person should pay. In this scenario:
- Amount determination : The consumption amount announced by each friend is similar to the payment instruction.
- Communication and verification : Everyone reports their consumption to each other and verifies the total amount. This link is equivalent to the steps of sending, receiving and confirming payment instructions in clearing.
- Total calculation : After calculating the total bill, determine the amount that each person should bear. This action is equivalent to exchanging payment information and confirming the final position to be settled (that is, the amount each should pay).
Therefore, settlement is a "verification and preparation" step, where the parties confirm the amount to be paid and prepare for the next step of settlement.
Settlement
In this example, once you know how much you need to pay, the next step is to actually make the payment. Everyone pays their portion, and the total is the restaurant's total bill. at this time:
- Payment : The actual amount paid per person is similar to the steps for transferring funds.
- Verification : Everyone confirms that their respective payments are accurate, verifying that each member has paid the correct amount, similar to the step in the settlement process that confirms the correct transfer of funds.
- Notification : If one friend is responsible for collecting all the money and paying the bill in one go, when he completes the payment, he will notify others that the payment has been completed. This notification step is similar to the process for notifying parties after settlement is complete.
Settlement , therefore, refers to the actual flow of funds from one party to another and confirmation of the completion of a transaction.
It can be seen that in the traditional financial system, clearing and settlement are a "calculative" accounting and confirmation process. All parties reach a consensus through constant checking and verification, and transfer assets on this basis. This process requires the collaboration of multiple financial departments and a lot of labor costs, and may be exposed to the risk of operational errors and credit risks.
On June 28, 1974, a remarkable bank failure triggered widespread concern in the international financial community, namely the collapse of Herstatt Bank, which exposed the credit risk of cross-border payments and its potential huge destructive power. On that day, several German banks conducted a series of foreign exchange transactions between German marks and U.S. dollars, with the purpose of sending U.S. dollars to New York. The counterparty to the transaction was Herstatt Bank.
However, because Germany and the United States belong to different time zones, the transaction settlement process encountered considerable delays. This time difference resulted in the U.S. dollars not being immediately transferred to the counterparty's bank account, but "stuck" in Herstatt Bank. In short, the expected dollar payments did not go as planned. During those critical hours, Herstatt Bank received a liquidation order from German officials.
Due to a lack of ability to pay, it failed to remit the corresponding U.S. dollar payments to New York, and eventually headed toward the abyss of bankruptcy. The shock wave caused by this sudden bankruptcy caused varying degrees of losses to many German and American banks engaged in foreign exchange transactions. The occurrence of this incident also promoted the widespread application of real-time gross settlement systems in the field of cross-border payments, as well as the establishment of the Basel Committee on Banking Supervision [12], which shows the importance of settlement and clearing in the international financial market.
Blockchain relies on the characteristics of its distributed ledger and the non-tamperability and traceability of data to provide an atomic settlement (Atomic Settlement) transaction method through smart contracts. When one party pays an asset to another party, the other party also The corresponding assets will be paid to the payer at the same time, eliminating the risks and costs caused by clearing and settlement. At the same time, real-time settlement brings a huge improvement in transaction efficiency.
By integrating blockchain technology into cross-border payment settlement, we reveal its far-reaching significance: it builds an efficient point-to-point payment network and alleviates the problem of too long settlement time in traditional cross-border payment methods. By eliminating the intervention of third-party institutions, it has achieved all-weather payment, instant collection, and easy cash withdrawal, and successfully met the convenience needs of cross-border e-commerce payment and settlement services. In addition, it creates a globally integrated cross-border payment trust platform at a lower cost, mitigating the financial risks caused by cross-border payment fraud [13].
Projeto Mariana is a collaboration between the Bank for International Settlements (BISIH), the Bank of France, the Monetary Authority of Singapore (MAS) and the Swiss National Bank. A test report was released on September 28, 2023, and the plan successfully verified the technical feasibility of using automated market makers (AMM) for international cross-border transactions and settlement of the tokenized central bank digital currency CBDC [14].
Image source: https://www.bis.org/publ/othp75.htm
In general, payment behavior in the traditional financial system is often accompanied by cumbersome clearing and settlement processes , which not only incurs additional costs, but is also inefficient due to settlement delays, while also facing human errors, credit risks, and strict time windows. Restrictions and other issues. The use of blockchain and DeFi technology provides an effective solution.
Through blockchain technology, the transaction process can be optimized and intermediate links can be cut, thereby significantly reducing related costs. This technology avoids the long waiting time of traditional financial settlements and achieves true round-the-clock market operations, especially in cross-border payments, which greatly improves processing speed and accuracy. More importantly, as transaction costs decrease, indirect profit improvements may far exceed direct cost savings, thereby promoting the vitality and efficiency of financial markets on a broader level.
Programmability and transparency
For the traditional financial system , the programmability and transparency of real-world asset tokenization will bring about disruptive changes. We can take financial derivatives as an example to illustrate the disruption brought about by programmability and transparency. Financial Derivatives (Financial Derivatives) is an extremely large market in the traditional financial market, with an estimated nominal value exceeding 100 billion U.S. dollars [15]. The types of derivatives markets are large and complex, including stocks, fixed income, foreign exchange, Different types of contracts in credit, interest rates, commodities and other markets. These types of contracts include options (plain calls and puts as well as exotic options), warrants, futures, forwards, swaps, etc.
It is the huge potential of the leverage effect of financial derivatives that enables them to create an asset scale that far exceeds the value of the underlying assets by dozens of times. Among them, the 2008 financial crisis is a classic case of a global financial disaster triggered by financial derivatives. During this crisis, banks packaged a series of mortgage loans into a special financial product—Mortgage-Backed Securities (MBS)—and sold them to investors. For banks, this approach can transfer the original loan risk, generate cash flow by selling these packaged mortgage loans, and earn interest rate differentials. For banks, the issuance of each loan has almost become the creation of a profit, which creates great risks.
The movie "The Big Short" vividly demonstrates this phenomenon: when a home loan means a profit and the risk has nothing to do with the bank, banks tend to create endless home loan contracts. When all the home buyers with good credit are exhausted, banks tend to look for other individuals with bad credit to continue the game. A person without any collateral can even get a loan from the bank in the name of his dog. These “subprime loans[16]” of poor quality became the trigger for the subsequent financial tsunami.
Against the background of continued rise in U.S. real estate prices and low interest rates and loose monetary policy, banks have continued to issue subprime loans, and Wall Street financial institutions have also invented a variety of financial derivatives, such as collateralized debt obligations (CDOs). ), which is a financial instrument that packages various MBS; and synthetic CDO, which packages various CDOs and credit default swaps (CDS).
Eventually, an endless stream of complex financial derivatives emerged on the market, making it impossible to trace the physical assets behind these products. In addition, a large number of subprime loans were mixed into financial derivatives rated as "low risk". Due to the distortion of ratings, high-risk assets only had to pay extremely low premiums. These layers of stacked and packaged derivatives were sold to a variety of brokers and investors. The leverage ratio of the entire financial system soared rapidly and became precarious.
Subsequently, the United States began to raise interest rates, and the increase in loan interest rates led to a large number of borrowers defaulting. This problem first emerged in the subprime loan market, but since subprime loans were packaged in asset-backed securities (ABS), MBS, and even CDOs, The problem quickly rippled across financial markets. Many seemingly high-grade, low-risk financial derivatives were suddenly exposed to huge default risks, and investors had almost no idea of the actual risks of these derivatives. Market confidence was severely hit, and financial markets suffered massive sell-offs, which became an important trigger for the outbreak of the financial crisis in 2008. All this stems from the chaos, opacity and overly complex structural system of the financial market.
This shows how important transparency is for complex financial derivatives. We can imagine that if the technology of tokenization had been used before 2008, investors could easily penetrate and understand the underlying assets, and perhaps this would not have happened. Such a financial crisis. Not only that, tokenizing financial derivatives can also improve the efficiency of multiple stages of the asset securitization process, such as the servicing, financing, and structuring (i.e., grading) stages [17].
For example, in the process of asset securitization, the semi-homogeneous token standard ERC-3525 is used to package assets. The digital container feature of ERC-3525 can package non-standard assets into a standard asset that can be split and combined using smart contracts. By stratifying it (prioritizing mezzanine and inferior), you can also program the cash flow of assets, reduce operating and third-party costs, and greatly improve asset transparency and settlement certainty.
When using blockchain, the monitoring role of regulators can be partly assumed by the platform. When key information, such as seller submissions, past records, and updates are visible to all key stakeholders on the blockchain platform, single-sided governance de facto becomes multi-party governance. That is to say, any party has the right to analyze data and detect anomalies, and this timely information disclosure can reduce transaction costs in financial markets [17].
In order to further understand the benefits that programmability and transparency bring to the traditional financial system, the Australian startup Unizon was selected into the CBDC pilot project of the Australian Central Bank. The "Digital Invoice Tokenization" project based on ERC-3525 is a very good case [ 18] , in supply chain finance, accounts receivable factoring (Factoring) is a common business model. It allows companies to sell accounts receivable to a third party (usually a factoring company) at a certain discount to obtain the necessary financing and improve their cash flow situation.
However, due to the problem of falsification of bills, small and medium-sized enterprises generally lack sufficient credit support , and investors are unable to carry out reasonable risk control on a large number of small and medium-sized enterprises. As a result, small and medium-sized enterprises generally face financing problems in reality. If small and medium-sized enterprises cannot accept delayed payment of accounts, it will be difficult to receive orders from large enterprises. However, accepting orders from large enterprises will lead to tight liquidity of enterprises and increase cash. Risk of flow breakage.
By tokenizing the bill, we can use private key signature to add a confirmation step in the bill issuance process. Once confirmed, the ticket will be generated with the confirmation signatures of both parties, ensuring that the ticket is generated in a confirmed state by both parties. Considering that account arrears are actually equivalent to a form of loan provided by the seller to the buyer, if the issue of bill authenticity can be effectively solved, the seller can rely on the buyer's creditworthiness to use this account receivable at a certain discount rate. Sold to a factoring agency to receive discounted payments.
Thanks to the cash flow programmability of tokenization using ERC-3525, payment notes can be tokenized in the “digital invoice tokenization” scenario. Create a pair of accounts through ERC-3525: payment account (Payable) and accounts receivable account (Receivable). The two accounts form a payment channel that is bound to each other similar to quantum entanglement. As long as the buyer remits money to the payment account, the funds will be automatically distributed to the accounts receivable account through smart contracts. This means that no matter how many shares the accounts receivable is split into, no matter whose hands it ends up in, it will eventually be transferred to the accounts receivable account according to a predetermined proportion. This is extremely costly and difficult to do in the traditional financial system. Implemented operations, using tokenization technology can greatly increase the liquidity and composability of supply chain financial factoring business and reduce operating costs.
Image source: https://mirror.xyz/bocaibocai.eth/q3s_DhjFj6DETb5xX1NRirr7St1e2xha6uG9x3V2D-A
To sum up, the programmability and transparency of tokenization have a huge impact on the traditional financial system. The transparency brought by the use of blockchain platforms can not only reduce financial risks and information asymmetry problems in the traditional financial system, Moreover, the programmability of tokenization also opens the door for us, making many operations that are difficult to achieve in the traditional financial system possible, greatly reducing the cost of manual intervention and third-party participation. This not only greatly enhances the liquidity and composability of financial services, but also creates room for innovation, potentially giving birth to unprecedented types of financial products.
4. What else is needed to realize asset tokenization Mass Adoption?
Tokenization has undoubtedly brought revolutionary innovations to the traditional financial system, but if we want this innovation to be truly applied in real application scenarios, we still face many challenges and difficulties. Listed below are some of the key factors that need to be considered to achieve large-scale adoption of asset tokenization:
Complete legal system guarantee and permission chain
As a purely "computational system", blockchain can only solve people's demands for "computational" things (reducing friction costs, programmability, traceability, etc.), but it cannot solve the problem of confirming relationship rights, judging right and wrong, and rights and interests. Demands such as guarantees require a set of non-computing systems based on cognition to solve, such as a complete legal supervision system, because the legal and supervisory system cannot rely on a set of inherent procedures to execute, and the execution, determination and risk assessment of the law are Judgment and control are all based on human cognition, and this is exactly what the public blockchain cannot satisfy . Not to mention the rampant hackers and frequent security incidents in the public chain ecosystem. When a user's wallet is stolen on the public chain, It is almost impossible to recover assets and nowhere to protect rights and interests. The open and anonymous nature of public chains also makes supervision and law enforcement difficult.
The application scenarios of real-life asset tokenization in the traditional financial field involve a large number of asset issuance, transactions and other operations. For financial institutions that control core assets, compliance and security are the main demands . Imagine if a financial institution Hundreds of millions of dollars of tokenized financial assets were issued on the public chain, but all the assets were stolen by North Korean hacker groups. In this case, neither the asset losses can be recovered, nor the criminals can be punished by law. Obviously, this is unacceptable.
The financial industry therefore relies on a range of legal safeguards to protect investors from fraud and abuse, combat financial crime and cyber malfeasance, maintain investor privacy, ensure that industry participants meet certain minimum standards, and provide security when issues arise. recourse mechanism. Therefore, only permissioned chains can satisfy both "computational" and "non-computational" requirements . We can imagine that in the future, each country and region may have different legal supervision systems, and each region will comply with the legal supervision system of that region. A permissioned chain to carry tokenized real assets.
Identity system and privacy protection
Relational identity vs contractual identity
If the blockchain hopes to be closely integrated with the real world and achieve large-scale applications, a complete on-chain identity system is the key. For a long time, blockchain has made it difficult to reveal the true identity of wallet holders due to its anonymous nature, and a system lacking identity authentication naturally has difficulty establishing credibility. Credit is a product of human social cognition, and it relies on deep social connections between people. In fact, the blockchain world has always lacked a "relational identity" system based on interpersonal relationships. This system is not a simple identity label, but a complex structure that reflects the various roles and relationships of individuals in the social network.
As early as more than 150 years ago, the ancient British jurist Henry Maine inspired people to think deeply about the nature of identity [30]. He proposed that there are two major categories of identity: one is "relational identity" , which originates from an individual's role in society and interpersonal relationships, such as being a father, having a nationality of a certain country, or being a civil servant, a soldier, etc. This identity is a reflection of social attributes, emphasizing a person's position in the social structure and his or her relationship with others.
Another type of identity is the "contractual identity" system based on "contract execution", such as contracts in the form of labor agreements, company organizational structures, and contract terms. In the blockchain field, this can be compared to the "identi
