Simplifying & Understanding Real-World Assets

Welcome to the Real World Assets (RWAs) blog by QuillAudits!

This is the first part of the RWA blog series in which we’ll be going through the topics and concepts we covered in the first RWA live session on our YouTube channel. We’ll majorly be focusing on the theoretical and logical concepts in this blog to build the base for understanding and building real world assets.

What is RWA?

Tokenized real-world assets (RWAs) are blockchain-based digital tokens that represent physical and traditional financial assets, such as cash, commodities, equities, bonds, credit, artwork, and intellectual property.

RWAs can be tokenized on blockchain networks, allowing for fractional ownership, increased liquidity, and enhanced accessibility to traditionally illiquid assets.

Types of RWAs

Real World Assets (RWAs) encompass a wide range of tangible and intangible assets with intrinsic value. These are just a few examples of the diverse range of assets that can be tokenized on the blockchain.

• Real Estate: This includes residential, commercial, and industrial properties. Real estate tokenization allows investors to own fractional shares of properties, providing liquidity and diversification.
• Commodities: Physical commodities such as precious metals (gold, silver), energy resources (oil, natural gas), and others can be tokenized to facilitate trading and investment.
• Art and Collectibles: Tokenization of art, rare collectibles, and memorabilia enables fractional ownership and investment opportunities in traditionally illiquid markets.
• Intellectual Property (IP): This includes patents, copyrights, trademarks, and other forms of intellectual property rights. Tokenization allows creators to monetize their IP assets and investors to participate in revenue-sharing agreements.
• Equity and Securities: Shares of private companies, stocks, bonds, and other financial instruments can be tokenized to increase liquidity, streamline transactions, and enable global access to capital markets.
• Revenue-Generating Contracts: Contracts with predictable revenue streams, such as leases, royalties, and licensing agreements, can be tokenized to provide investors with recurring income opportunities.
• Deeds and Titles: Tokenization of deeds, titles, and ownership certificates for real estate, vehicles, and other assets can streamline transfer processes and enhance transparency in ownership records.
• Carbon Credits and Renewable Energy Assets: Environmental assets such as carbon credits, renewable energy certificates (RECs), and carbon offsets can be tokenized to facilitate trading and investment in sustainable initiatives.
• Luxury Assets: High-value luxury items such as yachts, private jets, and luxury watches can be tokenized to fractionalize ownership and broaden access to exclusive markets.

Key Components and Considerations in RWAs

Developing a Real World Asset (RWA) on the blockchain involves several steps and considerations to ensure compliance, security, and efficiency.

• Define the Asset: Determine the real-world asset you want to tokenize on the blockchain. This could include real estate, commodities, art, intellectual property, or any other asset with tangible or intrinsic value.
• Legal and Regulatory Compliance: Understand the legal and regulatory requirements for tokenizing the chosen asset. Depending on the jurisdiction and type of asset, you may need to comply with securities regulations, property laws, anti-money laundering (AML) regulations, and know-your-customer (KYC) requirements.
• Choose the Blockchain Platform: Select a suitable blockchain platform for tokenizing the asset. Ethereum and other smart contract platforms are commonly used for tokenization due to their programmability and established ecosystem.
• Token Standards: Choose or develop a token standard that best suits the characteristics of the asset. For example, ERC-20, ERC-721 (NFTs), or ERC-1400 (Security Tokens) are common standards used for tokenizing assets on Ethereum.
• Collateralization: Many tokenized RWAs are backed by collateral, which could be the asset itself (in the case of direct backing) or other assets and financial instruments (in the case of indirect backing). The collateralization process ensures that the on-chain token maintains a stable and defined value relative to the off-chain asset it represents.
• Smart Contract Development: Develop smart contracts to represent and manage the asset on the blockchain. These contracts should define token issuance, transfer rules, ownership rights, and any other functionalities required to manage the asset's lifecycle.
• Oracles and Data Feeds: Integrate oracles or data feeds to bridge the gap between the blockchain and the real world. Oracles provide external data, such as asset valuations, ownership records, or regulatory compliance information, ensuring transparency and accuracy.
• Tokenization Process: Tokenize the asset by minting digital tokens on the blockchain. Each token represents ownership or fractional ownership of the underlying asset. Ensure that the tokenization process follows legal requirements and is properly documented.
• Security and Audits (we're here for it :D): Conduct security audits of smart contracts and overall system architecture to identify and mitigate potential vulnerabilities or attack vectors.

Categorization of RWAs

We can tokenize real-world assets by combining any of the following traits:

• Asset location: On-chain or Off-Chain
• Collateral location: On-chain or Off-Chain Collateral
• Backing type: Direct backing or Indirect (synthetic)

• Asset location - refers to the location of the asset which is being tokenized. Example: Real estate & Gold are Off-chain assets whereas BTC & ETH are On-chain assets.

• Collateral location - refers to the location of the collateral Example: PAXG is a digital token backed by physical gold (Off-chain collateral) & DAI stablecoin requires On-chain collateral.
• Backing type - refers to the type of the collateral backing the asset. Direct backing - Collateral backing the asset is the same as the asset. Example: PAXG token is directly backed by gold. Similarly, USDC is also directly backed by actual USD. Synthetic (Indirect) backing - Collateral backing the asset is not the same as the asset. Example: DAI coin by MakerDAO is backed by on-chain collateral assets which can consist of other crypto tokens but not USDT(since DAI is a stablecoin).

We'll be focusing on the five majorly used categories of RWAs:

• On-Chain Asset with On-Chain Collateral and Direct Backing
• On-Chain Asset with On-Chain Collateral and Synthetic (Indirect) Backing
• Off-Chain Asset with Off-Chain Collateral and Direct Backing
• Off-Chain Asset with Off-Chain Collateral and Indirect Backing
• Off-Chain Asset with On-Chain Collateral and Indirect Backing

On-Chain Asset with On-Chain Collateral and Direct/Indirect Backing

Wrapped ETH (WETH) and Wrapped BTC (WBTC) are examples of on-chain assets which are directly/indirectly backed by on-chain collateral.

• WETH: Ether (ETH), the native cryptocurrency of Ethereum, doesn't conform to the ERC-20 token standard, which is a widely adopted standard for Ethereum tokens. This discrepancy can cause compatibility issues with ERC-20 based dApps. The value of WETH is directly backed by ETH at a 1:1 ratio, ensuring that each WETH token is always equivalent to one ETH. The ETH used as collateral is held securely in the smart contract.

• WBTC: The value of WBTC is directly backed by BTC, with a 1:1 ratio. Each WBTC token represents one BTC, and the corresponding BTC is held by custodians off the Ethereum blockchain but is managed through on-chain contracts and mechanisms for minting and burning WBTC.

Off-Chain Asset with Off-Chain Collateral and Direct/Indirect Backing

USDT and USDC fall into a unique category of RWAs, which are digital tokens representing fiat currencies like the US dollar on blockchain platforms. These RWAs are characterized by their off-chain assets (fiat currencies, gold, stock shares, real estate, etc) and off-chain collateral, with their value directly or indirectly backed by these reserves.

Technical Framework for Tokenizing RWAs:

• Smart Contracts: The backbone of any tokenization platform is smart contracts, self-executing contracts with the terms of the agreement directly written into code.
• Asset Custody and Verification: Essential to the process is ensuring that the real-world asset is securely held and verified. For instance, tokenizing gold would require a secure vault, and tokenizing real estate would need a reliable registry to confirm ownership and liens.
• Oracles for Real-World Data: Oracles are used to bring real-world information onto the blockchain securely. They can provide data on asset valuation, ownership changes, or even gold price fluctuations, which is crucial for maintaining the token's value and relevance.
• Regulatory Compliance and Legal Framework: Ensuring compliance with local and international regulations is critical. This might involve setting up legal structures that recognize token ownership as equivalent to owning a portion of the physical asset.
• Token Standards and Interoperability: Using established token standards like ERC-20 (for fungible tokens) or ERC-721 (for non-fungible tokens, useful in real estate to represent unique properties) ensures that the tokens can interact seamlessly with wallets, exchanges, and other smart contracts.

Examples:

Gold: Tokenizing gold involves issuing digital tokens backed by physical gold stored in secure vaults. The physical gold acts as collateral, and the token's value is directly tied to the gold price, offering investors exposure to gold without the need for physical possession. Example - Paxos Gold (PAXG)

Real Estate: Real estate tokenization breaks down property ownership into digital tokens, allowing for fractional ownership and investment. Each token might represent a share of ownership in a property, a right to rental income, or other property-related rights. Currently active Real Estate RWA projects

Off-Chain Asset with On-Chain Collateral and Indirect Backing

The DAI stablecoin is a notable example of an off-chain asset with on-chain collateral and indirect backing, primarily because its value is pegged to the U.S. dollar (an off-chain asset), while its collateral consists of various cryptocurrencies stored on-chain within the MakerDAO system. This setup represents an indirect backing because the value of DAI is stabilized against the U.S. dollar through smart contracts and collateralized debt positions (CDPs), rather than a direct 1:1 reserve of dollars.

In the next blog, we’ll be building a synthetic asset - an ERC-20 token pegged 1:1 to the real time value of an Apple stock (AAPL) in the US stock market with ETH collateral. We’ll go through the step-by-step explanation of the code, logic and concepts which we’ve covered in RWA live session #2.

Conclusion

In this blog, we've explored the foundational concepts and theoretical underpinnings of tokenizing real-world assets on the blockchain. By understanding the diverse types of RWAs, the key components involved in their development, and the various categorization methods, we can appreciate the immense potential this technology holds for revolutionizing traditional markets. Tokenization offers unprecedented opportunities for fractional ownership, liquidity, and global access to assets. Stay tuned for our next installment, where we'll dive into a hands-on walkthrough of creating a synthetic asset, providing practical insights into the tokenization process.