Publish Date
November 11, 2024
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Imagine owning a piece of a Manhattan skyscraper or a fraction of a Picasso painting with just a few clicks.
This is what tokenization of assets promises, and in this guide, we’ll delve into the intricacies of real-world asset tokenization, exploring its benefits, challenges, and transformative potential in reshaping the financial landscape.
RWA tokenization is the process of turning physical assets (like real estate, stocks, or art) into digital tokens on a blockchain. Each token represents a fraction of ownership in that asset, making it possible for people to buy and sell pieces of assets, not just the whole thing.
Initially, blockchain was just for digital currencies like Bitcoin, but as the technology grew, it began being used for more complex applications.
Around 2017-2018, people started experimenting with creating tokens that represent real-world assets.
These early experiments involved issuing “asset-backed tokens” on blockchains like Ethereum, using smart contracts to represent fractional ownership in these assets.
Techniques like the ERC-20 and ERC-721 token standards allowed developers to create fungible tokens (for divisible assets like real estate) and non-fungible tokens (NFTs, for unique assets like individual artworks).
These tokens were traded on blockchain marketplaces, allowing people to buy, sell, and trade small portions of physical assets, making previously illiquid assets more accessible and flexible for investors.
Today, tokenization is popular because it allows people to invest in pieces of assets, making investing more accessible and flexible.
Let’s walk through a simple example of how tokenization would work for a piece of real estate, like a $1 million apartment building.
Before anything digital happens, the asset owner(s) and legal team prepare the asset to ensure it can be represented by tokens.
This might involve creating documents to outline the rights of future token holders—such as a share of rental income—and ensuring that the company has the legal authority to tokenize and sell parts of the building in this way.
Next, they create a “smart contract” on a blockchain like Ethereum.
💡 A smart contract is basically a piece of code that automatically enforces the rules for owning and transferring tokens.
For this apartment building, the smart contract might specify:
With the smart contract in place, the company “mints” (creates) 1 million tokens, each representing $1 of the apartment building’s value.
So if you buy 1,000 tokens, you effectively own a $1,000 share of the building.
💡 These tokens are created on the blockchain, making it easy to track and verify who owns what.
Now, the tokens are listed on a digital marketplace or exchange where investors can buy and sell them, much like stocks.
💡 Purchasing 500 tokens = owning a small share of the apartment building.
This digital approach makes it easy to buy and sell shares in the asset, which traditionally would require significant paperwork and legal hurdles. The token’s value might also fluctuate based on the building’s performance, the real estate market, or demand for tokens.
Let’s say the apartment building generates $100,000 in rental income each year. With the smart contract, this income could be automatically distributed among token holders.
If you hold 1% of the tokens, you would receive $1,000 annually.
💡 The smart contract automatically sends payments to token holders without needing banks or brokers.
Maybe you’d like to diversify by swapping some of these tokens for ownership in a tokenized art piece. On a blockchain marketplace, you can trade your apartment tokens directly for art tokens.
Again, a smart contract handles the swap, so both sides receive their assets instantly without needing a middleman.
💡 If there’s a liquidity pool with both assets available, you can even do this swap immediately.
As of May 2023, the market value of tokenized assets on public blockchains was estimated at approximately $2.15 billion (and $185 billion with stablecoins).
Notably, tokenized money market funds have attracted over $1 billion in assets under management, indicating growing investor interest in on-chain financial products.
Projections suggest that the tokenized asset market could reach around $2 trillion to $30 trillion by 2030, representing a potential 50-fold increase.
Major players and platforms in real world asset tokenization include:
💡 Example: By converting assets such as invoices, real estate, and royalties into digital tokens, Centrifuge enables these businesses to access decentralized finance (DeFi) markets, thereby improving their cash flow and reducing reliance on traditional financial intermediaries.
💡 Example: Borrowers undergo a thorough credit assessment conducted by professional underwriters, ensuring that only creditworthy entities receive funding. Lenders, in turn, can earn yields by supplying liquidity to lending pools managed by these underwriters.
💡 Example: These assets are converted into tokens, each representing a small share of the asset’s value. Smart contracts automate income distribution (like bond interest) to token holders, and built-in KYC and AML checks ensure compliance.
💡 Example: MC² Finance is advised by BlackRock and it shall soon start tokenizing RWAs (and open unprecedented level of DeFi reviewability and tradability).
Here is an overview of real-world asset (RWA) tokenization models:
These models organize ownership and investment structures for tokenized assets.
Use-case: A $10 million luxury hotel is tokenized into 100,000 tokens. Investors buy tokens to own a share of the hotel. They earn a portion of rental income from the hotel and can benefit if the hotel’s value increases, making the tokens more valuable.
Use-case: A commercial real estate project issues debt tokens that entitle holders to monthly income from tenant rents, while equity tokens allow holders to benefit from property appreciation over time.
Use-case: A pool of tokenized art pieces allows investors to buy shares in the entire collection rather than a single artwork, spreading investment risk and potential gains across multiple pieces.
These models ensure tokenized assets comply with legal and regulatory standards:
Use-case: A tokenized private equity fund issues regulated security tokens to accredited investors, ensuring compliance with securities laws while automating KYC checks through the blockchain.
Use-case: A luxury hotel is placed into an SPV, which then issues tokens representing shares of ownership. This allows investors to own a stake in the hotel, while the SPV handles management and insurance.
Use-case: A fine art collection is placed into a trust, with tokens representing shares in the trust. This provides token holders with legal protections and the ability to trade their shares without directly managing the artwork.
These models enhance the tradeability and liquidity of tokenized assets.
Use-case: A tokenized real estate fund is added to an AMM pool, enabling investors to buy and sell shares in the fund instantly.
Use-case: Investors stake tokenized shares of a gold reserve, receiving regular rewards based on the value of their staked gold, encouraging long-term holding.
These models enhance the tradeability and liquidity of tokenized assets.
Use-case: A tokenized commodities fund uses live data feeds to update token values based on current market prices for oil, gold, and other assets, giving investors real-time insight into their investments.
Use-case: A tokenized art collection includes built-in insurance coverage for each token, protecting investors from loss in case of theft or damage to the artwork.
These models define how ownership and transferability are managed.
Use-case: A luxury car is represented by an NFT, allowing the owner to transfer ownership instantly on the blockchain while ensuring that the car’s history is accurately tracked.
Use-case: A tokenized apartment building offers fractional shares via fungible tokens for investors, while an NFT represents the exclusive right to manage the property.
These models enable token holders to participate in asset management decisions.
Use-case: A tokenized residential complex operates under a DAO, with token holders voting on major property decisions, such as renovations or tenant policies.
Use-case: A tokenized investment fund uses quadratic voting to allow all token holders, regardless of their holdings, an equal say in selecting new investments.
These models allow token holders to earn income from tokenized assets.
Use-case: Token holders of a commercial building receive monthly rental income distributed directly to their wallets via smart contracts, reducing administrative fees.
Use-case: A musician tokenizes their song catalog, and token holders earn a share of royalties from streaming revenue, with payouts handled by smart contracts.
Tokenizing Real World Assets (RWAs) involves a structured process that integrates legal, financial, and technological components to create digital representations of physical assets on a blockchain.
These include:
💡 Imagine you are a famous comic book creator who wants to tokenize the rights to an iconic character. You’ll need to choose the character’s intellectual property (IP)—including rights to comics, merchandise, and future adaptations—as the asset to tokenize.
💡 The creator ensures they own the full rights and checks for any existing contracts or restrictions.
💡 A professional appraiser estimates the IP’s value based on current revenue from merchandise, comic sales, and potential deals for movies or shows.
💡 The creator makes sure the token offering follows securities laws, possibly registering it with financial authorities.
💡 They set up a special-purpose vehicle (SPV) to hold the IP rights, which allows tokens to represent shares in the character’s future revenue.
💡 The creator picks a blockchain like Ethereum, which can handle smart contracts and track royalties from merchandise and adaptations.
💡 They create a smart contract that defines token holder rights, including access to future revenue from movies, comics, or merchandise sales.
💡 An audit is done to ensure the smart contract is secure and can manage revenue distribution without issues.
💡 They design ERC-20 tokens, with each one representing a fractional share of the character’s revenue.
💡 Tokens are minted on the blockchain, reflecting the IP’s appraised value.
💡 The tokens are offered to fans and investors through a Security Token Offering (STO), with KYC checks in place to ensure everything’s secure.
💡 Token holders may vote on big decisions, like approving merchandise or new comic adaptations.
💡 The SPV and smart contract are regularly checked to stay compliant with regulatory standards.
💡 Token holders can trade their shares on a digital asset exchange, giving them the option to cash out or buy more.
Using this checklist can help you make informed, balanced investment decisions with tokenized assets.
Evaluating tokenized assets
[ ] Research the asset's underlying value and market potential.
[ ] Examine the asset's historical performance and market demand.
[ ] Assess how well the asset aligns with your investment goals.
[ ] Determine the token’s structure (fractional ownership, equity, debt, or revenue-sharing rights) and associated risks.
Exploring platforms and marketplaces
[ ] Explore different platforms (e.g., Securitize, tZERO, OpenSea) that offer tokenized assets.
[ ] Understand each platform's offerings, asset types, and fee structures.
[ ] Check for additional services, such as portfolio management tools or integrated wallets.
[ ] Verify built-in compliance features, like KYC and AML checks, to ensure regulatory standards are met.
Cost considerations
[ ] Account for blockchain transaction (gas) fees, especially on high-fee blockchains like Ethereum.
[ ] Consider platform-specific fees, including trading and withdrawal fees.
[ ] Include these costs in your budgeting to evaluate the true return potential.
Understanding risks and rewards
[ ] Assess the potential for liquidity and diversification benefits from tokenized assets.
[ ] Understand the risks, such as market volatility, regulatory changes, and blockchain security issues.
[ ] Recognize that tokenized assets may lack some protections available in traditional markets.
Applying portfolio diversification strategies
[ ] Diversify investments across various asset types, industries, or geographies.
[ ] Combine different types of tokenized assets (e.g., real estate, commodities, intellectual property) for balance.
[ ] Periodically track and rebalance the portfolio to adapt to changing market conditions and personal goals.
At mc2.fi, we’re excited about this future and are working on bringing these RWA tokenization features directly to you.
Follow us on our socials and stay tuned for updates.
Question: What is the typical ROI for tokenized assets?
Answer: ROI for tokenized assets varies widely based on the type of asset and market conditions. For example, tokenized real estate might give returns similar to traditional property, with income from rent and value appreciation. Tokenization also adds liquidity and allows fractional ownership, which can improve returns. Each asset’s potential ROI depends on its class, market trends, and risks.
How does tokenization affect asset liquidity?
Answer: Tokenization makes assets more liquid by allowing fractional ownership and easy trading of tokens. This means investors can buy and sell parts of assets like real estate or art that would normally be hard to trade. However, liquidity also depends on demand and available marketplaces for the specific asset.
What happens to tokenized assets if the issuer defaults?
Answer: If the issuer defaults, what happens depends on the token’s setup. In some cases, token holders might directly own part of the asset and can claim their share. In others, like debt-based tokens, it could be harder to recover the investment. It’s important to know the legal rights tied to each token before investing.
Can tokenized assets be used as collateral for loans?
Answer: Yes, tokenized assets can be used as loan collateral. Many banks and DeFi platforms accept tokenized assets, letting borrowers access funds without selling their holdings. The collateral’s value depends on the asset’s market value and stability. Loan terms may vary based on the platform’s policies.
How do tax implications differ for tokenized assets?
Answer: Taxes for tokenized assets can differ from regular assets due to their digital nature. Token trades may lead to capital gains tax, while income from tokens (like rent) is usually taxable as income. Tax rules depend on the investor’s location and the asset’s location, so consulting a tax expert is advised for clarity.
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