February 5th, 2024
Blockchain technology has a wide range of potential applications. However, one of the most straightforward and promising is tracking asset ownership.
The blockchain is designed to maintain a distributed, digital ledger to track transfers of various assets. While it was originally intended to support cryptocurrency transactions, blockchain technology now supports a much wider range of potential tokens and assets.
As blockchain technology evolves, the community continues to look for opportunities to host new capabilities or assets on-chain. Real world asset (RWA) tokenization is the effort to leverage blockchain’s built-in capabilities to manage ownership of non-digital assets.
Blockchains have a variety of different types of tokens. Bitcoin and other non-smart contract platforms typically have a built-in cryptocurrency that is used to transfer value on the blockchain. Smart contract platforms introduce the ability to create other types of tokens, such as security and utility tokens.
Tokenization is the process of tracking ownership of assets on the blockchain. Ownership of these assets is tracked using non-fungible tokens (NFTs). Unlike cryptocurrencies like Bitcoin — which are fungible and interchangeable 1:1 — NFTs have unique, inherent values. This enables them to uniquely track ownership of a particular asset.
Historically, many tokenized assets were digital assets. For example, NFTs have been widely used to manage ownership of digital art. Bored Apes Yacht Club (BAYC) is a famous example of a digital art collection that uses NFTs to track ownership.
However, blockchains are increasingly moving to tokenize ownership of real-world assets (or RWAs). Often, this is used to tokenize assets such as real estate, art, or luxury goods.
With RWA tokenization, there is typically some form of ceremony in which the responsibility for tracking ownership is assumed by the blockchain. After this point, ownership is transferred from one owner to another by transferring the corresponding NFT on-chain.
RWA tokenization is currently an area of extensive research and development in the blockchain space. The reason for this is that RWA tokenization offers a range of potential benefits, including the following:
Increased Liquidity: Certain types of assets, such as real estate or art — are commonly considered illiquid due to the time and effort required to buy or sell them. By tracking ownership on the blockchain and tying it to ownership of a token, it becomes easier to transfer ownership or fractionalize ownership of assets.
Global Access: Blockchains are designed to be globally accessible, enabling anyone to create accounts and transfer assets on the blockchain. RWA tokenization expands the range of investors and markets who can access these assets.
Greater Efficiency: Traditionally, transfers of land and similar assets are a complex process requiring a significant amount of paperwork. Tokenization eliminates much of this complexity while providing an equivalent level of security.
Reduced Costs: The complex processes of transferring land and similar assets create a network of middlemen, which can increase the costs of these transfers. With tokenization, all of these functions can be implemented using smart contracts, reducing the complexity and the cost of performing the transfer.
Increased Transparency: Blockchains’ digital ledgers are designed to be transparent and publicly accessible. Tracking and transferring ownership of RWAs on the blockchain makes the process more transparent and makes it easier to determine who the real owner of a particular asset is.
Reduced Fraud: Ownership of tokenized assets is transparent and backed by cryptographic algorithms. This makes it more difficult to forge proof of ownership and commit fraud than with traditional methods of tracking ownership of RWAs.
RWA tokenization has its benefits, but it also faces significant challenges on the way to full adoption. Some of the main hurdles RWA tokenization needs to overcome include the following:
Proving Ownership: With RWA tokenization, it’s essential to prove that ownership of the token confers ownership of the corresponding asset. Historically, there have been several cases of tokens being created that falsely claim to track ownership of assets such as digital art.
Regulatory Compliance: Different countries have various laws governing securities, and many of these predate the creation or widespread adoption of blockchain technology. As a result, efforts to tokenize RWAs may need to navigate a complex regulatory landscape.
Market Adoption: Blockchain technology is a relatively new and frequently distrusted technology. As a result, investors may be hesitant to purchase, trade, and adopt tokenized RWAs, making it more difficult for them to gain adoption.
Technical and Security Challenges: RWA tokenization requires the ability to implement smart contracts that encode the rules and processes governing these tokenized assets. These technical requirements can make it more difficult to implement and secure tokenized RWAs.
System Integration: RWA tokenization depends on blockchain infrastructure. It can be difficult to integrate these systems with existing systems within the financial ecosystem, complicating their integration into existing financial markets.
Decision-Making: Fractional token ownership has its benefits, but it can also complicate the process of making decisions. Selling an asset may require consent from most or all of its owners, requiring on-chain governance protocols.
RWA tokenization is a promising application of blockchain technology. By tracking ownership of real world assets on-chain, it creates a range of new investment opportunities and opens up markets to a wide population of investors around the world. Additionally, the use of blockchains and smart contracts to track and manage ownership offers substantial benefits when compared to more traditional processes.
However, implementing RWA tokenization does create potential security risks. Tokenized assets are high-value targets for cybercriminals. Therefore, the smart contracts that govern them would be prime targets for attack, and any vulnerabilities that they contain face a high risk of exploitation.
Halborn has extensive experience in performing smart contract audits, looking not only for vulnerabilities in the code but also business logic errors that could create unintentional effects. Before launching any smart contract — including ones tokenizing RWAs — it's wise to undergo a thorough smart contract audit. For more information on best practices for implementing, securing, and deploying smart contracts for RWA tokenization, get in touch with Halborn.