Real-World Asset Tokenization and AI: Bridging TradFi and DeFi

We continue our series on the convergence of AI and blockchain technology by examining one of the most exciting niches in the crypto and Web3 space. Real World Assets (RWA). The merging of the physical world assets with the frictionless world of digital ownership through digitization and tokenization.

In one of our earlier pieces, we explored AI's role in strengthening the security of interoperable blockchain protocols and the issues that still need to be overcome. There are a lot of similarities between the benefits and challenges of moving assets between blockchains and moving physical assets on-chain. 

In this article, we will examine what exactly RWAs are, how they are digitized, tokenized, and added to blockchains, and the unique challenges involved. We will then examine some of the success stories like Centrifuge before analyzing how AI can improve the processes and ending on where the RWA space is headed with the introduction of AI.

The Digitization, Tokenization, and Monetization of RWAs

The rise of RWAs in the blockchain industry has caught the attention of the world’s largest money management funds, with Blackrock projecting the space to explode into a $10 trillion (with a T) industry in its own right. So what is this pioneering new space?

RWAs are simply real-world assets like currencies, commodities, equities, and bonds that can be represented as digitized assets on the blockchain. They are important because they allow for the integration and ability to move real-world value across the DeFi space. Everything from buying and selling real-world assets to the fractionalization and leveraging the value of users' wealth in real-time.

Real estate is often given as one of the primary examples of how RWAs can be leveraged for digitization and tokenization in this manner. The ERC-1155 standard can further enhance RWA’s utility by enabling them to be minted as dynamic NFTs on SPVs, whereby the RWA’s features can be continually updated without compromising the provenance of ownership. Imagine owning the tokenized version of your house whose value adjusts in real-time every time you upgrade a feature like adding solar panels or replacing the roof. 

RWAs remove much of the friction of transacting real-world assets through tokenization. The ability to sell your house as easily as you can an NFT on Opensea only begins to scratch the surface of their potential. It is easy to see why companies like Blackrock are so bullish on the space.

RWAs enable fractionalized ownership of physical assets that previously had been cumbersome, expensive, or legally impossible to do by remaining solely in the physical realm. If we stay on the example of real estate, we can see why fractionalization of physical assets may seem appealing. Fractionalization allows for ownership to become decentralized, shared, and derisked. It enables smaller investors to enter the space and acquire a portion of a physical asset that they may not have been able to afford otherwise. Imagine the development of a skyscraper. The fractionalization of it as an RWA could allow someone to be an investor for one-tenth of the development cost, allowing for more diversification, risk mitigation, and opening up access for more competition amongst investors.

The limitations of RWAs

Now that we understand the basics of RWAs, we must understand how they operate before we can grasp their limitations and how AI protocols can help overcome some of these hurdles.

The Role of Special Purpose Vehicles 

SPVs are key to understanding how RWAs operate. They are created as a separate asset to provide legal separation from a parent company. They protect the asset from exposure if the parent company were to go bankrupt. In traditional finance, they are commonly used to limit financial risk for a parent company when they take on a risky position but can also be used negatively for concealing debt from the shareholders. 

For RWAs, they are the method for providing separation of ownership from the primary asset and enabling the tokenization of those assets. This is key in tokenization and even more important when fractionalizing tokenized assets. It allows ownership to remain with the token holder even if the rest of the asset is insolvent.

RWA Data Silos and Double Spend Issuance

We have explored extensively the problem of data silos both in the legacy tech and in isolated blockchains in our article on the limits to a technological revolution. When it comes to RWAs, this becomes an area of special importance. With blockchains that remain independent and isolated from each other, there is a risk that RWAs issued on one blockchain could be reissued deliberately or by accident on another, creating a duplication of ownership.

Regulated industries like real estate could limit this issue by regionally selecting only one blockchain to deploy RWAs. However, this could create additional barriers to entry, additional costs for indexing and deploying, and delay the overall adoption of the technology. There are also layers of oversight in most regulated markets, with limitations on who can access certain products, such as Canada's current foreign buyer ban. This can again be resolved by applying digital IDs within a blockchain, but it would require working with the established regulators and be a point of contention for many users who are hesitant to disclose personal information and undermining the overall usefulness of blockchains as a means to eliminate the reliance on third-party intermediaries.

Driving the Future of RWAs

Centrifuge was founded in 2017 and has been a leading project in the tokenization of RWAs. Focusing primarily on tokenizing, managing, and distributing asset funds, they have also championed industry initiatives like the Tokenized Asset Coalition and the Real World Asset Summit. Like other RWAs, Centrifuge relies primarily on creating an SPV to tokenize asset funds. They are demonstrating the power of blockchain technology for the frictionless movement of these asset funds.

AI in RWA - More Than a Novelty

We have seen in our article on AI-driven risk assessment the role that AI can play in early detection and fraud prevention. This becomes even more essential when dealing with RWAs, where the loss of ownership of the physical asset can have real, tangible implications and a devastating impact on the reputation of the industry as a whole. 

The example of Centrifuge and the tokenized asset funds they offer are clear examples of the impact that RWAs can have on revolutionizing traditional asset management. They are enhancing the offerings of traditional funds, making them more liquid through the ease of transaction that RWAs provide, and leading the charge in bridging traditional financial offerings with the DeFi space. AI can further enhance this process, similarly to how we saw Yearn Finance improve its yield generation offerings in our previous piece on AI yield optimization in DeFi. This will create more efficient markets with better capital allocation and drive DeFi adoption overall.

We also alluded to AI's role in remaining compliant in markets and preventing the double issuance of an RWA on multiple blockchains. AI cannot only improve the interoperability of blockchains but simultaneously analyze in real-time the provenance of ownership of an RWA, establishing a comprehensive overall ledger that is essential when dealing with the issue of RWAs' legitimate ownership.

More than in most areas of DeFi, AI will be an essential part of the RWA space moving forward. As more of the physical world becomes tokenized, AI will provide an essential service in reducing risk, establishing provenance, and creating more efficient markets for everything from currencies and commodities to equities and bonds. AI will be key to driving the tokenization of everything and hitting that ten TRILLION Blackrock evaluation.