A few quick thoughts as I reflect on both the advancements in the real world asset ecosystem over the past six months, and additionally some resistance from retail.
As the conversation about high risk and highly volatile assets dies down, the demand for digital assets with ‘substance’ arises. And yes, in this case talking about Real World Assets(RWA’s), somewhat interchangeable with the ‘tokenization’ movement. Not to say this is the only path blockchain finance has in a search for maturity, but that it is a strong step forward in the direction of creating additional value leveraging blockchain. The impact permissionless liquidity can have in traditional finance(TradeFi), or the role sustainable earning from the real world can have in DeFi, are vast to say the least.
From when I first wrote about digital securities early last spring, the amount of intermingling of blockchain and TradeFi has exploded. There are now dozens and dozens of use cases; young companies and protocols springing up in every direction. While the supply is growing fast for digital assets tied to the real world, retail hasn’t seemed as enthusiastic as many thought they would at this stage. Especially when the discrepancy between lending rates in the real world and those in DeFi are at an all time high. After all, aren’t capital markets supposed to be efficient? Shouldn’t capital be able to flow freely through both systems? Certainly not the case(for now). While there are many reasons I feel this could be, that’s somewhat of a separate topic.
What conversation seems to be lost on the topic of tokenization is that are assets being sold to on-chain investors representative of the assets, or the assets themselves? You could theoretically take this question in many directions, but I think the legal perspective is probably the most relevant. That is to say, if I buy this asset and hold it in my metamask wallet, what claim do I truly have?
There are currently many ways companies and protocols are doing, or planning on doing the facilitation of RWA’s on-chain from an operational/legal perspective. The spectrum of legality ranges from 100% legal to possibly a gray area, each with its benefits. I’m often going to pick on real estate to demonstrate the landscape as real estate has by far emerged as the most developed RWA in the digital world due its prominence in finance, everyday life, and highlighted by its illiquid nature.
Ownership vs Representation: Two sides of the story
In order for you to legally own an asset on-chain, at least in the U.S, there is going to have to be some level of KYC(at least for now). While the permissionless nature is what so many of us rushed into DeFi for(myself included), it’s not the end all be all in my opinion. Because with ownership, comes well, true ownership. And once an asset is purchased, it’s yours no questions asked. Thanks to the nature of smart contracts, the code is law, increasing transparency for transactions taking place so that the transaction executes flawlessly. Due to current SEC regulations, there are various form to which securities can be sold on-chain, each with varying levels of accreditation and geographic rules among others.
I don’t want to gloss over the fact that I used the frowned upon words: ‘KYC’. Yes, I’m aware that KYC to many people is the antithesis of DeFi, and from a certain angle I agree. But what are the goals of DeFi? If it’s to build an entirely permissionless ecosystem, then I struggle to find the practicality in ever achieving the connection between the real world and blockchain(and maybe that’s fine). If the goal is to improve the legacy financial system(s) that we have in place, then diversifying DeFi into including semi-permissionless systems seems like a strong step towards that goal. Example, providing minor personal details in order to purchase fractional real estate equity is certainly an improvement from the traditional home transaction for countless reasons.
Representation is not bad
Representation of real world assets are not inherently bad, they often come with less restrictions around purchasing requirements, and trading. The caveat often ends up being, one doesn’t truly own an asset being represented. You end up trusting some intermediary, which should not be surprising, we trust intermediaries to do as they promise every day, hence the free market. Tokens(often fractionalized NFT’s) representing underlying real estate means that there is someone, or some entity who truly owns the asset, and if you go to the county courthouse with your token, you’re going to find out quickly that only one name is in their records(and it’s not yours).
But when I hear representation in RWA’s, I often think ‘permissionless’, meaning literally anyone globally can own U.S equities at the click of a button. And this representative strategy seems to be more aligned with the characteristics that users fled to DeFi for in the first place. So the underlying questions arise, do I trust the seller? What are the legal implications of this? I think a-lot of clarification will come over time as these protocols/companies become tested from the market and possibly receive scrutiny from the law(although not likely in the near term due to size).
While I don’t have answers from who will ‘win’, the permissioned vs permissionless, ownership vs representation, I certainly have high hopes for the space. I tend to feel that blockchain continuing to make impact in the form of DeFi is going to have to make some sort of compromise in order to interact with the real world. And semi-permissioned protocols using innovative legal systems may just have an edge. It is safe to say for me, the world could benefit from blockchain, and blockchain could most certainly benefit from the world, and that connection is where I see the most value being created for those willing to innovate.
Original Medium: https://graysonalto.medium.com/ownership-v-representation-semi-permissioned-ecc8f6f6e15d
