Amidst the persisting crypto downturn, RWA (real world asset) tokenization has re-emerged as one of the most promising areas within blockchain development and what many believe to be a potential “killer use case” for the industry. To understand why, it’s worth considering that the combined market value of cryptocurrencies is just over $1T, whereas the market worth of real world assets exceeds $500T — highlighting a vast, largely untapped, and highly attractive market potential.
The growing interest in tokenized real world assets (RWAs) has been fueled by stablecoins (representing tokenized fiat) and tokenized treasuries, where momentum has been primarily driven by growing institutional participation, a higher interest rate environment, and ongoing developments in blockchain technology amongst other reasons. Notably, a commonly referenced study by BCG claims that asset tokenization, including both liquid and illiquid asset classes, represents a potential $16T opportunity by 2030.
While the case for liquid tokenized assets is becoming increasingly clear, illiquid assets have yet to follow a similar path. Illiquid alternative investments, such as real estate, private equity, and private credit, remain out of reach for many willing investors, often entail substantial transaction costs and lack transparency. By bringing traditional real world assets onto the blockchain, there’s an opportunity to foster innovation in capital market infrastructure, addressing these legacy challenges. In essence, blockchains are open-sourced distributed databases that facilitate rapid, cost-effective, transparent & immutable record keeping and value transfer. Leveraging these technical advantages, builders introduce liquidity, efficiency and transparency to underserved and illiquid markets that were previously inaccessible, similar to how equity and debt exchanges created marketplaces for capital formation.
At Verda Ventures, we believe that high-yield, short-duration tokenized private credit will drive substantial adoption of tokenized real-world assets. In this post, we’ll provide our perspective on tokenized private credit, starting with an overview of the current state of tokenized RWAs, exploring key driving forces, and discussing the direction of this evolving opportunity.
The Current Landscape of Tokenized RWAs
As of this writing, the total value of active private credit on RWA protocols like Centrifuge, Goldfinch, Credix, Huma Finance and others stands at approximately $557M. This represents a decrease from the all-time high of nearly $1.5B just over a year ago. Conversely, the value of tokenized treasuries has surged nearly sixfold since the start of 2023, reaching a total value exceeding $600M. Additionally, it’s worth mentioning that the market capitalization of stablecoins (which are tokens representing fiat currency) is approaching $124B.
This current landscape can be attributed to the ongoing quantitative tightening measures, which have kept investor sentiment in risk-off territory, and driven by the popularity of stablecoins in both DeFi and emerging real-world applications. However, we’re still far from our goal of bringing blockchain to the real world. In order to reach critical mass, we must observe continuous development of compelling applications, organic user demand, substantial on-chain liquidity and the presence of supporting macroeconomic catalysts. That said, an increasing number of tailwinds are creating an inflection point for tokenized RWAs which we’ll cover with a particular focus on tokenized private credit.
Global Catalysts for Tokenized Private Credit
Below are a few areas that we believe are driving forces not just for tokenized private credit and for tokenized real-world assets broadly.
Global funding gap remains high: According to an estimate by the World Bank, SMEs represent around 90% of employment globally, up to 40% of GDP in emerging economies but face an estimated $5T funding gap every year, amplified by tightening financial regulation worldwide.
Growing institutional participation: While stablecoins and higher yielding tokenized treasuries have served as a wedge for institutional capital on-chain (recent examples including Franklin Templeton & Visa), we believe investors will eventually continue their search for high quality, competitive and uncorrelated yields, presenting an attractive opportunity for tokenized private credit to absorb an increasing amount of liquidity.
Private credit in emerging markets is a nascent but growing asset class: While there’s been a record increase in the amount of private credit allocated in emerging markets, the asset class is still considered relatively small when compared to private credit in developed markets.
Improvement in productive private credit quality in emerging markets using new methods: Asset originators are increasingly leveraging alternative data and digitally-native methods to underwrite high quality customers who are being underserved by the traditional banking system.
Strong global demand for U.S. dollar: The demand and utility for the U.S. dollar in global trade remains strong and is now even more accessible in the form of U.S. dollar stablecoin denominated working capital loans.
Global mobile penetration continues to be prevalent: An estimated 85.88% of people globally own a smartphone today, just slightly under 7 billion individuals. This creates a wide distribution channel for mobile-first applications built on blockchain rails to meet end users where they are.
Growing adoption of crypto: Adoption of crypto in emerging markets continues to grow in emerging markets including Latin America, Africa & APAC.
Benefits of leveraging DeFi vs. TradFi: While blockchain isn’t a solution for everything, its benefits compared to existing financial infrastructure are clear. Breaking a few areas below:
- Efficiency — Programmable smart contract logic can theoretically automate tedious back-office tasks such as loan servicing, accounting and distribution, removing the need for high cost intermediaries & lowering borrowing costs and increasing yields to lenders (a study by the IMF below highlighting costs in DeFi lending relative to TradFi lending).
- Liquidity — New capital markets infrastructure built on top of blockchains can facilitate competitive volumes of rapid and cost-effective transactions for illiquid assets, also enabling better price discovery and greater accessibility to a historically opaque asset class.
- Transparency — Auditability of immutable on-chain activity facilitates trust between counterparties and higher willingness to participate in markets.
Macroeconomic factors: There is broad expectation that the cycle of interest rate increases in the U.S. is reaching its maturity. This would potentially help re-establish a level of economic stability in emerging markets that borrow in dollar-denominated terms.
Technological developments: Ongoing innovation in blockchain technology addresses key pain points that currently deter large scale institutional participation.
- Security & Scalability: Ongoing initiatives to simultaneously increase the cost of corruption and transaction throughput on blockchain protocols.
- Account abstraction: Simplifying the end use experience while still leveraging the full benefits of traditionally complex blockchain infrastructure.
- Zero Knowledge: Implementing novel cryptographic proofs and emerging methodologies to enhance security and privacy in a scalable way, creating trust for institutional and retail participation.
Navigating the Path to Blockchain Integration
Stablecoins and tokenized treasuries are proving to be clear drivers of on-chain liquidity. We anticipate tokenized private credit will play a similarly crucial role in the adoption of tokenized real-world assets (RWAs) due to macroeconomic trends, latent organic demand, active distribution channels, portfolio diversification benefits, and technological advancements in blockchain.
However, we don’t believe the entire private credit process needs immediate migration to the blockchain. Blockchain, without manual intervention, isn’t yet equipped to address inherent risks related to credit, foreign exchange, loan duration and liquidity. The success of this asset class has fundamentally depended on quality deal access, local expertise, robust underwriting practices, and sound risk management processes, regardless of blockchain usage.
Asset originators are likely to lead in tokenized private credit — we foresee a growing number of asset originators (i.e. credit funds and FinTechs), with high underwriting standards, leveraging on-chain lending infrastructure like Huma Finance, Centrifuge, or emerging protocols for cost-effective capital formation. KYC, asset diligence, and portfolio monitoring will likely remain off-chain initially, but we expect this will also change as tokenized private credit liquidity grows and blockchain technology matures.
Future Developments in Tokenized Private Credit: Unlocking New Opportunities
As we look ahead, we’re particularly interested in the following developments in tokenized private credit that will open up further opportunities beyond basic payment infrastructure:
- Enhanced Underwriting: With growing volumes of immutable payment activity recorded on the blockchain, asset originators can automate data collection and continuously refine their underwriting models with lower operational costs.
- Digital Distribution: As crypto-enabled mobile wallet adoption continues to grow, borrowers can establish unique on-chain identities, enabling asset originators to automate debt funding and collections digitally.
- Collateral Quality: DeFi has predominantly relied on overcollateralized lending, leading to capital inefficiencies. However, as asset originators selectively introduce more high-quality real-world assets to the blockchain, un(der)collateralized lending/borrowing may emerge as a significant aspect of the DeFi market.
- New Structured Products: High-quality and customizable structured private credit products could offer greater economic efficiency compared to individual loans. This includes risk profiles, price discovery through secondary markets, and improved access to liquidity.
- New Incentive Models: Captured value within the tokenized private credit ecosystem can be redistributed among participants to stimulate network effects. For instance, rewarding high-quality borrowers with high payback rates can attract new debt investors and incentivize those supporting the on-chain private lending ecosystem.
- App-chain Originators: Asset originators with the necessary technical expertise have an opportunity to build and deploy their own on-chain credit protocols. This allows them to design applications with unique features tailored to the needs of investors and borrowers they’ve onboarded.
- Regulation: Amidst fragmented global regulatory standards for tokens, rising institutional demand for this asset class is expected to drive the emergence of standardized regulatory frameworks. These will govern tokenized assets, including considerations like KYC/AML, securities law, taxation, and facilitate compliant secondary trading on regulated exchanges, enhancing economic efficiency for tokenized private debt.
- Security: While tokenized RWAs offer composability and the ability to use programmable tokenized private credit assets across multiple applications, the challenge lies in smart contract security as a potential attack vector. However, ongoing development efforts are expected to address these security concerns in the long term.
- Value Accrual: Value is likely to accrue to several areas within the tokenized private credit ecosystem, including underlying blockchain protocols facilitating productive private credit transactions, RWA lending protocols generating origination fees, and asset originators and borrowers achieving higher loan margin profitability and bottom-line revenue
Conclusion
In summary, tokenized private credit presents an exciting opportunity driven by growing demand and blockchain maturation. While tokenized RWAs are regaining momentum, their adoption is still in its early stages. Blockchain, while powerful, isn’t yet a complete replacement for traditional finance but serves as a powerful supplementary tool for capital formation in untapped areas. With emerging catalysts and ongoing advancements in technology and regulation, we anticipate significant financial engineering in tokenized private credit as it moves towards mainstream adoption.
