Top 6 Challenges in RWA Tokenization and How to Overcome Them

RWA tokenization is the novel process of converting real-world assets into digital tokens, making them easier and safer to trade. From real estate and artwork to precious metals and company shares, tokenization platform development services like the one offered here at Debut Infotech Pvt Ltd make it simple to manage and exchange assets on the blockchain securely. 

However, despite the numerous benefits that this innovative approach offers, it is still in its infancy. As such, it is facing some major obstacles hindering its growth and widespread adoption. 

So, whether you’re an investor launching RWA tokenization projects or just a blockchain enthusiast, it is important to be aware of these challenges and some possible ways to overcome them. 

That’s why this article itemizes 6 major challenges in RWA tokenization and actionable steps to solving them. By the end of this article, you will be able to conduct thorough RWA tokenization risk assessment checks before launching your RWA tokens.

Without further ado, let’s address these RWA challenges.  

1. Proving Token Legitimacy, Ownership, and Custody 

Despite the technological advancements in real-world asset tokenization, it’s still relatively difficult to prove that a token represents the ownership of the underlying real-world asset. 

In principle, when a real-world asset, such as real estate, art, or a luxury item, has been tokenized, then ownership of such tokens should mean ownership of the underlying asset. However, in practice, it is not that simple for a number of reasons. For example, what’s to stop a random individual with no legitimate claims at all to a property from launching a tokenization project claiming they own such properties? Exactly! 

In fact, Forbes reports that 95% of NFTs are virtually worthless. This is largely because it is very easy to create and launch NFTs. 

Consequently, it is becoming increasingly difficult to establish a clear and undisputable link between token and asset ownership, making token legitimacy, ownership, and custody a tricky affair. 

Furthermore, when legitimate tokens pass through multiple owners, it can also become difficult to identify the real owners of the token and its underlying assets. In such cases, the decentralized nature of the blockchain technology upon which real-world asset tokenization projects are built means there are no centralized authorities for settling ownership disputes. 

So, what can be done to prove token legitimacy and ownership?

It starts on the technical side. Blockchain developers need to build more advanced cryptographic techniques and blockchain functionalities that make it easy to verify a token’s links to a real-world asset. For instance, fungible tokens can employ specific ERC standards. In contrast, non-fungible tokens (NFTs) could be limited to unique assets as opposed to just being able to mint anything as an NFT.

Secondly, some legal changes need to be made to ensure that tokens like NFTs can pass as official records of ownership for an asset. This will ensure that token holders have enforceable rights that can be tendered in the courts in cases of ownership disputes.

2. Legal/Regulatory Ambiguity and Court Acceptance 

In today’s current legal landscape, token ownership doesn’t carry the same weight as traditional proofs of ownership. As a matter of fact, the legal and regulatory frameworks governing the ownership of tokenized assets are all very blurry right now, with different regions having different sets of regulatory standards for them. From securities laws and tax regulations to property laws and the like, there are just so many legal hurdles that tokenized real-world assets have to skip to be considered legitimate. Some regions are even completely hostile towards them altogether. 

These legal ambiguities complicate most activities involving real-world asset tokenization. For instance, selling tokenized real-world assets in some countries may fall under the oversight of financial regulators in some regions. As such, involved parties are compelled to abide by cumbersome compliance regulations that require full disclosure and reporting. 

Navigating these fragmented regulatory frameworks requires a lot of resources, thus increasing the burden on tokenization platforms to stay on the right side of the law. 

These inconsistencies and legal hurdles significantly affect investor confidence, making adoption increasingly difficult. More specifically, they alienate small players from the real-world asset tokenization market.

So, what can be done to navigate the complex regulatory landscape?

Regulatory bodies across different regions need to make significant efforts to accommodate RWA tokenization. This means that these agencies need to create standardized regulatory frameworks that span different regions to foster trust and encourage cross-border transactions. To take things even further, these clear legal frameworks need to ensure that token holders have enforceable property rights. 

On the path of tokenization platforms and project owners, more must be done to understand the existing legal frameworks and statutes. Most of these platforms often focus majorly on the technical side of things, i.e., how the smart contracts are built and how the real-world assets can be properly tokenized. However, to ensure that the tokens are usable for real-world scenarios, they must increase their focus on the legal side to ensure that they understand the legal definitions and requirements in different jurisdictions before launching any RWA tokenization project. 

3. Technological Complexities and Security Risks 

The technology governing RWA tokenization projects is also not yet at its best. Numerous reported cases of hacked blockchain smart contracts have led to huge financial losses. From smart contract vulnerabilities to phishing attacks, there are serious security risks that make it difficult for new investors to trust RWA tokenization projects. More so, the decentralized nature of the blockchain technology upon which these projects are based leaves room for other cyber risks. For example, there are still no clear methods of proving if a token transfer is legitimate or a result of a hack. And when this happens as a result of a hack, the immutable nature of the blockchain networks makes it difficult to reverse. 

There’s also the risk of permanent property losses if a legitimate owner forgets or loses access to their private keys. 

Finally, there’s the agelong issue of blockchain concepts being abstract and difficult to understand for beginners. Some organizations that may be open to RWA tokenization quite simply do not understand how it works. 

All these infrastructural vulnerabilities and knowledge gaps further make it difficult to create a fully secure and compliant environment for trading RWAs and tokenized securities. 

So, what can be done to mitigate technical complexities and security risks? 

Firstly, tokenization platforms take rigorous testing and smart contract audits more seriously. There can not be any mistakes in the smart contracts before they are launched. And even after launching smart contracts and RWA tokenization projects, they must be committed to regular updates and patches to spot these vulnerabilities before any malicious actors spot them. 

Secondly, regulatory frameworks and tokenization platforms need to invest more in fraud prevention measures like robust KYC (Know Your Customer) and Anti-Money Laundering (AML) protocols. These protocols implement efficient checks that make it easy to spot and prevent fraudulent activities on-chain. 

Finally, the RWA tokenization community should regularly demystify complex blockchain concepts and make knowledge more easily accessible to all members of the tokenization community. 

4. Liquidity Risks

All the RWA challenges we’ve discussed so far ultimately make it difficult for investors to participate in RWA tokenization. By extension, the limited participants mean there’ll be less liquidity and low trading volumes in RWA tokenization markets. As a result, the market moves slowly, leading to volatility and possible losses for investors. 

This is even more common in niche RWA tokenization markets like the art industry, where most purchase interests come from a few high-net-worth individuals and institutions. The limited number of participants often causes liquidity issues when it comes to NFTs. 

So, how can liquidity be enhanced in the RWA tokenization market? 

Major players and tokenization platforms need to collaborate to create secondary trading markets for these RWA tokens. This can be done by creating Automated Market Makers (AMMs) and liquidity pools. These structures help active investors to pool their resources together to ensure smoother transactions and facilitate a smoother RWA tokenization market in general. 

Furthermore, the concept of liquidity pools can be incentivized if tokenization platforms issue rewards for investors who contribute their resources to the liquidity pools. This idea is similar to the incentivization techniques currently in practice in decentralized crypto and centralized crypto exchanges. 

Finally, as opposed to limiting investments to high-net-worth individuals and institutions, especially in niche RWA tokenization markets, tokenization platforms should also incentivize fractional ownership. The markets can get a lot of liquidity from retail investors if they have an avenue to invest their limited resources in fractional ownership of some RWA assets. So, instead of simply buying whole assets, retail investors should be encouraged to purchase as few tokens as their financial capacity permits. This will make the investments accessible to a broader audience and consequently increase the liquidity. 

5. Technical Standardization and Interoperability Issues 

As it stands, the RWA tokenization market is fragmented to a large extent. This is because different tokenization platforms and projects employ different technologies, protocols, and standards for building and launching different projects. Acquiring tokenized assets on one platform limits the platform’s usage of such tokens. For now, traditional assets have an edge over tokenized assets in that they can move seamlessly across different systems. 

In simpler terms, the challenge here is that RWA tokens are not interoperable or standardized across multiple systems. This implication is that the growth and adoption of RWA tokens are stunted because, let’s face it, no investor wants to endure the stress imposed by those restrictions. Not to mention, it is costly and even less secure to move across different systems right now. 

But what if all RWA tokens can move seamlessly across systems? What if different RWA tokenization systems can work together? What if there is an industry-wide standard for creating RWA tokens? 

Well, investors will have more faith in the system. 

So, how can interoperability and standardization be achieved in the RWA tokenization market?

The obvious answer is that all regulatory bodies and tokenization platforms need to come together to create common frameworks for tokenized assets. This means there should be industry-wide standards that will dictate the kind of token standards for specific categories of RWA tokens, ranging from real estate to art. Not only will this facilitate smoother transactions, but it will also make it easy for different organizations to launch their own RWA tokens. By so doing, the industry will gain more participants, and liquidity issues will be solved gradually. 

In addition to this collaboration between industry stakeholders, the token developers also need to develop interoperability protocols that facilitate cross-chain connectivity. 

This involves Interoperability platforms that allow seamless transfer and trading of tokenized assets across different blockchains, such as public, private, EVM, and non-EVM. Such platforms must support diverse execution models and security requirements to accommodate the preferences of financial institutions.

6. Price Stability Between Different Blockchains 

Not only are tokenized RWAs highly susceptible to significant price swings, but the underlying blockchain tokens or cryptocurrencies they reside on are also highly volatile. For example, if the native token of a blockchain (like Ether on Ethereum) experiences a sharp price drop or security issues, the value of the tokenized asset can be adversely affected despite the real-world asset itself being stable. 

Combining this inherent volatility with the issue of fragmented markets discussed earlier, tokenized RWAs are bound to experience inconsistent pricing and reduced market depth. This is because the use and preference of different tokenization platforms and investors for different blockchains automatically create “liquidity islands” where tokenized assets cannot be transferred from one platform to another.

Finally, the lack of unified pricing mechanisms represents the final straw in this case. Without a standardized or synchronized pricing mechanism across blockchains, tokenized RWAs can have varying prices on different chains due to differences in liquidity, demand, and trading venues. This disparity undermines the stability and trust in the tokenized asset’s value.

So, how can we maintain price stability? 

One effective method to mitigate price volatility is to peg tokenized RWAs to stablecoins such as USDT or USDC, which are designed to maintain a stable value against fiat currencies. This pegging reduces price fluctuations caused by the volatility of the underlying blockchain or the crypto market, providing a more stable and reliable valuation for token holders.

Not only that. 

Tokenization projects also need to start applying dynamic pricing systems that adjust token prices based on real-time market data, asset performance, and economic indicators. This approach can help reflect the true value of the underlying asset more accurately, thus reducing extreme price swings and aligning token prices closer to the real-world asset value. 

New projects can also back stablecoins with tokenized RWAs to enhance the stablecoin’s value stability by reducing reliance on volatile crypto reserves. Since RWAs tend to have lower volatility than cryptocurrencies, their inclusion in stablecoin reserves helps maintain a steadier price, which in turn supports stable pricing for tokenized assets linked to these stablecoins. 

Conclusion

There is no doubt about the huge potential of RWA tokenization, especially in democratizing access to high-quality investments. 

However, many investors are still very skeptical about its longevity and security. This is due to obvious RWA challenges like the inability to prove token ownership, legal ambiguities, liquidity risks, price instability, and interoperability and standardization issues. 

To remedy these challenges, tokenization platforms, regulatory authorities, and blockchain investors need to collaborate across spheres to create uniform legal frameworks and maintain price stability. 

At Debut Infotech Pvt Ltd, our token development services are expertly structured to overcome these challenges. We don’t just create tokens, we launch tokenization projects that are ready to address today’s challenges and seize tomorrow’s opportunities. 

Would you like to launch something like that? 

Speak with our tokenization experts. 

Frequently Asked Questions (FAQs)