Tokens are a central part of the blockchain ecosystem. Cryptocurrencies like Bitcoin act as digital currencies, enabling users to make payments, store value, or trade between different tokens. Non-fungible tokens (NFTs) are unique and non-fungible, enabling them to demonstrate ownership of an asset or to be used to hold tickets for an event, a degree or other award, and similar applications.
NFTs have already been extensively used to track ownership of digital assets. NFT collections like the Bored Apes Yacht Club (BAYC) allow ownership of digital art to be stored on-chain. Some of these collections have done extremely well, while others have lost all of their value.
Real-world asset (or RWA) tokenization refers to the practice of tracking ownership of real-world, physical assets on-chain. NFTs are well-suited to recording ownership of luxury goods, real estate, art, and anything else with unique value. However, RWA tokenization also faces significant challenges that complicate and hinder widespread adoption.
3 Key Challenges for RWA Tokenization
RWA tokenization is an exciting area of research for blockchain technology. In most cases, the traditional methods of managing ownership of RWAs are cumbersome, with transfers taking a significant amount of time and incurring fees from various intermediaries. By tokenizing these assets, blockchains can streamline the process and can open up new opportunities, such as fractionalized ownership of RWAs that are not otherwise easily divisible.
However, while RWA tokenization has significant promise, there are roadblocks standing in the way of its widespread adoption.
Below are some of the top challenges faced by efforts to implement RWA tokenization.
1. Proving Token Legitimacy
Creating an NFT is pretty easy on most smart contract platforms. In many cases, there are templates available where the deployer can fill in a few fields and have a functional token contract. Once the code is complete, deploying it to the blockchain is relatively simple as well, and, once complete, a new NFT is born.
However, in and of itself, an NFT has no inherent value. In fact, an estimated 95% of NFTs in existence have zero value. The fact that anyone can launch an NFT means that the market can be easily flooded, and NFTs have to have an external source of value to be worth anything.
For most of the NFTs launched to date, this external source of value is ownership of digital art. For example, BAYC NFTs are rare collectibles that many people want, which pushes up their values. Since an NFT records ownership of an ape, the NFT is valuable.
However, proving that an NFT confers ownership is a tricky task. There have been several cases of fake NFTs being created that claim to confer ownership of art without the original artist’s knowledge or consent. These fake NFTs are worthless once discovered but can be used to scam buyers who believe in them.
The challenge of proving ownership is exacerbated with RWA tokenization. In the case of property, art, luxury goods, etc., there are already processes in place for claiming and transferring ownership of assets. Unless NFTs are accepted as the official record of ownership for an asset, they are worthless and may be disputed.
2. Acceptance in the Courts
Beyond common acceptance of an NFT as an official method of tracking asset ownership, there is also the challenge of getting it accepted in the courts as well. In some legal proceedings, a judge may order that ownership of an asset be transferred to one of the parties in the lawsuit. For example, one party may gain the rights to property in a divorce, or a failure to pay taxes could result in land being put up for auction in a bankruptcy proceeding.
With traditional proof of ownership, a judge can force transfers by submitting the correct legal documents, like a court order deed for property transfers. However, compelling a transfer on-chain is more difficult. Unless that capability is built into a token contract — which can introduce complexity and security risks — the only way to compel a transfer on-chain is if the judge has access to the account’s private key or can force the account owner to perform the transfer.
3. Token Contract Security
Like any smart contract, NFT contracts have the potential to contain vulnerabilities. Numerous blockchain smart contracts have been hacked, leading to millions of dollars in lost assets. A hack of a smart contract controlling a tokenized real-world asset could create significant uncertainty about the ownership of that asset.
For example, ownership of a piece of art may be tracked on-chain. If an attacker manages to force a transfer — whether through exploiting a smart contract vulnerability or a phishing attack — is the owner of the art required to transfer the physical asset to the hacker? Or will there be some means of proving that a transfer was the result of an attack, invalidating the previous NFT, and causing a new one to be issued? If so, what does this process look like, and who acts as arbitrator for the claim of theft?
In the DeFi space, it’s often difficult to tell the difference between a rug pull and a hack, so conclusively proving that a transfer was the result of a hack will be difficult or impossible.
The Difficult Road to RWA Tokenization
RWA tokenization has significant promise, and several projects are working toward making it a reality. The ability to indisputably track ownership of real-world assets on-chain has several benefits, such as the greater transparency and transferability of ownership when compared to traditional methods of tracking ownership.
However, RWA tokenization must overcome significant challenges before it becomes a mainstream or default way of tracking ownership of various assets. Without the ability to prove that NFTs represent ownership of an asset — and to protect the smart contracts governing these assets against attack and abuse — there will continue to be resistance to using them to record ownership of high-value assets. Overcoming these hurdles will require developing methods to authenticate NFTs, support court-ordered transfers, and mitigate the potential effects of NFT contract hacks.
