Real-World Assets (RWA) is a major part of the next Crypto wave. Deep dive into stock tokenization.
Real World Assets (RWA) is one of the most innovative areas in crypto. This area includes real estate, stocks, loans, agricultural products, gold, and carbon credits, not to mention a huge market. This article will discuss the current state and future development of tokenization of stocks, one of the fastest developing areas of the market.
Physical collateral and synthetic assets
There are two main ways to create equity tokens. The physical collateral method and the synthetic asset method.
A physically collateralized scheme is one where a custodian holds the physical inventory and issues stock tokens in the same amount. It is the same as USDC or USDT in the case of stablecoin, and it is still fresh in our minds that Binance and FTX have issued stock tokens under this scheme.
The good thing about the physical collateral system is that the actual stock price and the price of the stock token will be very closely linked if there are no problems with the custodian's management system. Depending on how it is structured, it is also possible to distribute dividends and stock tokens to stock token holders.
However, it should be noted that there is a risk that stock tokens may not be maintained if the custodian is ordered by the authorities to cease operations. There is also a risk of loss of client assets if physical inventory is not properly secured.
The synthetic asset scheme is a way to overcollateralize tokens like ETH and USDC to issue and borrow stock tokens, and then use the oracle and liquidation mechanism to peg the stock price and stock tokens. The stablecoin analogy is similar to MakerDAO's DAI; Synthetix, Mirror Protocol, and others attracted many users with this scheme in 2021.
The good thing about the synthetic asset approach is that it is permissionless: the tokens that serve as collateral for stock tokens are controlled by smart contracts and cannot be manipulated except by governance. This is a more censorship-resistant feature than the physical collateral method.
However, synthetic assets cannot pay stock dividends. Stock tokens issued in a physically backed structure will provide higher returns to users. There is also a higher risk that the price of the stock tokens will deviate from the actual stock price compared to the physically collateralized form. Of course, as long as the liquidation mechanism works, users' assets will not be lost because the tokens used as collateral for the issuance of synthetic assets are overly locked into smart contracts. However, depending on supply and demand and the algorithm to prevent depegging, the stock price and stock token price may depeg in the short term.
Binance and FTX are platforms based on physical collateral, while Synthetix and Mirror Protocol are platforms based on synthetic assets. Both platforms have stopped offering stock token services for security, legal and other reasons.
Binance failed to properly structure its licensing and was criticized by authorities in various countries, leading to the suspension of its services.
Synthetix stopped handling stock tokens after its stock tokens were banned from Uniswap's front-end, and the SEC has been very negative about issuing stock tokens without a license and will not issue stock tokens without a license until July 2021. In July 2021, stock token projects, including Mirror Protocol, were removed from the Uniswap UI.
Mirror Protocol was hit with a bug in the source code and stopped working. The bug was in the code for the LUNA price oracle, which was a very elementary bug.
Thus, the well-known stock token platforms are shutting down one after another, and after 2023, many projects will enter the market that overcome the weaknesses of the previous platforms. This space will drive the next crypto wave.
Future prospects of the stock token
The widespread use of stock tokens will lead to an explosion of asset management options, and the day is not far off when this will become ubiquitous. Even residents of countries without a securities infrastructure outside of North America and Europe will be able to take asset exposure to stocks of companies around the world.
Backed Finance is probably the most popular platform for physically backed stock tokens. Established by three Israeli founders, Backed is licensed in Switzerland to store physical stocks, issues stock tokens to players who meet certain criteria, and meets legal requirements by excluding a significant number of countries from the offering.
Jungle Protocol is also being developed with a similar structure.
Synthetic asset-based platforms include ZDX Finance, a platform that improves on the security and UX issues of the Mirror Protocol and will soon be launched on the mainnet on Arbitrum.
Kresko Finance is also developing a similar structure.
In addition to the above, more and more platforms are being developed in the area of stock tokens, and the day is coming soon when people will be able to take stock exposure around the world, no matter where they live.