Demand for tokenized real-world assets (RWAs) is rapidly growing across the decentralized finance (DeFi) community, with growing interest among existing crypto-native participants and across the traditional finance industry generally. Major financial institutions, either have launched or have disclosed an intention to actively pursue development and utilization of blockchain networks to facilitate the tokenization and transfer of RWAs. The interest in tokenized RWAs as a unique asset class arises from the plethora of potential benefits they can provide. Tokenized RWAs enhance the ability to fractionalize high-cost assets, helping to democratize potential financial investments to a broader community. They also expand on one of the ultimate promises of blockchain and tokenization—faster and smoother settlements of financial instruments, potentially resulting in cost savings through reduction of intermediaries and 24/7 trading. However, broad access to tokenized RWAs within the United States remains limited, having to date largely been restricted to accredited investors as a result of an unclear regulatory pathway to register these assets with the U.S. Securities and Exchange Commission (SEC).
The RWA Tokenization Process
RWA tokenization refers to the process of representing legal ownership or certain rights or indicia of control to physical assets digitally using blockchain technology. This can allow traditionally illiquid assets, such as real estate, commodities, art, music rights, and other forms of intellectual property to be fractionalized, tokenized and ultimately traded on digital platforms with an ease of use not otherwise available. Tokenization can also be extended to financial instruments, including stocks, bonds and U.S. Treasuries. Tokenization of these financial instruments involves their conversion into transferrable digital tokens. This process creates a digital representation of ownership, facilitating trading on blockchain-based platforms.
Tokenized Financial Instruments
The U.S. dollar-backed stablecoin market is effectively the first large, liquid, tokenized RWA market, with the stablecoin market estimated at $150 billion already 1. Beyond U.S. dollar-backed stablecoins, tokenized U.S. Treasuries reflect the next potential high-growth RWA market, in particular in an environment of heightened interest rates, as these instruments allow crypto-native investors to capture additional yield in a stable, relatively secure asset without moving funds out of a crypto environment. The current market value of funds backed by tokenized U.S. Treasuries is currently over $1.2 billion 2. These funds are being utilized by institutional investors looking for entry into the blockchain space as well as crypto-native parties such as DAO treasury management groups looking for the stability of stablecoins with additional yield opportunities.
The tokenized U.S. Treasury market is expected to continue to grow substantially. Franklin Templeton issued the first U.S. registered mutual fund substantially invested in U.S. Treasuries on the blockchain in 20213 and has continued to grow and add more blockchain functionality to this fund. In March 2024, BlackRock announced its first tokenized fund on a public blockchain 4, which allows direct on-chain trading of a fund invested in U.S. dollars, U.S. Treasuries and repo agreements. In the short time since launch, this BlackRock fund is already the largest tokenized Treasury-backed fund in existence. We expect more traditional financial firms to continue to explore ways to offer tokenized financial instruments to both crypto-native parties and others exploring on-chain asset investments.
U.S. Regulatory Limitations
Despite the growing demand for tokenized RWAs, and in particular the fast-growing market for tokenized U.S. Treasuries, there remain significant hurdles to their widespread use within the United States. While several crypto projects have been designed with the intention of being outside the scope of U.S. securities laws, the structure of most tokenized RWAs, with an explicit focus on yield generation and appreciation in value, will generally cause them to be treated as securities under the Securities Act of 1933 (as amended, the Securities Act), including both tokens representing underlying financial securities (like stocks and bonds) and tokens representing interests in underlying physical assets where the goal is receipt of payment streams or appreciation of the underlying asset. As a result, it will be difficult to see meaningful adoption of tokenized RWAs without these assets complying with applicable U.S. securities laws.
To date, the United States has not implemented comprehensive regulations specifically for issuing security instruments on the blockchain, and therefore tokenized RWAs in the United States need to be structured in a way that complies with the current securities law framework. As a result, the most straightforward path for issuers of security tokens to offer these tokens in the United States is to only offer them to “accredited investors” and to rely on Regulation D promulgated under the Securities Act. This is the approach taken by most issuers of tokenized U.S. Treasuries in the market today. However, these restrictions effectively limit the potential investor pool to high-net-worth individuals and entities, leaving out a large portion of potential retail investors in the United States. This inability to market or sell to all persons in the United States, and all the securities compliance obligations necessary to comply with these restrictions, ultimately limit the potential for large-scale adoption and trading of tokenized RWAs in the United States.
While the United States has not yet adopted a specific regulatory regime for blockchain-based securities, multiple international jurisdictions have been proactive in setting forth such blockchain-specific regulatory regimes. In the European Union the Markets in Crypto-Assets (MiCA) regulation came into effect in 2023 with specific regulation covering crypto-assets, including “asset reference tokens” and “e-money tokens.” Europe has also seen the issuance of bonds on the blockchain, with the European Investment Bank issuing digital bonds on public and private blockchains in 2023. Switzerland has also long been a leader in digital asset tokenization regulation as well. In the active Asian crypto market, the Monetary Authority of Singapore has set forth comprehensive guidelines for issuing security tokens.
To date there have been multiple legislative and regulatory proposals put forth to adopt a more crypto-specific regulatory regime in the United States. However, until such proposals receive significantly more support either by legislators or regulators, the path to creating a tokenized security that is marketable to, and tradeable by, a broad base of U.S. investors will require taking the proposed token through an applicable registration process with the SEC.
U.S. Securities Law Registration Pathways
The Securities Act and the regulations promulgated thereunder is fundamentally a principle-based statutory framework, intended to be flexible to adapt to changes in the market. With this background in mind, the SEC has taken the position in public statements that blockchain technology can be seen as a new development in the market, but one that should be able to fit in with the broad existing regulatory framework of the Securities Act. However, the SEC has expressed significant concerns about the crypto sector broadly, and in recent years has leaned more on a “regulation by enforcement” approach instead of regulation by proactive guidance, limiting the ability for market participants to create structures that they can be confident are clearly within the bounds of the Securities Act. The SEC has brought enforcement actions against several crypto companies in recent years for a variety of securities law violations, including for failure to register tokens that pay interest or generate yield as securities. While the SEC has continued to state that it is possible for token projects to comply with existing U.S. securities law, in order for our principles-based approach to be effective in practice, issuers need to have a clear pathway and guidance for how security tokens, and tokenized RWAs in particular, can best be structured to comply with the Securities Act.
While the SEC has continued to express concern about specific issues within the crypto industry, the sheer size of the market and the continued development of regulatory pathways ex-U.S. will put pressure on the SEC and Congress to modernize the current securities law frameworks in order to accommodate digital assets like tokenized RWAs, so that the United States does not fall further behind other countries in this regulatory space.
For an issuer looking to register tokenized RWAs in the United States, there are a handful of paths available, consistent with the SEC’s view that tokenized security instruments can be structured under the existing Securities Act framework. Further development in this market will require issuers willing to dive into these registration pathways, and work with the SEC to produce legally valid and economically viable products. Set forth below are the main potential pathways a potential tokenized RWA issuer may consider for issuing RWAs to all potential U.S. investors.
Regulation CF
Regulation CF is an exemption from U.S. securities laws that permits eligible companies to offer and sell securities through a crowdfunding process. While on its face promising, this process is limited to issuances of up to $5 million in a 12-month period, generally includes a one-year holding period for further resales, and requires ongoing filing obligations with the SEC. The relatively low dollar size maximum as well as other potential compliance restrictions associated with this exemption makes it of limited utility for many potential issuers.
Regulation A
Regulation A, commonly referred to as a “mini-IPO,” is a potentially more attractive middle ground between the Regulation CF requirements and full Form S-1 registration described below. Regulation A consists of two tiers: (i) Tier 1 offerings for raising up to $20 million in a 12-month period and (ii) Tier 2 offerings for raising up to $75 million in a 12-month period. A Tier 2 offering imposes additional requirements relative to a Tier 1 offering, in particular a requirement for audited financial statements and ongoing reporting obligations, but it does provide several benefits that can make it a useable registration path for issuers interested in this market size. In particular, a Tier 2 qualified Regulation A offering is exempt from U.S. state securities laws (or “blue sky laws”), removing a substantial obstacle to expanding adoption within the United States. There is also historical precedence for the Regulation A path for crypto tokens. In 2019, the first Regulation A crypto-token offering was qualified by the SEC. Additionally, Regulation A has been an attractive path for issuers looking to offer fractional interests in real estate and collectible assets. For example, Masterworks offers investors the ability to invest in a fractional share of artwork and structures these offerings as Regulation A offerings of interests in an LLC whose sole asset is a particular artwork. Additionally, several issuers have used Regulation A offerings to offer fractional share investing in real estate investments. We expect to continue to see more issuers explore Regulation A to offer fractional interests in physical assets.
Form S-1
Finally, the ultimate path for a project looking to offer tokenized securities at scale will be through a full SEC review of a registration statement on Form S-1 (or Form F-1 for certain non-U.S. issuers). The Form S-1 registration process has relatively higher up-front costs and fulsome disclosure obligations compared to Regulation A or Regulation CF, but provides the maximum flexibility in size of offering and tradability of assets. In August 2020, INX Limited succeeded in clearing SEC comments and registering its offering of INX Tokens, more than 30 months and 10 amendments after its initial Form S-1 filing. While this was certainly an arduous process, and longer and more involved than the Form S-1 process is for most non-crypto assets, it did ultimately succeed in receiving SEC clearance and conducting its offering, and it continues to trade. More recently, Figure Certificate, a provider of stablecoin alternatives, filed a Form S-1 to register Figure Certificates, which are proposed to be interest-bearing digital asset securities. The Form S-1 for Figure Certificate is currently pending SEC review.
While the path to a Form S-1 registration can be a daunting challenge, and certain aspects of the requirements in a Form S-1 may not on their face appear to be applicable to RWA token issuers, a well-drafted Form S-1, with appropriate advisors, can provide a roadmap to meaningful engagement with the SEC to bring freely tradeable RWA tokens to the public at large.
Regardless of the regulatory pathway an issuer decides to take, it will need to be prepared for a potentially lengthy SEC review process, as the SEC has to date generally taken substantially longer to review filings of crypto-related issuers than they have taken to review comparable filings by non-crypto issuers. Issuers also need to be mindful of other potential legal compliance matters, including structuring the offering entity in compliance with the Investment Company Act of 1940.
Legal Structures of RWA Token Issuers
For any entity looking to tokenize RWAs and work through the SEC registration process, a key issue for the SEC is the ultimate legal rights a token holder has in the underlying asset. One of the cornerstones of SEC review is making clear to potential investors what rights a potential investor does and does not have in the security being offered. Ultimately, “ownership” via tokens can be represented in many ways. A token could simply represent a fractional interest of direct ownership of the asset. However, there are practical issues with such a structure; if a large, unconnected, disparate group each own a small percentage of an asset, it’s unclear who can make decisions, organize custody or use and exploit the asset. Far more likely will be structures where the token represents an equity interest in a legal entity that owns the underlying asset, a debt interest of an entity holding the underlying physical assets (whether collateralized or not), or simply a right to a cash stream coming from an underlying asset. Each of these approaches has its own advantages and disadvantages, and the type of underlying asset will largely drive the preferred legal structure. Assets with steady revenue streams, such as real estate, royalty streams, and dividend-paying financial instruments, are more likely to be candidates for a debt-like structure where a token represents a right to a regular payment secured by underlying collateral. On the other hand, tokenized RWAs where the investment goal is appreciation over time, such as artwork and other collectibles, will need to be structured as equity-like interests, whether as LPs of a fund or beneficiaries of a trust.
In all of these cases, there will need to be a clear set of underlying agreements outlining the rights of a token holder, how expenses such as custody of the asset and other administrative expenses are paid, and who has rights to use and exploit the asset. Further, how the token holder’s interest in the underlying asset is protected from other creditors of the token issuer or other involved parties will be a continued area of concern for regulators as RWAs expand in use. State governments have begun to address some of these issues through the spreading adoption of Article 12 of the Uniform Commercial Code, more clearly putting in place a framework for perfection and prioritization of security interests in digital assets, in particular tokens representing rights to payment.
Ultimately, a clear legal structure, with articulable legal rights and protections for token recipients, will be a fundamental requirement in clearing SEC hurdles for RWA tokens.
Conclusion
Tokenized RWAs present a compelling use case for blockchain assets going forward and are quickly gaining traction around the world. While there is clear demand for such assets in the United States, these types of assets will not be available to investors broadly unless and until issuers are able to work with the SEC to issue registered tokenized RWAs. Current U.S. securities law does provide potential avenues a party may take in registering tokenized RWAs, and we believe once such an issuer approach has gone through the rigor of SEC review and come out the other side with a widely tradeable token, the pathway for additional parties will become clearer and the market for further registered tokenized RWAs will rapidly expand.
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Footnotes:
1 - Per rwa.xyz
2 - Per rwa.xyz
3 - The Franklin OnChain U.S. Government Money Fund
4 - The BlackRock USD Institutional Digital Liquidity Fund