How are RWAs linked on-chain?

Tokenisation will revolutionise how we own, trade, and manage real-world assets (RWAs). These assets fall into categories such as off-chain vs. on-chain and tangible vs. intangible.

As this technology gains widespread acceptance, establishing the right infrastructure to guarantee security, transparency, and trust becomes paramount, especially as more institutions enter this arena.

A crucial component of the infrastructure is connecting RWAs to their digital representations on the blockchain and subsequently keeping the token updated with both on-chain and off-chain information. Information originating from sources outside the blockchain is termed "off-chain," while data already residing on the blockchain is referred to as "on-chain."

Consider a scenario involving private debt, an intangible off-chain asset, featuring variable interest payments in the form of a coupon. When the interest rate fluctuates, it becomes necessary to update the token with the latest interest rates. The question arises: What is the most efficient method for accomplishing this update?

In this article we will tackle answering questions like these.

The process of tokenisation

Before we dive into how assets are connected on-chain, let's first explore two methods of tokenising assets, whether they are tangible or intangible.

The first method, which is the most commonly used for tokenisation, involves using non-native tokens, also known as synthetic tokens. In simple terms, this means that the token represents the underlying asset.
The typical structure for this method involves launching a Special Purpose Vehicle (SPV) that owns the asset to be tokenised. For instance, private debt may be issued to the SPV. This asset is usually held by a custodian, serving as a neutral third party responsible for its safekeeping. Subsequently, the shares of the SPV are tokenised. Investors purchase tokens that represent these shares in the SPV, and these shares, in turn, own the underlying asset.

While the specific process may vary for different tokenised assets, this approach is commonly employed.

The second method involves native tokens, where an on-chain token is issued and functions as the Real World Asset (RWA) itself, without representing any off-chain asset.

For instance, bonds that are directly issued on-chain as tokens are considered native RWAs. On the other hand, a bond issued and held off-chain can be tokenised as a non-native RWA.

In both cases, there needs to be a way to update information from off-chain sources to on-chain for transparency. This is where oracles come into play.

If you want to learn more about the process of tokenising assets, read our article here. 

What is an oracle?

In order to launch a token on the blockchain, a coded smart contract has to be created and executed. The problem is that these smart contracts are isolated from any data, both on and off chain. 

Oracles provide a solution to this problem, by creating a form of “hybrid” smart contracts, which allow smart contracts to access external data sources.

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To explain this concept, think of a regular smart contract like an isolated island without internet access. So, if a conflict erupted on the other side of the world, you wouldn't be aware of it. Now, picture someone setting up a functional Wi-Fi hotspot on that island, giving you access to the news and information about the war. This is essentially what an oracle does for a smart contract. It provides the contract with external data and updates, bridging the gap between the blockchain and the real world.

When using oracles, the quality of data becomes crucial because inaccurate data can result in significant repercussions. If a centralised oracle with a single node fetches data from a single source, there's a risk of that data being incorrect or the node becoming compromised, either by going offline or being corrupted. 

On the other hand, a decentralised oracle network, comprising thousands of nodes from various data sources, mitigates the risks associated with data manipulation, inaccuracy, and downtime. This decentralised approach enhances the reliability and security of data used by smart contracts.

To ensure the best accuracy and quality, oracles typically work in the following sequence of events:

1. Data Collection: Oracle nodes are responsible for retrieving data from sources that exist off the blockchain, such as financial markets or external APIs.
2. Data Verification: The data obtained is subjected to rigorous verification processes aimed at ensuring its accuracy and reliability. Various methods, including consensus algorithms, are employed for this purpose.
3. Data Formatting: Following verification, the data is formatted into a suitable structure that aligns with the blockchain's requirements and standards.
4. Data Transmission: The formatted data is securely transmitted onto the blockchain, where it becomes accessible and available for integration with smart contracts and other applications.
5. Smart Contract Integration: With the data now available on the blockchain, smart contracts can seamlessly incorporate and utilise it to execute specific functions or make well-informed decisions as needed.

How do oracles help tokenised assets?

Oracles play a crucial role in enhancing and expanding the capabilities of tokenised assets, particularly Real World Assets (RWAs). They serve several key functions in this context:

Proof of Reserve: Oracles, such as Chainlink services, provide autonomous and reliable verification of reserves backing tokenized RWAs. This ensures that consumers, monetary authorities, asset issuers, and on-chain applications can monitor cross-chain or off-chain reserves in a transparent manner. This verification enables circuit breakers to be implemented, safeguarding users in cases where the value of off-chain assets diverges from on-chain tokenised assets.

Identity Verification: Establishing the identity of counterparties and asset owners is essential for regulatory compliance when dealing with RWAs. Privacy-preserving oracle protocols, like DECO, use zero-knowledge technology to enable institutions and individuals to prove the provenance and verify ownership of tokenised RWAs without disclosing sensitive personal information to third parties. Oracles facilitate secure and compliant transactions in the RWA space.

Data Streams and Feeds: Oracles provide a secure and decentralised source of financial market data. They supply a wide range of data, including commodities, equities, forex, indices, economic data, business financials, cryptocurrencies, and more. This data is crucial for pricing, valuation, and risk management of tokenised assets, ensuring that the information available to participants is accurate and up-to-date.

Functions Synchronisation: Oracles enable the synchronisation of off-chain events and data with on-chain smart contracts. This synchronisation can encompass various aspects such as standing settlement instructions, corporate actions, proxy voting, ESG data, dividends and interest, and net asset value (NAV). By bringing these functions on-chain, oracles enhance the programmability and automation of tokenised RWAs, making them more efficient and responsive to market dynamics.

Case study: Stablecoins

Stablecoins represent a category of tokenised cryptocurrency assets pegged to a fixed value tied to the market price of an external asset, typically a fiat currency like the US dollar, although other commodities may also be used. The primary approach for achieving this price stability involves a centralised entity issuing tokens backed by US dollars held securely in an off-chain custody arrangement, effectively digitising the value of the USD.

In recent years, there has been an exponential growth in the supply of stablecoins, with the current circulation exceeding $132 billion on public blockchain networks. 

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Price feed oracles play a pivotal role in the stablecoin ecosystem. They are essential for maintaining the pegged value of stablecoins, which are often tied to external assets like fiat currencies or commodities. By providing real-time data on the value of these external assets, price feeds ensure that stablecoins maintain their intended peg. 

Additionally, price feeds are crucial for stablecoin risk management. They help assess and mitigate risk by monitoring the value of collateral assets. If the value of these assets drops below a predetermined threshold, price feeds trigger risk management actions, such as asset liquidation, to safeguard the stability of the stablecoin.

Conclusion

In summary, the tokenisation of real-world assets (RWAs) is set to revolutionise asset ownership and management across different categories, from off-chain to on-chain and tangible to intangible. As this technology gains wider acceptance, establishing a robust infrastructure is vital to ensure security, transparency, and trust, particularly with increasing institutional involvement.

One crucial piece of this infrastructure is oracles, which act as a bridge between RWAs and their digital representations on the blockchain, updating tokens with both on-chain and off-chain data. Oracles enhance smart contracts' functionality, allowing them to access external data sources. Decentralised oracle networks with multiple nodes are preferred for their data reliability and security.

Oracles offer significant benefits to tokenised assets, including proof of reserve, identity verification, data streams, and synchronisation of off-chain events. A prime example is stablecoins, tied to external assets like fiat currencies. Price feed oracles play a pivotal role in maintaining stablecoin pegs and managing risks by monitoring collateral values.

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Sources

https://blog.chain.link/tokenized-real-world-assets/ 

https://www.doubloin.com/learn/stablecoin-oracles-price-feeds#:~:text=Key%20Takeaways,up%2Dto%2Ddate%20information. 

https://blog.chain.link/stages-enriching-real-world-assets/