"The tokenization of RWA is not only the greatest potential for the development of Web3 in Hong Kong, but also the future trend of Web3 worldwide."

Authors: Wang Yang and Zhu Haokang, Vice President of the Hong Kong University of Science and Technology and Ph.D. student in Financial Technology at the Hong Kong Polytechnic University, respectively

Source: Ta Kung Pao

On June 1st of this year, the official implementation of Hong Kong's new virtual asset regulations undoubtedly marked an important milestone in the development of Web3.0 in Hong Kong. This historically significant event strongly confirms the views expressed by Carrie Lam, the Chief Executive of the Hong Kong Special Administrative Region, at the "Hong Kong Web3.0 Association" inaugural ceremony on April 11th of this year, namely the profound impact of Web3.0 on the development of financial technology and the open attitude and firm determination of the SAR government towards this. At the same time, the Securities and Futures Commission of Hong Kong has opened applications for virtual asset trading platform licenses, and compliant operators can now provide virtual asset services to professional and retail investors. The implementation of this policy undoubtedly further promotes the development of the virtual asset industry and paves the way for the wider expansion of virtual assets and Web3.0 in Hong Kong. Despite the global trend of tightening regulation on virtual assets, the SAR government has firmly maintained its position, and a series of strategies and actions clearly demonstrate its determination and support for promoting the development of the virtual asset industry in Hong Kong, further proving the SAR government's firm determination to develop the space for virtual assets and Web3.0.

Building a Compliant and Reasonable Friendly Ecosystem for Web3

However, the development of virtual assets and Web3 in Hong Kong has mainly focused on compliance and licensing, rather than on building a vibrant ecosystem that allows licensed institutions to have a viable business plan. Although the implementation of such regulation by the Securities and Futures Commission is to maintain order in the virtual market, this licensing system is undoubtedly a heavy burden for virtual asset enterprises in Hong Kong. The phrase "A license to be killed" is more appropriate here, as it is currently seen that licensed exchanges like OSL have incurred millions of dollars in losses annually after obtaining a license. Therefore, Hong Kong urgently needs a broader vision to lead the global development of Web3 by creating the world's first compliant, reasonable, and friendly ecosystem for Web3, truly leading the development of Web3 globally.

I firmly believe that in the development of Web3.0 in Hong Kong, the next step should focus on the deep integration of virtual and real-world assets. We can fully utilize blockchain technology to build a strong Web3 ecosystem based on the Hong Kong dollar stablecoin. Our focus should be on the digitization and tokenization of real-world assets (RWA), such as bonds, private credit, trade finance, real estate, carbon credit certificates, and precious metals. This series of actions will greatly promote the close integration of the virtual economy with physical assets. In fact, the tokenization of RWA is not only the greatest potential for the development of Web3 in Hong Kong, but also the future trend of Web3 worldwide.

In a favorable regulatory environment, RWA can provide a truly prosperous opportunity for legitimate participants, rather than just becoming a sacrificial victim of "a license to be killed." This transformation will undoubtedly lead Hong Kong to the forefront of global Web3 development.

The tokenization of RWA—transforming tangible or intangible assets into digital tokens—is a groundbreaking transformation in the digital asset field, expected to redefine the market landscape. The introduction of blockchain technology has revolutionized RWA compared to traditional securitization. RWA tokenization provides transparency and security, and expands liquidity by realizing partial ownership. This approach not only solves the inefficiency of the traditional financial system but also breaks the limitations of the traditional financial system, enabling assets to be digitized and unique, bridging the gap between traditional and new finance, meeting users' personalized financial needs, and lowering the investment threshold. This will stimulate the entry and participation of more small and medium-sized investors in financial activities, thereby creating enormous value and returns. At the same time, RWA injects liquidity and diversity into the real economy, expanding the variety of assets and increasing the scale of funds.

In addition, RWA based on the Hong Kong dollar stablecoin also provides an additional layer of security, allowing traditional finance and the real economy to enjoy the liquidity, transparency, and innovation brought by blockchain technology while protecting the funds of investors and participants. In September 2022, the Boston Consulting Group (BCG) predicted that the scale of tokenization of real-world assets would reach $16 trillion by 2030. Correspondingly, in March 2023, Citibank released a 162-page research report, comprehensively analyzing the path to achieving one billion users and digital assets reaching tens of trillions of dollars in the Web3. Citibank predicts that by 2030, $4 trillion to $5 trillion of assets will be tokenized, and the trade finance transaction volume based on blockchain technology will reach $1 trillion.

Reasonable Regulation Promotes the Healthy Development of RWA

The healthy development of the RWA ecosystem depends on reasonable regulation. However, building a compliant, reasonable, and friendly environment for RWA tokenization is not easy and requires the joint efforts of the government and the industry. To this end, we propose to adopt the "RWA 2+4" advocated by the author Zhu Haokang as a feasible research entry point. This methodology revolves around two types of tokens (security tokens and utility tokens) and four core elements (legal foundation, financial framework, technical tools, and data-driven) for research and practice, in order to find opportunities in challenges and promote the healthy development of RWA.

First, security tokens represent ownership or profit rights of assets or enterprises, and their value is usually directly related to the performance of the physical assets or enterprises they represent. People who purchase these tokens typically expect to receive returns through the appreciation of assets or profit distribution. On the other hand, utility tokens provide the right to use a service or resource, while allowing data generated during the token process to be recorded on the chain. Understanding the characteristics and differences of these two types of tokens is crucial for the correct evaluation and investment in RWA.

Next, we need to focus on four core elements: legal regulation, financial architecture, technical support, and data application.

The law forms the foundation of RWA, determining which assets can be tokenized and the regulations that need to be followed during the tokenization process. As a globally important financial center, Hong Kong has a comprehensive securities legal system, with unique advantages in promoting compliant security token offerings (STOs) that comply with regulations. Hong Kong's securities laws comprehensively regulate the issuance and circulation of various securities assets such as stocks and bonds. Financial assets that need to be tokenized, such as stocks, bonds, and funds, have clear legal definitions in the Hong Kong market. In addition, the Securities and Futures Commission of Hong Kong has established comprehensive standards for the review of securities issuance and listing. RWA conducting STOs need to be linked to corporate equity, debt, and other assets, and these underlying assets need to comply with the information disclosure and approval regulations of the Securities and Futures Commission to ensure their quality. Furthermore, Hong Kong has established a strict suitability management system for investors to prevent ordinary investors from purchasing complex and high-risk RWA products.

Finance is the framework of RWA, defining the specific structure of asset tokenization and trading, including asset valuation, audit and confirmation, token issuance and trading, and related risk management. In terms of debt and equity financing, Hong Kong has rich experience and a world-leading scale. Hong Kong's investment banks and audit firms can provide professional valuation and audit services for the underlying assets of RWA, determining the quality and clear ownership of the assets for token issuance. In addition, compliant licensed virtual asset trading platforms in Hong Kong can ensure the public and fair issuance and trading of RWA tokens.

Technology is the tool of RWA, providing the technological means to achieve tokenization and trading, including blockchain technology, smart contract technology, oracles, cross-chain, and related security and privacy protection technologies. Since the release of the virtual asset development policy declaration by Hong Kong on October 31, 2022, excellent blockchain technology companies from around the world have begun to actively settle in Hong Kong.

At the "2023 Shanghai Blockchain International Week - 9th Blockchain Global Summit" held on September 19, 2023, Mr. Edmond Lai, CEO of Cyberport Management Company Limited, stated that Cyberport now has over 190 Web 3.0 related enterprises, including important underlying blockchain infrastructure companies such as zCloak, a digital identity and privacy computing infrastructure company, and Safeheron, a professional digital asset custody solution company.

Establishing a Public Chain that Meets Hong Kong Standards

Data is the driving force of RWA, providing crucial information about assets and markets to support investment decisions and market analysis. The tokenization of RWA, as a new investment method, not only provides investors with a broader range of investment choices but also brings a wealth of data and rich information to the market, such as trading data and user behavior data. This data forms a powerful driving force, significantly enhancing the ability of asset operators and investors to understand market dynamics, predict market trends, and manage investment risks. The application of this data will also promote the organic integration of artificial intelligence with Web3, further driving the development of technological innovation in Hong Kong.

To promote the development of RWA tokenization in Hong Kong, we first need to build a compliant and robust infrastructure, with blockchain technology being the core component. It not only provides a decentralized, secure, and transparent platform for assets to flow globally but also enables the automatic execution of complex financial transactions and protocols. However, due to the complexity of putting RWA on the chain, we need to implement a robust, secure, and Hong Kong-standard compliant Know Your Customer (KYC) mechanism. Organizations such as the Hong Kong Web3.0 Association have proposed the establishment of a new public blockchain for RWA in Hong Kong, incorporating the necessary KYC mechanism. While establishing a new public chain requires significant technological investment and extensive community development, it is a crucial step in promoting the development of RWA and an important step in the financial technology innovation in Hong Kong.

However, establishing a new public chain is not a simple task. It requires significant technological investment, including designing efficient consensus mechanisms, building robust network architecture, and developing user-friendly clients. Additionally, extensive community development and management are also necessary to attract and retain developers, users, and investors. We believe that as long as Hong Kong is determined to lead in RWA, these challenges can be quickly overcome.

Stablecoin is another essential infrastructure for RWA tokenization, and its healthy implementation is crucial for the development of RWA. We must ensure its effective implementation in Hong Kong to pave the way for further development of RWA. As a hub for global Web3.0 development and an international financial center, Hong Kong needs to swiftly issue a Hong Kong dollar stablecoin. With the flourishing development of RWA, the demand for stablecoin is expected to grow sharply.

In our previous article "Proposal for the Issuance of Hong Kong Dollar Stablecoin Backed by Foreign Reserves," we proposed that Hong Kong should issue a unified Hong Kong dollar stablecoin (HKDG). However, when we saw Singapore's management system for the stablecoin market—specifically the Singapore Stablecoin Framework "Response to Public Consultation: Regulatory Approach to Proposed Stablecoin Activities," we are very concerned that Hong Kong may adopt a similar stablecoin policy, which could have a serious negative impact on the future development of RWA in Hong Kong. Singapore's stablecoin policy does not have a unified plan for the issuance entities and the types of pegged currencies, which will inevitably lead to fragmentation and confusion in stablecoin issuance schemes, likely to trigger vicious competition among stablecoins, increase financial risks, hinder the formation of mature stablecoins, and may even marginalize stablecoins as niche products. This approach cannot meet the large-scale demand for stablecoins in the future development of RWA.

Therefore, we strongly urge Hong Kong to introduce a unified stablecoin, guided by an overall plan and issued by licensed institutions (which may include government, banks, insurance, and fund institutions), along with corresponding profit distribution schemes. Only in this way can we avoid market fragmentation, reduce financial risks, meet the large-scale demand for stablecoins, make Hong Kong stablecoin a mature and widely used financial product, lay the foundation for the healthy development of the RWA ecosystem in Hong Kong, and further consolidate Hong Kong's leading position in the global financial technology field.

In fact, we don't have much time left. The field of RWA tokenization has attracted widespread attention and has been widely applied in different industries. As part of decentralized finance (DeFi) protocols, MakerDAO is one of the earliest institutions to include RWA in its strategic planning. As early as 2020, MakerDAO passed a proposal to use RWA as collateral for tokenizing real estate and other items, significantly expanding the issuance scale of DAI (MakerDAO's stablecoin). Despite the overall situation of DeFi not being ideal in the past year, MakerDAO's investment in the RWA field has continued to increase. As of May this year, the total amount of MakerDAO's RWA investment portfolio has reached 23.4 billion DAI. It is predicted that the annualized income from RWA will reach as high as $71 million, which has become an important source of income for MakerDAO. Additionally, the U.S.-based platform Propy is a typical application of real estate RWA. The platform uses blockchain technology to put real estate on the chain in the form of non-fungible tokens (NFTs) and supports purchases using cryptocurrencies, while also using artificial intelligence (AI) technology to improve transaction efficiency. On July 6 this year, Propy announced that the value of its platform token PRO had increased from $0.268 to $0.571, a growth of over 200%. This event strongly demonstrates the enormous potential and value of RWA in real-world applications.

Clarifying the Regulatory Policy for RWA Token Issuance

As an international trade port and world trade center, Hong Kong naturally has unparalleled advantages and substantial market demand in terms of its geographical location and economic status. Hong Kong has the ability to lead the global RWA market, so it should seize the opportunity to quickly build an RWA business ecosystem based in Hong Kong. First, we need to clarify the regulatory policies for RWA securitization and security token issuance (STO), specifying the scope of assets that security tokens can be pegged to and the disclosure requirements to protect investor rights. Establishing RWA token issuance trading platforms in on-exchange markets such as the Hong Kong Stock Exchange to enhance their liquidity.

We should encourage banks, insurance companies, funds, and other financial institutions to fully utilize their professional capabilities to participate in RWA business. At the same time, Hong Kong should strengthen cooperation with Singapore, the European Union, and other regions in the field of RWA tokenization business to jointly expand the market. Through education and training, we can accumulate the professional talents needed for RWA tokenization business. Building an open, standardized, and vibrant RWA tokenization business ecosystem will significantly enhance Hong Kong's digital economy and financial technology capabilities, laying a solid foundation for Hong Kong's future.

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