Over the past month, Real World Assets (RWAs) have quickly become one of the hottest buzzworthy trends in the Web3 space, filling everyone with equal parts optimism and skepticism. All of these projects have the goal of tokenizing real-world assets and moving them onto the blockchain. Combined, they stitch together a fascinating tapestry of old finance meets new decentralized tech. The growing landscape is filled with minefields, from regulatory challenges to real fraud. Attorney Honglin has been actively watching the RWA market. He encourages participants in these efforts to proceed thoughtfully and to raise the hard questions before developing these projects.
Four Key Questions for RWA Projects
Here are four critical questions to ask to ensure any RWA project is truly legitimate and viable.
The bedrock of any real world asset project is the existence and security of those underlying assets. Are the assets real and verifiable? Given that we know that institutional assets are here, is there a very strong custodial mechanism to protect those assets? Are the funds regularly audited to guarantee that monies are spent openly and with accountability? These questions are key in the judgment of whether the project is responsive to a true foundation or just a set front.
The majority of RWA projects miss the mark on this front, failing to provide a compliant custody mechanism. This deficiency creates deep uncertainties as to the safety, quality and security of such underlying assets, putting investors at peril with unknown risks.
The token design of an RWA project must not be a vehicle for avoiding securities regulations. If the token exhibits characteristics of a security, it may be considered touting profits derived from the efforts of others. If so, it could be considered a security and thus subject to securities laws. Projects seeking to avoid these regulations with fancy token design start to evoke concern. So deal with them at your own risk!
And, even with real underlying assets, selling these tradable tokens to the general public often constitutes illegal fundraising. This is a reminder that it’s essential to approach any new token design first by making sure it’s in line with the applicable regulations.
Who the specific target audience for RWA token sales is becomes another key consideration. Are the tokens offered only to accredited investors who understand the risks of the investment? Or are they just being marketed widely, including to those with the lowest levels of financial literacy? When the selling of really complicated financial products to really unsophisticated investors ends up hurting people a lot, this shit invites a regulatory buzzsaw.
Unlike most RWA projects, these ones tie tokens directly to individual users with no minimum investment requirement. This practice contravenes principles of investor protection and may be unlawful under the federal securities laws.
5. Are Project Owners receiving sufficient legal counsel and plans of regulatory response?
Do the public project owners have sufficient legal guidance that their project will comply with whatever laws and regulations apply? Have they articulated a robust plan for dealing with expected regulatory/legal challenges? Without the proper legal knowledge and regulatory readiness, a project can put itself and its investors at immense risk.
This second question identifies the important distinction of recognizing what is different about each individual RWA project. Understanding this information is important before investing directly or indirectly into the technology.
Honglin finds three primary categories of RWA projects that are up and running in today’s market. Knowing the difference between these categories can help investors more accurately gauge the risks and opportunities that each type presents.
This category encompasses both projects which tokenize the existence and rights of real-world assets in a compliant and transparent way. These kinds of projects generally do not have the participation of well-known financial institutions and do not follow strict regulatory guidelines. Notable examples include on-chain platforms like Swarm, Ondo and Matrixdock that let people directly purchase tokenized T-Bill notes.
"What kind of RWA are you talking about?" - Liu Honglin
We’ve seen a few publicly traded companies use RWA as a story line to signal their pivot into the Web3 world. These projects often have much less clear intentions in terms of market building versus hype building, speculation chasing versus value creation. Savvy investors will get up-close and personal with the underlying assets and business model of these projects before writing any checks.
Three Main Types of RWA Projects
Many RWA projects are just scams to defraud investors. These so-called projects are usually not transparent, don’t deliver on real or attainable promises, and exist with no tangible, underlying asset. Investors need to be highly skeptical of any RWA project that creates a magic bullet. In recent years, RWA has been misused by certain project owners to defraud, underscoring the need to research and conduct due diligence before investing.
A number of seemingly innocuous practices should send investors running from RWA projects. These include:
Public security organs, public security, market supervision bureaus and financial supervision bureaus are all highly attentive to RWA projects. This new basis of scrutiny places a premium on RWA projects to ensure that they are operating in a compliant and transparent way.
2. RWA Hype for Web3 Entry:
Some listed companies are using RWA as a narrative to announce their entry into the Web3 space. These projects may be more focused on generating hype and attracting market speculation than on creating genuine value. Investors should carefully scrutinize the underlying assets and business model of these projects before investing.
3. Potential Fraud:
Unfortunately, some RWA projects are simply scams designed to defraud investors. These projects often lack transparency, make unrealistic promises, and have no real underlying assets. Investors should be extremely cautious of any RWA project that seems too good to be true. Some project owners use RWA to defraud, which is why it is important to do your research before investing.
Common Red Flags in RWA Projects
Several common routines should raise red flags for potential investors in RWA projects. These include:
- Lack of Compliant Custody Mechanism: As mentioned earlier, a robust custodial mechanism is essential for safeguarding the underlying assets.
- Direct Connection to Individual Users: Tokens directly connected to individual users without any investment threshold raise concerns about investor protection.
- Promising High Returns: Unrealistic promises of high returns are a classic sign of a Ponzi scheme or other fraudulent activity.
- RWA Press Releases for Hype: Some projects use "RWA press releases" to create hype and attract investors without any real substance.
- Rough Project Documents: Poorly written project documents, such as PPT and PDF offline files, lacking on-chain data and code audits, suggest a lack of professionalism and attention to detail.
- Focus on Market Value Management: Projects that prioritize "market value management" over the underlying assets may be more interested in manipulating the market than creating genuine value.
Public security organs, market supervision bureaus, and financial supervision bureaus are paying close attention to RWA projects. This increased scrutiny highlights the need for RWA projects to operate in a compliant and transparent manner.
