RWA tokenization is the biggest potential of Web3 in Hong Kong

Author: Wang Yang Zhu Haokang Source: Dagong.com

On June 1 this year, the official implementation of Hong Kong's new virtual asset regulations undoubtedly marked an important milestone in the development of Web 3.0 in Hong Kong.

This historic event strongly confirms the views expressed by the Chief Executive of the Hong Kong Special Administrative Region (HKSAR) John Lee Ka-chiu at the inauguration ceremony of the "Hong Kong Web 3.0 Association" on 11 April this year, that is, the far-reaching impact of Web 3.0 on the development of financial technology, and the HKSAR government's openness and firm determination to this regard.

During the same period, the SFC 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 has undoubtedly further promoted the development of the virtual asset industry and paved the way for the wider expansion of virtual assets and Web 3.0 in Hong Kong.

Despite the tightening of global regulation of virtual assets, the HKSAR Government has firmly maintained its position, and a series of strategies and actions have clearly demonstrated its determination and support for promoting the development of Hong Kong's virtual asset industry, which undoubtedly further proves the SAR Government's firm determination to develop the virtual asset space and Web 3.0.

Create a Web3 compliant, reasonable and friendly ecology

However, Hong Kong's development in the virtual assets and Web3 space has mainly focused on compliance and licensing, rather than building a vibrant ecosystem that allows licensed institutions to have a viable business plan.

Although the SFC imposes such regulation to maintain order in the virtual market, this licensing regime is undoubtedly a heavy burden for virtual asset enterprises in Hong Kong. ** The phrase "A license to be killed" is more apt here, because as it stands, licensed exchanges like OSL lose tens of millions of dollars a year after obtaining a license. **

Therefore, Hong Kong urgently needs to have a broader vision, look at building the world's first Web3 compliant and friendly ecosystem, and truly lead the development of global Web3.

The author believes that on the road of Web 3.0 development, the next step in Hong Kong should focus on the deep integration of virtual world and real world assets. We can make full use of blockchain technology to build a strong Web3 ecosystem based on HKD stablecoins. 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 and real assets. In fact, the tokenization of RWA is not only the biggest potential for the development of Web3 in Hong Kong, but also the future trend of Web3 in the world. **

In a well-regulated environment, RWA can provide a real opportunity for legitimate actors to prosper, rather than just falling victim to "licensed killing." This shift will undoubtedly lead Hong Kong to the forefront of global Web3 development.

The tokenization of RWA – the conversion of tangible or intangible assets into digital tokens – is a groundbreaking shift in the digital asset space that promises 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 enabling fractional ownership. This method not only solves the problem of inefficiency of the traditional financial system, but also breaks the limitations of the traditional financial system, so that assets can be digitized and unique, shorten the distance between traditional finance and new finance, meet the personalized financial needs of users, and lower the investment threshold. This will stimulate more small and medium-sized investors to enter and participate in financial activities, thereby creating huge value and income. At the same time, RWA injects liquidity and diversity into the real economy, increasing the scale of capital by expanding the asset type.

In addition, RWA based on Hong Kong dollar stablecoins also has a layer of security, so that traditional finance and the real economy can enjoy the advantages of liquidity, transparency and innovation brought by blockchain technology, while protecting the capital security of investors and participants. In September 2022, research by Boston Consulting Group (BCG) predicted that tokenized real-world assets would reach $16 trillion by 2030.

Correspondingly, Citibank released a 162-page research report in March 2023, comprehensively analyzing Web3's path to achieving one billion users and digital assets reaching tens of trillions of dollars. Citibank predicts that by 2030, $4 trillion to $5 trillion in assets will be tokenized, and trade finance transactions based on blockchain technology will reach $1 trillion.

Reasonable regulation promotes the healthy development of RWA

The healthy development of the RWA ecosystem is inseparable from reasonable supervision. However, building a compliant, reasonable and friendly RWA tokenization environment is not easy, which requires the joint efforts of governments and industry. To this end, we suggest that the "RWA 2+4" advocated earlier by Zhu Haokang as the entry point for the feasibility study.

This methodology is researched and practiced around two tokens (security tokens and utility tokens) and four core elements (legal foundation, financial framework, technical tools and data-driven) in order to find opportunities in the challenges and promote the healthy development of RWA.

First, security tokens represent the ownership or income rights of an asset or business, and their value is usually directly related to the performance of the physical asset or business represented. People who buy such tokens usually expect to be able to earn a return through the appreciation of the asset or the distribution of proceeds.

On the other hand, Utility Tokens provide the right to use a service or resource, while allowing the data generated during the token process to be uploaded to the chain. Understanding the characteristics and differences between the two tokens is essential to properly evaluate and invest in RWA.

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

**The law forms the basis of RWA, which determines which assets can be tokenized and what regulations need to be followed during the tokenization process. **As an important global financial center, Hong Kong has a well-established securities legal system and is uniquely positioned to promote Security Token Offering (STO).

Hong Kong's securities laws comprehensively regulate the issuance and circulation of various types of securities assets such as stocks and bonds. RWA requires tokenized financial assets such as stocks, bonds, funds, etc. with clear legal definitions in the Hong Kong market.

In addition, the Hong Kong Securities and Futures Commission has formulated sound review standards for securities issuance and listing. RWA for STO needs to be linked to the company's equity, debt and other assets, and these underlying assets need to comply with the information disclosure and approval requirements of the CSRC to ensure their quality. In addition, Hong Kong has established a strict investor suitability management system to prevent ordinary investors from purchasing complex and high-risk RWA products.

Finance is the framework of RWA, which defines the specific structure of asset tokenization and trading, including asset valuation, audit and confirmation, token issuance and trading, and related risk management. Hong Kong has extensive experience and world-leading scale in debt and equity financing.

Investment banks and auditors in Hong Kong can provide professional valuation and audit services for RWA's underlying assets, determine the quality and clarity of ownership of assets, and provide a basis for token issuance. In addition, a compliant licensed virtual asset trading platform in Hong Kong can ensure that the issuance and trading of RWA tokens is open and fair.

Technology is a tool of RWA, which provides the technological means to tokenize and trade. **This includes blockchain technology, smart contract technology, oracles, cross-chain, and related security and privacy protection technologies. Since Hong Kong issued the Virtual Asset Development Policy Declaration on October 31, 2022, outstanding blockchain technology companies from all over the world have begun to actively settle in Hong Kong.

On September 19, 2023, the "2023 Shanghai Blockchain International Week. At the 9th Blockchain Global Summit, Ren Jingxin, CEO of Hong Kong Cyberport Management Co., Ltd., said that there are now more than 190 Web 3.0-related enterprises in Cyberport, including important underlying blockchain infrastructure companies and enterprises, such as digital identity and privacy computing infrastructure company zCloak, professional digital asset custody solution company Safeheron, etc.

Establish a public chain that meets Hong Kong standards

Data is RWA-driven, providing important information about assets and markets, supporting investment decisions and market analysis. RWA tokenization is a new type of investment method, which not only provides investors with broader investment options, but also brings a large amount of data and rich information to the market, such as transaction data and user behavior data.

This data forms a powerful driving force that greatly improves the ability of asset operators and investors to understand market dynamics, predict market trends, manage investment risks, and more. The application of these data will also promote the organic integration of artificial intelligence and Web3, and further promote the development of technological innovation in Hong Kong.

**In order to promote the development of RWA tokenization in Hong Kong, we first need to build a compliant and robust infrastructure, of which blockchain technology is the core part. It not only provides a decentralized, secure and transparent platform that allows assets to flow globally, but also automates complex financial transactions and protocols.

However, due to the complexity of the process of bringing RWA on-chain, we need to implement a robust, secure and Hong Kong-compliant Customer Due Diligence (KYC) mechanism. Some organizations, such as the Hong Kong Web 3.0 Association, have proposed to build a new public blockchain for RWA in Hong Kong with corresponding KYC mechanisms built into it.

Although the establishment of a new public chain requires a lot of technical investment and extensive community building, it is a key link to promote the development of RWA and an important step in Hong Kong's fintech innovation. Of course, building a new public chain is not something that happens overnight. It requires a lot of technical investment, including designing an efficient consensus mechanism, building a robust network architecture, and developing easy-to-use clients.

In addition, extensive community building and management is required to attract and retain developers, users, and investors. We believe that as long as Hong Kong is determined to become a leader in RWA, these challenges will be overcome quickly.

**Stablecoins are another infrastructure that cannot be ignored for RWA tokenization, and their healthy implementation is crucial to the development of RWA. **We must ensure its effective implementation in Hong Kong to pave the way for the further development of RWA.

As a hub for global Web 3.0 development and an international financial center, it is necessary for Hong Kong to issue Hong Kong dollar stablecoins quickly. As RWA booms, the demand for stablecoins is expected to grow dramatically.

In our previous article, "Proposal for Hong Kong to Issue a Hong Kong Dollar Stablecoin Backed by Foreign Exchange Reserves", we have argued that Hong Kong should issue a unified Hong Kong dollar stablecoin (HKDG).

However, when we look at Singapore's regulatory regime for the stablecoin market, namely the Singapore Stablecoin Framework "Response to Public Consultation: A Regulatory Approach to Proposed Stablecoin-related Activities", we are very concerned that Hong Kong will adopt a similar stablecoin policy, which will have a serious negative impact on the future development of RWA in Hong Kong.

Singapore's stablecoin policy does not carry out a global unified planning of the issuer of stablecoins and the type of linked currency, which will inevitably lead to fragmentation and confusion of stablecoin issuance schemes, which is likely to trigger vicious competition between stablecoins, increase financial risks, hinder the formation of mature stablecoins, and may even make stablecoins a marginalized niche product. This approach cannot meet the large-scale demand for stablecoins under the full development of RWA in the future.

Therefore, we reiterate our strong call for Hong Kong to launch a unified stablecoin, guided by the overall plan, issued by concessionary institutions (which can include the government and financial institutions such as banks, insurance, funds, etc.), and accompanied by corresponding profit distribution plans. Only in this way can we avoid market fragmentation, reduce financial risks, meet the large-scale demand for stablecoins, make Hong Kong stablecoins a mature and widely used financial product, pave the way for the healthy development of Hong Kong's RWA ecosystem, and further consolidate Hong Kong's leading position in the global financial technology field.

Actually, we don't have much time left. The field of RWA tokenization has attracted a lot of attention and has been widely used in different industries. As part of the decentralized finance (DeFi) protocol, MakerDAO was one of the first to incorporate RWA into its strategic planning. Back in 2020, MakerDAO passed the proposal to use RWA as collateral for items such as tokenized real estate, a decision that significantly expanded the issuance of DAI (MakerDAO's stablecoin).

While the overall situation for DeFi has not been ideal over the past year, MakerDAO's investment in RWA has continued to increase. According to statistics, as of May this year, MakerDAO's total portfolio in RWA has reached 2.34 billion DAI. It is predicted that the annualized revenue from RWA will be as high as $71 million, which has become an important source of revenue for MakerDAO.

In addition, the Propy platform in the United States is a typical application of real estate RWA. The platform utilizes blockchain technology to put real estate on-chain in the form of non-fungible tokens (NFTs) and supports purchases using cryptocurrencies, while also leveraging artificial intelligence (AI) technology to improve transaction efficiency. On July 6 this year, Propy announced that the value of its platform token, PRO, rose from $0.268 to $0.571, an increase of more than 200%. This event is a strong testament to the great potential and value of RWA in real-world applications.

Clarify RWA token issuance regulatory policies

As an international trade port and world trade center, Hong Kong naturally has unparalleled advantages and actual huge market demand in terms of geographical location and economic status. Hong Kong has the ability to lead the global RWA market, so it should seize the opportunity to build a Hong Kong-based RWA business ecosystem as soon as possible.

First of all, we need to clarify the regulatory policies for RWA securitization and security token issuance (STO), clarify the scope of assets and information disclosure requirements that security tokens can be attached to, and protect investors' rights and interests. Establish an RWA token issuance trading platform in the exchange market such as the Hong Kong Stock Exchange to enhance its liquidity.

We should encourage financial institutions such as banks, insurance, and funds to make full use of their professional capabilities to participate in RWA business. At the same time, Hong Kong should strengthen cooperation with Singapore, the EU and other places in the field of RWA tokenization business to jointly expand the market. Through education and training, we can accumulate the professionals needed for RWA tokenized business. Building an open, standardized and dynamic RWA tokenized business ecosystem will effectively enhance Hong Kong's digital economy and fintech strength, and lay a solid foundation for Hong Kong's future.

The authors are Vice President (University Development) of the Hong Kong University of Science and Technology and Chief Scientist of the Hong Kong Web 3.0 Association

PhD student in Fintech at The Hong Kong Polytechnic University, founding member of the RWA and Stablecoin Working Group of the Hong Kong Web 3.0 Association