RWAs shouldn’t be for everyone

Real-world assets has become a strong narrative in the Web3 space over the past year. As interest rates have risen while DeFi yields have dropped (and exploits have impacted some blue-chip protocols), more and more players are emerging with offers of tokenized Treasurys, illiquid assets and credit products for new sources of yield. 

The question is, is access alone a benefit?

While some will argue that access to these asset classes should be universal, I disagree. 

There is a reason why complex credit products are currently only sold to investors who have the means and ability to understand and handle the risks. It’s not reasonable to expect someone who trades stocks on Robinhood to also have the ability to appropriately discern their risk when buying a private debt security. These are deals done by professionals for professionals — allowing retail investors access will surely devolve into a situation where smart money dumps on those less sophisticated.

The drive toward bringing RWA’s on chain should strike a balance between a need for access and the reasonable expectation that investors understand the risks. 

And — in balancing these guiding principles with the products investors need — I believe the next RWA opportunity is in foreign exchange.

I’m not suggesting non-dollar stablecoins. These exist in abundance and yet have not reached scale, mostly due to fixed banking hours causing liquidity gaps and dislocations between the tokenized version and the real-world version. 

Instead, I suggest the next RWA opportunity is in tokenized FX forwards. 

As the US Federal Reserve has embarked on the fastest hiking cycle in history, global central banks have also been forced to raise rates. Specifically in emerging market countries, rates have moved exponentially to protect their economies from importing inflation from the US. Holding non-dollar currencies in token form becomes an even bigger challenge without a way to earn that country’s risk-free yield.

Read more from our opinion section: How RWAs robbed 2023 of its liquidity

While some emerging and developed market currencies have been unable to keep up with the US dollar, plenty of countries have and are still paying high interest rates. 

Brazil is a great example. BRL/USD is currently in the middle of the range over the past five years, and the risk-free rate is just over 11%. For a nonfinancial professional to get exposure to BRL is tricky, and it’s even harder to get exposure to local interest rates. Creating an RWA that gives offshore clients access to the currency and yield is a game changer. It provides access to investors who want to invest in emerging market countries, but would otherwise be unable to do so.

Therein lies the opportunity. A product that offers investors access to non-dollar currencies and pays those currencies risk-free yield. Said another way, the product is a tokenized FX forward. This allows the buyer access to other countries’ high-interest rates and their risk/reward vs. the US dollar. And, unlike tokenized private credit products, there is no information asymmetry as all FX information is publicly available, leaving retail with as fair a chance as institutional capital. Tokenized FX forwards would become a new asset class in the crypto ecosystem. 

Read more from our opinion section: Stop tokenizing everything

Considering the risk-free yield as the currency’s staking rate, we can do a comparative risk-reward analysis vs. USD stablecoins and yield-generating cryptocurrencies. 

Tokenized FX forwards would sit between those risk categories with different return profiles. Tokenized FX forwards and PoS tokens both pay a yield, while stablecoins do not. While every currency and country differ, you will find some currencies, especially in Latin America, where the nominal interest rate is much higher than staking yields on top 20 tokens like SOL, DOT and ADA. Furthermore, the downside risk vs. the USD is much lower in FX forwards than in cryptocurrencies.

Using Brazil again as an example, BRL can drop 20% vs. the USD in a highly adverse scenario, while most cryptocurrencies have experienced an 80%+ loss during bear markets. Meanwhile, BRL risk free yields are close to 11%, while SOL, ADA and even ETH are low single digits. This product has a lower risk/reward profile than most cryptocurrencies, while delivering a much higher yield. 

The major downside of BRL and other major FX forwards compared to crypto is that the ability to outperform the dollar is limited. In the case of BRL, an extreme upside scenario would only see BRL beat the US dollar by 20%. 

For these reasons, I see tokenized FX forwards as a risk profile that sits in between USD stablecoins and cryptocurrencies.

Products that represent the short-term interest rates of non-US countries have both a market fit and provide access to people who can adequately assess the risk. Tokenized FX forwards are a natural next step in the tokenized RWA movement: they give access to a new form of cryptocurrency while providing a better defensive opportunity in bear markets. 

While other tokenization attempts have questionable utility, tokenized FX forwards offer a clear benefit and at the same time, actually move the world of on-chain money forward. 

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