How to Securely Move Assets & Value in the Future Web3 Economy - The Asset Proxy NFT Paradigm
Today there is a growing interest in the use of the Non-Fungible Tokens (NFTs) on the blockchain to represent assets that are hybrid assets.
In this post we briefly explore:
- What are the emerging use cases for hybrid NFTs
- Which are the constraints for public & private orgs entering Web3
- How our new “Asset Proxy NFT” paradigm addresses security risks and interoperability challenges
The emerging world of Hybrid NFTs
Hybrid assets generally consist of two parts, namely a real-world valuable good/resource (off-chain) and an NFT that represents the asset on a blockchain. The notion here is that the ownership of the NFT on-chain would legally imply the corresponding ownership of the asset off-chain.
The real estate industry has been the leader in asset tokenisation, using security tokens and hybrid NFTs to tap into crypto capital and improve liquidity for real estate assets. Based on a recent report by Security Token Market featured on Cointelegraph Research Terminal, “89% of all traded security tokens are for real estate, suggesting that the blockchain industry may be primed for further adoption of real estate NFTs”.
Hybrid NFTs for artworks is another rapidly emerging use case. On 9 November 2021, BEEPLE’s Human One, a hybrid digital and physical artwork, was sold for USD 28,985,000 during Christie’s 21st Century Evening Sale auction.
Alongside real estate, “phygital” art, and consumer products like wines, the luxury industry has been also taking big steps into the blockchain and hybrid NFTs universe.
Enabling product traceability and authentication using blockchain has become a strategic goal for the major players in this category. The LVMH Group stated in April that all products would have traceability information by 2026. In addition, based on the Vogue Business NFT Tracker, 17% of brands in their index had worked with NFTs as of Winter 2021.
The Web3 market is growing, but what about the tech?
This interest in hybrid assets dovetails into the current broad discourse regarding the future Web3 as the “Internet of Value” — versus the current Web2 as the “Internet of Communications”.
However, there are today several challenges facing blockchain technology in its current iteration as a part of the Web3 proposition. We believe that many of these issues arise largely from an incorrect view of assets.
An asset-centric view of the world must take into account the fact that in the majority of cases the assets and their associated economic value originate from outside the blockchain.
Just as the design of the internet was centered around communications survivability, we believe Web3 must be centered around assets and not around the mechanics of blockchain technology.
Although Web3 is currently going through its own hype-cycle, Web2 computing infrastructures are not going away anytime soon.
NFT tech challenges still persist
The unique NFT which accompanied BEEPLE’s physical Human One artwork included this mp4 video that is hosted on an online server and can be accessed by anyone following the NFT’s metadata link.
If the link to the video is removed or replaced (accidentally or as a result of a security breach) with a different digital artifact, the meaning and the content of the NFT would be completely altered.
This problem was demonstrated by an artist who pulled the rug on NFTs he created by changing their images after they were minted and sold to others.
Another critical issue in the NFT space is the lack of rigorous authenticity assurance and fraud-protection mechanisms. As self-reported by OpenSea, the world’s largest NFT marketplace, more than 80% of NFTs created for free are fraud or spam.
Creating robust technical capabilities that can facilitate open, secure, and trusted trade of assets feels more urgent than ever before. Not only for protecting consumers, investors, and brands but also for creating the “new digital rails & bridges” that modern economies can use to connect globally and grow sustainably.
Towards the future Web3
For the past few decades, enterprises and financial institutions have invested heavily in IT infrastructures — including cloud computing — to enable the digitization of the various commercial and financial services (B2B and B2C).
The fintech innovations catalysed by the emergence of new digital assets will require institutions and market infrastructures to develop technical capabilities that facilitate asset-based transactions including traditional fiat currencies, Central Bank Digital Currencies (CBDCs), digital or native tokens, as well as NFTs.
As highlighted in the recent EU regulation 2022/858 of 30 May 2022 on a pilot regime for market infrastructures based on distributed ledger technology, “as fundamental trade-offs involving credit risk and liquidity remain in a tokenised world, the success of token-based systems will depend on how well they interact with traditional account-based systems.”
How can we drive widespread blockchain adoption when in essence the current Web3 paradigm entails that organisations must render their existing investments in IT systems obsolete?
This need for future Web3 infrastructures to integrate securely with these existing Web2 systems and networks has been an oft-overlooked aspect of the Web3 discourse.
We believe that an asset-centric view must allow for the bridging between the Web2 world and the future Web3.
In our recent paper co-authored with MIT’s Dr. Thomas Hardjono, we propose an Asset Proxy paradigm for NFTs where the focus is placed on the asset itself and where the NFT construct is seen as a proxy (on-chain) for the asset (off-chain).
The paper proposes the creation of specific, well-defined NFT design patterns. Such patterns would specialize the Asset Proxy NFT paradigm in particular cases focusing on targeted but generic business or technical issues, including:
- Trade-only NFTs for hybrid assets, implementing the usual “plain vanilla” NFT that is common today in most marketplaces, but with rigorous fraud protection and Anti-Money Laundering (AML) assurances
- Cross-chain transferable NFTs for hybrid assets with long lifecycles (such as high-value product components or other mechanical/system engineering artifacts) that may undergo changes of ownership in their long lifetime
- Hidden metadata NFTs for hybrid assets where the information about the asset (e.g. number of units produced) must be protected or even hidden
- Zero-value NFTs for hybrid assets that follow more complex supply chain, taxation, custom clearance, or safety and security clearance procedures (like in the case of Digital Product Passports that provide information about products in the material, construction, agri-food, and seafood sectors)
We expect this list to grow as the NFT usage becomes more widespread and NFT technology becomes more mainstream across industries.
The Asset Proxy NFT paradigm in itself introduces several new challenges, notably the need for a bilateral synchronization mechanism to be utilised that ensures the perpetual consistency of the state between the NFT on-chain and the asset off-chain. The technical background of this paper can be found in the previous paper we co-authored with Dr. Hardjono on blockchain-enabled open architectures for scalable digital asset platforms.
Interested in working with us?
Since 2018, Compellio works with leading private and public institutions to drive real-life Web3 innovations by leveraging our proprietary Blockchain Gateway to create plug-and-play building blocks in conjunction with Single-Sovereign Identities, W3C Verifiable Credentials, and NFTs. Our solutions are blockchain-agnostic and complement existing IT systems in a fully interoperable and GDPR-compliant manner.
Contact us at email@example.com to request more info about our commercial Web3 solutions or to discuss collaborations in your blockchain/NFT projects.