Time to Take the Reins on Tokenization, or Risk Missing Out

The arrival of the first bitcoin ETFs in the U.S. in January was a turning point for the convergence of traditional and digital assets. For the first time, investors were granted exposure to bitcoin through their traditional brokerage account.

The core technology associated with bitcoin, cryptography, is not new but it has re-emerged with blockchain and smart contract technology, which supports tokenization. A token is a unit of value that can be transferred, stored, and traded on the blockchain and is a digital representation of potentially many different kinds of assets, such as ownership rights for cryptocurrencies as well as real-world assets like stock shares, real estate or even art. For some, the SEC’s approval of Bitcoin ETFs helped boost the legitimacy of this technology, and now we’re seeing more firms and retail investors exploring the many benefits of tokenization.

You're reading Crypto Long & Short, our weekly newsletter featuring insights, news and analysis for the professional investor. Sign up here to get it in your inbox every Wednesday. Nadine Chakar is a speaker at Consensus 2024, May 29-31.

With tokenization, firms could be more capital-efficient, create new business models and more easily expand product offerings and distribution channels. Firms could unlock new efficiencies and uncover ways to streamline existing processes while finding new markets and ways of unlocking liquidity – and they can likely do it cheaper and faster.

At the same time, tokenization could revolutionize the way transactions are processed. Take securities lending for example. With tokenization, collateral could be exchanged in real time, enabling firms to lower the risk of their existing processes. Managing a securities lending pool using smart contracts, or transactions that automatically execute when certain conditions are met, could also unlock efficiencies by embedding compliance within tokens, paving the way to 24/7 trading – without the need for a network of trading desks around the world.

These benefits, however, are just the tip of the iceberg. The real promise of blockchain technology lies in the assets themselves. Consider how assets operate today. Various systems are needed to run vital processes such as pricing an asset, distributing interest and dividends, and communicating with investors. With tokenization, we could incorporate these processes into the asset itself. Given a tokenized asset is capable of executing automated processes on its own, we could eliminate the need for potentially dozens of systems working behind the scenes.

If the benefits are so tangible, why haven’t we seen more widespread adoption in the financial services industry? Mainly because we are somewhat still in the infancy stage around this technology, and policymakers are still assessing the landscape and considering the appropriate legal and regulatory frameworks.

There are also concerns about counterparty risk, finality of settlement, and control locations, not to mention a lack of standards and taxonomy. More philosophically, digital asset owners want to ensure that their ownership rights will be preserved in the absence of a tangible asset they can hold in their hand.

At the same time, the industry’s approach to innovation continues in siloes and represents another roadblock to adoption. In 2023, nearly three out of four projects involving distributed ledger technology (DLT) had fewer than seven participants, according to a study from the International Securities Services Association (ISSA). Of course, it’s encouraging to see firms dive in and explore DLT. However, if innovation continues in silos, one of the core promises offered by tokenization will be missed: creating broad efficiencies across the industry.

The answer here is simple: let’s work together. Experiments should have a shared infrastructure. There should be many participants representing the financial industry’s wide range of stakeholders. There’s mutual benefit to be found here. Together, we can lay the foundation for successful experimentation in sandboxes with initiatives that expand upon each other incrementally and create an ecosystem that’s scalable and works for all counterparties.

Collaboration would also help ensure digital assets thrive within a well-regulated framework, with standardized governance that reduces risks and costs. In addition, collaboration could facilitate connectivity by improving optionality and the choice of platforms, ultimately improving the way digital assets interact with traditional securities and payment infrastructures.

But before all of this, firms must look inward to realize the full potential of tokenization. There’s no one size-fits-all approach, and every organization has its own, unique business model. More and more firms from across the industry are sitting down and thinking through what tokenization means for them. How can it revolutionize their business and the way it serves their clients?

In the end, the value of tokenization is directly correlated to the strength of a firm’s imagination. We are only limited by our creativity in the way we’re able to reimagine business and operating models, and the way tokenization could unlock new opportunities.