If I were to imagine how the future of finance should operate, I would undoubtedly introduce the many advantages that digital currencies and blockchain technology can bring: 24/7 availability, instant global liquidity, fair access without permission, asset composability, and transparent asset management. This imagined future financial world is gradually being built through tokenization.
Blackrock CEO Larry Fink emphasized the importance of tokenization for the future of finance in early 2024, stating, “We believe the next step in financial services will be the tokenization of financial assets, meaning that every stock, every bond, every financial asset will operate on the same ledger.”
Asset digitization can unfold comprehensively alongside the maturity of technology and measurable economic benefits, but the widespread adoption of asset tokenization will not happen overnight. One of the most challenging aspects is the transformation of traditional financial infrastructure in the heavily regulated financial services industry, requiring the participation of all players in the entire value chain.
Nevertheless, we can already see the first wave of tokenization emerging, primarily driven by investment returns in the current high-interest rate environment and existing use cases at scale (such as stablecoins, tokenized US Treasuries). The second wave of tokenization may be driven by use cases of asset categories with smaller market share, less obvious returns, or more challenging technical hurdles.
This article attempts to analyze tokenization from the perspective of traditional finance using McKinsey Co’s framework, examining the potential benefits and long-term challenges that tokenization can bring, while combining real-world objective cases to conclude that despite challenges remaining, the first wave of tokenization has arrived.
Tokenization is the process of creating digital representations of assets on the blockchain;
Tokenization brings many advantages: 24/7 availability, instant global liquidity, fair access without permission, asset composability, and transparent asset management;
In the financial services sector, the focus of tokenization is shifting towards “blockchain, not cryptocurrencies”;
Despite challenges, with the widespread adoption of stablecoins, the launch of tokenized US Treasuries, and clear regulatory frameworks, the first wave of tokenization has arrived;
McKinsey predicts that by 2030, the total market value of the tokenization market could reach around $20 trillion to $40 trillion (excluding the market value of cryptocurrencies and stablecoins);
Comparing the current state of tokenization with other major paradigm shifts in technology indicates that we are still in the early stages of the market;
The next wave of tokenization may be led by financial institutions and market infrastructure participants.
I. What is Tokenization?
“Tokenization” refers to the process of recording ownership of financial or real assets that exist on traditional ledgers onto a blockchain programmable platform, creating digital representations of assets. These assets can be traditional tangible assets (such as real estate, agricultural or mineral commodities, tokenized art), financial assets (stocks, bonds), or intangible assets (digital art and other intellectual property).
The resulting “tokens” are certificates of ownership available for trading on a blockchain programmable platform. Tokens are not just single digital certificates; they typically encapsulate the rules and logic governing the transfer of underlying assets in traditional ledgers. Therefore, tokens are programmable, customizable to meet personalized scenarios and regulatory compliance requirements.
Asset “tokenization” involves the following four steps:
1. Identify underlying assets
When the asset owner or issuer determines that the asset will benefit from tokenization, the process begins. This step requires clarity on the structure of tokenization, as specific details will determine the design of the entire tokenization scheme, such as tokenizing a money market fund differs from tokenizing carbon credit quotas. The design of the tokenization scheme is crucial to clarify whether tokenized assets will be considered securities or commodities, which regulatory frameworks will apply, and with which partners to collaborate.
1.2 Token issuance and custody
Creating digital representations of assets based on blockchain requires first locking the underlying assets corresponding to the digital representation. This involves transferring the assets to a controllable range (physical or virtual), typically managed by qualified custodians or licensed trust companies.
Then, specific forms of tokens are adopted on the blockchain to create digital representations of underlying assets, embedding functions in the tokens to execute code for predefined rules. For this, asset owners select specific token standards (ERC-20 and ERC-3643 are common standards), networks (private or public blockchains), and functions to embed (such as user transfer restrictions, freeze functions, and recovery), which can be implemented through tokenization service providers.
1.3 Token distribution and trading
Tokenized assets can be distributed to end investors through traditional channels or new channels like digital asset exchanges. Investors need to establish an account or wallet to hold digital assets, while any physical assets equivalent remains locked in the issuer’s account with traditional custodians. This step typically involves distributors (such as private wealth departments of large banks) and transfer agents or trading brokers.
Depending on the issuer and asset category, tokenized assets can also be listed on secondary market exchanges, creating liquidity markets for these tokenized assets post-issuance.
1.4 Asset servicing and data reconciliation
Digitally distributed assets to end investors still require ongoing servicing, including regulatory, tax, and accounting reporting, as well as regular net asset value (NAV) calculations. The nature of services depends on the asset category. For example, services for carbon credit tokens require different audits than fund tokens. Services need to coordinate on-chain and off-chain activities, handling a wide range of data sources.
The current tokenization process is quite complex; for instance, in a money market fund tokenization scheme, up to nine parties may be involved (asset owners, issuers, traditional custodians, tokenization providers, transfer agents, digital asset custodians or trading brokers, secondary markets, distributors, and end investors), two more than traditional asset processes.
II. Advantages of Tokenization
Tokenization enables assets to harness the vast potential brought by digital currencies and blockchain technology. Broadly speaking, these advantages include 24/7 operational availability, data availability, and so-called instant atomic settlement. Additionally, tokenization provides programmability – the ability to embed code in tokens, and composability – the ability of tokens to interact with smart contracts, enabling a higher degree of automation.
Specifically, as asset tokenization advances on a large scale, the following advantages, in addition to conceptual validation, will become more prominent:
2.1 Improved capital efficiency
Tokenization can significantly enhance the capital efficiency of assets in the market. For example, post-tokenization repurchase agreements (Repo) or redemptions of money market funds can be settled instantly within minutes T+ 0, compared to the current traditional settlement time of T+ 2. Shorter settlement times can save significant capital in the current high-interest rate market environment. For investors, these savings in funding costs may be the reason why recent tokenized US Treasury projects can have a huge impact.
On March 21, 2024, Blackrock partnered with Securitize to launch the first tokenized fund BUIDL on the public blockchain Ethereum. After tokenization, the fund can achieve real-time settlement on the chain, significantly reducing transaction costs and improving capital efficiency. It can achieve (1) 24/7/365 USD fund subscription/redemption, which is a desired feature for many traditional financial institutions – real-time redemption. It also partnered with Circle to achieve (2) real-time 1:1 exchange of stablecoin USDC to fund token BUIDL 24/7365.
This tokenization fund that connects traditional finance with digital finance is a landmark innovation for the financial industry.
2.2 Permissionless democratic access
One of the touted benefits of tokenization or blockchain is democratized access, which, beyond token fragmentation (dividing ownership into smaller shares to lower investment thresholds), may enhance asset liquidity, provided that tokenization markets become widespread. In some asset categories, simplifying intensive manual processes through smart contracts can significantly improve unit economics, thereby providing services to smaller investors. However, access to these investments may be subject to regulatory restrictions, meaning that many tokenized assets may only be available to qualified investors.
We can see prominent private equity giants Hamilton Lane and KKR partnering with Securitize to offer a “fair” way for a broad range of investors to participate in top-tier private equity funds by tokenizing their feeder funds. The minimum investment threshold has significantly decreased from an average of $5 million to just $20,000, but individual investors still need to undergo qualified investor verification through the Securitize platform, maintaining a certain threshold.
2.3 Operational cost savings
The programmability of assets can be another source of cost savings, especially for asset categories where services or issuance are often highly manual, error-prone, and involve numerous intermediaries, such as corporate bonds and other fixed-income products. These products typically involve custom structures, imprecise interest calculations, and coupon payments. Embedding interest calculations and coupon payments into smart contracts of tokens automates these functions, significantly reducing costs. System automation achieved through smart contracts can also lower the costs of services like securities lending and repurchase transactions.
In 2022, the Bank for International Settlements (BIS) and the Hong Kong Monetary Authority conducted the Evergreen project, issuing green bonds using tokenization and distributed ledgers. The project fully utilized the distributed ledger to integrate the participants involved in bond issuance onto the same data platform, supporting multi-party workflows and providing specific participant authorization, real-time validation, and signing features, enhancing transaction processing efficiency. The bond settlement achieved DvP settlement, reducing settlement delays and settlement risks, while the real-time data updates on the platform also enhanced transaction transparency.
Over time, the programmability of tokenized assets can create benefits at the portfolio level, enabling asset managers to rebalance portfolios in real-time automatically.
2.4 Enhanced compliance, auditability, and transparency
Current compliance systems often rely on manual checks and retrospective analyses. Asset issuers can automate these compliance checks by embedding specific compliance-related operations (such as transfer restrictions) into tokenized assets. Additionally, the 24/7 data availability based on blockchain systems creates opportunities for simplified consolidation reporting, immutable recordkeeping, and real-time auditability.
An intuitive case is carbon credits, where blockchain technology can provide immutable and transparent records for credit purchases, transfers, and cancellations, embedding transfer restrictions and measurement, reporting, and verification (MRV) functions in the smart contracts of tokens. Thus, when initiating carbon token transactions, tokens can automatically check the latest satellite images to ensure the underlying energy-saving emission reduction projects are still operational, enhancing trust in the project and its ecosystem.
2.5 Cheaper, more flexible infrastructure
Blockchain is fundamentally open-source and continuously evolving under the drive of thousands of Web3 developers and billions of dollars in venture capital. Assuming financial institutions choose to operate directly on public permissionless blockchains or public/private hybrid blockchains, innovations in blockchain technology (such as smart contracts and token standards) can be easily and quickly adopted, further reducing operational costs.
Given these advantages, it is not difficult to understand why many large banks and asset management companies are so interested in the prospects of this technology.
However, the benefits of tokenized assets, while evident in theory, remain largely theoretical due to the lack of use cases and adoption scale thus far.
III. Challenges of Mass Adoption
Despite the many benefits that tokenization may bring, some of the advantages outlined remain largely theoretical so far due to the insufficient use cases and adoption scale of tokenized assets.
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