Article by Zach Pandl, translated by Frank, Foresight News
Asset tokenization refers to the process of registering asset ownership on a blockchain infrastructure in tokenized form. This allows assets to benefit from the functionalities of the blockchain, such as more efficient settlement and the ability to interact with smart contracts. While the modern financial system is already quite efficient, tokenization itself may not bring immediate efficiency improvements. Instead, we believe that the main benefits may come from bringing users, assets, and applications together on a common global platform. From the perspective of the crypto market, while various assets can benefit from the tokenization trend, the most potential may lie in protocols that can provide this universal global platform. Currently, Grayscale Research believes that the Ethereum blockchain is most likely to achieve this goal in the future.
Public blockchains can be seen as general-purpose technologies with many potential use cases, from payments to video games to digital identity systems. The value of this technology partly comes from introducing various applications onto a permissionless and open architecture platform. When users, capital, and applications converge in one place, everyone in the ecosystem can benefit from network effects.
Tokenization is one of the many applications of public blockchain technology. In certain cases, if the existing “back-end” processes are very cumbersome, moving asset management onto a blockchain infrastructure may immediately improve efficiency. However, for many types of assets (such as publicly traded stocks), the current digital infrastructure works quite well, and it is not clear whether public blockchains can play a better role. In these cases, the potential benefits of tokenization may come from network effects: by transferring global assets onto a common platform, it is possible to create a more powerful, accessible, and cost-effective financial system.
From the perspective of the crypto market, while various assets can benefit from the tokenization trend, the most potential may lie in protocols that can serve as a unified platform for tokenized assets, investors, and related applications. Currently, Grayscale Research believes that the Ethereum blockchain is most likely to achieve this goal in the future.
System Upgrades
As blockchain technology is more widely adopted, securities may be fully issued and tracked on the chain. However, currently, ownership of securities income as well as ownership of physical assets such as real estate, commodities, and collectibles are recorded on traditional off-chain ledgers (typically electronic bookkeeping accounts). Tokenization is the process of registering asset ownership on a blockchain infrastructure so that market participants can benefit from the functionalities of the blockchain. By design, token prices based on blockchain should closely track the prices of the underlying reference assets.
Some benefits of converting asset ownership into blockchain-based tokens may include:
– Settlement efficiency: Blockchain transactions can settle almost instantly and can be set up to exchange assets under payment conditions, reducing the risk of settlement failures.
– Programmability: Tokenized assets can be integrated into software applications to allow for additional functionalities. For example, this may include conditionally transfers based on off-chain information (such as compliance approvals) or using tokens as collateral for decentralized lending platforms.
– Accessibility: Like the internet itself, blockchains are not restricted by borders. Therefore, tokenized assets can provide access to the best capital markets globally for investors from more countries or regions. Blockchains can also facilitate access to new asset types through fractionalization.
– Cost reduction: By increasing automation and reducing the role of intermediaries, tokenized assets can reduce the costs for issuers through lower underwriting fees and reduced interest rates.
Researchers at the Bank for International Settlements (BIS) have defined a tokenization “continuum” to consider how this process affects specific markets. On one end are markets that still require a significant amount of manual workflow, such as real estate or bank loans. These assets may be difficult to tokenize, but the process can create meaningful efficiency improvements.
On the other hand, many other markets currently use electronic bookkeeping systems that are quite efficient, such as listed stocks, mutual funds and ETFs, and listed derivatives. These assets may be easier to tokenize, but the efficiency gains offered by the process are more limited.
The best candidate assets for tokenization may lie somewhere in the middle of the BIS continuum: markets that can benefit from slightly better electronic recordkeeping and smart contract functionalities. This list may include various types of fixed-income securities such as government bonds and structured products.
However, as further discussed below, the greatest benefits may come from moving all assets onto a unified global platform.
Current and Future Tokenization
The first application where tokenization technology found product-market fit (PMF) is stablecoins, which tokenize the simplest and most liquid asset in the form of cash.
The total market capitalization of stablecoins has now reached $158 billion, with Tether (USDT) and USDC leading the way (Chart 1). Stablecoins come in various forms, but both USDT and USDC can be seen as fiat-backed stablecoins.
They operate similarly to other tokenized assets: traditional assets are held by off-chain custodians, and tokenization represents the ability to hold them in a blockchain wallet. This form of digital cash can then be used for payments, benefiting from the near-instant settlement, lower costs, and/or potential interaction with smart contracts offered by the blockchain.
Chart 1: Stablecoins Have Found Product-Market Fit
Following stablecoins, the next widely adopted tokenized asset is gold (Chart 2). The total market capitalization of the two largest projects, Tether Gold (XAUt) and PAX Gold (PAXG), is approximately $1 billion. While there are many ways to invest in gold, these products offer some blockchain functionalities, such as the ability to transfer risk outside of weekends or traditional market hours. This feature proved useful during recent geopolitical tensions in the Middle East, with both XAUt and PAXG experiencing noticeable increases during the week of April 13-14 when other markets were closed.
Chart 2: Timeline of Selected Tokenization Projects
The latest wave of tokenization focuses on two distinct markets: US Treasuries and closely related assets, and credit products.
Tokenized US Treasury products are designed as cash equivalents and can be seen as alternatives to interest-bearing stablecoins. According to data provider RWA.xyz, all existing products currently offered have an average weighted maturity of less than two years.
In other words, these products aim to provide returns and serve cash-like functions. When cash rates are close to zero, the opportunity cost of holding stablecoins is relatively low. However, now with US dollar rates close to 5%, investors have more incentive to seek alternative options that generate returns, which may fuel the development of tokenized Treasury products.
Currently, circulating tokenized Treasury funds, led by Franklin Templeton’s US Government Money Fund (FOBXX) and BlackRock’s USD Institutional Digital Liquid Fund (BUIDL), have surpassed $1 billion in total assets (Chart 3). Many existing products have launched on the Ethereum network and seem to be targeting crypto-native institutions such as cryptocurrency trading funds and decentralized autonomous organizations (DAOs).
However, the largest fund, FOBXX, takes a different approach: it was launched on the Stellar network and is accessible to retail investors through a mobile application. In conclusion, about 60% of tokenized assets are held by stablecoins, with gold and US Treasury-related assets becoming increasingly popular. Tokenization is a growing trend that has the potential to reshape the financial landscape by creating a unified global platform for various assets, investors, and applications.Tokenization of government bonds funds in Ethereum, 30% in Stellar blockchain, and the rest in other blockchains.
Chart 3: Approximately 60% of tokenized government bond products are on Ethereum.
Various companies have also launched tokenized credit products. This is a diversified category, including direct lending to individual counterparties, structured credit product pools (e.g., ABS, CLO), and loans to specific industry intermediaries (e.g., real estate financing, emerging markets). Although these products may be risky and complex, and currently designed only for institutional investors, their goal is simple – to guide capital from lenders to borrowers through blockchain infrastructure. According to RWA.xyz, there are currently $612 million active loans in this category, with an average yield of around 10% (Chart 4).
Chart 4: Tokenized credit products cover different borrower compositions.
Tokenization technology has many other potential applications, but few have moved beyond the experimental stage. For example, tokenized real estate platform RealT offers a way for investors outside the US to fractionalize property ownership; the protocol currently locks a total value of $103 million. There is also hope that tokenizing private equity can provide a channel for alternative investment industries to reach a broader range of investors, but whether these new distribution channels will make a significant contribution to the industry’s AUM remains to be seen.
Various fixed-income securities have been directly issued on the blockchain, with issuers including both public sector issuers (e.g., European Investment Bank) and private sector issuers (e.g., Siemens). While tokenization of stocks has been attempted before, we suspect these projects will require clearer regulatory frameworks before further progress can be made.
If continued, tokenization has the potential to drive significant blockchain activity and fee revenue, as the potential market size is enormous – in the US alone, US government bonds represent a $26 trillion market, and total loans in the non-financial sector amount to $36 trillion. Currently, the scale of tokenized assets on-chain accounts for a negligible fraction of these totals. However, in order for these products to develop beyond today’s crypto-native institutions, they will need to connect more efficiently with existing pools of capital. This may require establishing connections with brokers or bank accounts, or providing investors with convincing reasons to move their assets onto the chain.
Revolution won’t happen on private chains.
A common misconception is that tokenization may not benefit crypto assets because the activity will occur on private permissioned blockchains rather than public permissionless blockchains like Ethereum. While banks have indeed attempted to use private blockchain infrastructures (e.g., JPMorgan’s Onyx, HSBC’s Orion, and Goldman Sachs’ DAP), this reflects current regulatory constraints that prevent deposit-taking institutions from interacting with public chains, and asset management firms, which are not subject to these restrictions, have been operating on public chains or a mix of public and private chains.
In fact, almost all successful tokenization applications to date (e.g., stablecoins, tokenized government bonds, and tokenized credit products) have been launched on public blockchain infrastructures.
The reason is simple: users are here.
We expect that moving certain assets onto blockchain infrastructures will bring efficiency improvements, but the bigger potential of tokenization lies in seamlessly connecting assets and investors (or borrowers and lenders) from around the world and building richer experiences through interoperable applications.
Public blockchains have many other applications beyond tokenization, which makes them a natural center for user assets and activities over time. Therefore, they may also continue to be the primary destination for asset issuers and developers of open finance applications. We believe that private permissioned blockchains operated by companies or national governments are unlikely to provide a globally neutral platform trusted enough to host the world’s tokenized assets.
Trading, fees, and value accrual.
Blockchain transactions typically generate fees, which can flow directly to token holders (e.g., dividends) or indirectly through token supply reductions (e.g., buybacks), thus bringing value accrual to blockchain-based tokens if they can generate trading activity and fees. However, the mechanisms by which this happens will depend on the type of protocol and the attributes of the tokens (Chart 5).
Chart 5: Assets from various crypto industries that can benefit from tokenization.
Our smart contract platform components in the crypto space should see the most direct impact. L1 blockchains in this segment (and perhaps some components of their L2 ecosystems eventually) can serve as a universal global platform for tokenized assets. The native tokens of these protocols are typically used to pay transaction fees (“Gas”) and may receive staking rewards or benefit from token supply reductions.
There is fierce competition in the smart contract platform crypto space, but the Ethereum ecosystem still dominates others in terms of users, assets (total locked value), and decentralized applications. Additionally, we believe Ethereum can be considered highly decentralized and neutral to network participants, which may be a necessary condition for any global tokenized asset platform.
Therefore, we believe Ethereum is currently in the most advantageous position among smart contract blockchains to benefit from the tokenization trend. Other smart contract platforms that may benefit from the tokenization trend include Avalanche (a platform used by financial institutions for various proof-of-concept projects), Polygon, and Stellar, as well as L1 blockchains specifically designed for tokenization, such as Mantra and Polymesh.
The next set of beneficiaries includes the tokenization protocols themselves, platforms that facilitate the introduction of traditional assets into on-chain software applications (Chart 6). Many of these providers do not have governance tokens (e.g., Securitize, Superstate), but some do.
For example, Ondo Finance, which issues tokenized government bond products, and Centrifuge, a platform for tokenized credit products and part of the financial crypto space, should consider the governance nature of the tokens they grant and whether they confer any protocol revenue rights before investors consider these tokens.
Chart 6: Year-to-date returns of selected tokenization protocols.
Finally, as tokenization leads to increased blockchain activity, it may support many other components in the crypto ecosystem. For example, Chainlink hopes its Cross-Chain Interoperability Protocol (CCIP) can provide core infrastructure for messaging data across blockchains (both private and public). Similarly, the Biconomy protocol offers certain technical processes that can help traditional financial institutions interact with blockchain technology (e.g., “paymaster” service that allows users to pay gas fees with tokens other than native blockchain tokens).
Chainlink and Biconomy are part of our utility and service crypto space.
Tokenization vision.
In conclusion, many digital business use cases are transitioning from closed platforms hosted by centralized intermediaries to open and decentralized platforms based on public blockchain infrastructures, and tokenization is just one of many blockchain adoption trends.
But given the scale and scope of global capital markets, it could be an important trend, and if public chains can match borrowers and lenders (or asset issuers and investors) and disintermediate existing fintech, the increase in network activity should bring value to public chain tokens.
