With the rate at which the digital asset sector is growing and changing, it is easy to lose track of progress made and notable advancements. With that in mind, the team at Security Token Advisors does an admirable job of recapping market events on a quarterly basis in its ‘State of Security Tokens‘ research papers – the latest of which we will discuss below, highlighting a few of the key trends noted.
As it stands, stablecoins like Tether (USDT) and USD Coin (USDC) play a vital role within the digital asset sector and are often used as a means of settlement. STA notes that when it comes to banks and asset managers looking to ‘solve digital settlement with tokenized deposits', this is no longer the case.
Beyond their use in trading and settlement, STA notes that stablecoins have also suffered from a lack of uptake among asset managers due to their lack of yield generation.
“One of the key points STA hears on its advisory side from our asset managers and commercial bank prospects is that they simply cannot park $300 million of client assets into a non yield-generating stablecoin – especially when the risk-free rate is over 5%.”
While the reasons for this lack of use among institutions are varied (stability/de-pegging, transparency, compatibility with existing systems, etc.), the bottom line is that there is no clear-cut approach that makes sense for improving existing approaches. As a result, institutional players continue to consider options such as CBDCs, self-issued coins, etc., alongside what stablecoins can offer for settling both internal and external transactions.
Private vs. Public
Private blockchains are valuable tools for institutions in capital markets which typically maintain a focus on streamlining operations, minimizing risks, and boosting profits. This aligns with how technology has traditionally enhanced capital market infrastructure.
A few examples of notable private blockchains currently in use include,
- Digital Asset (Daml, Canton)
- JP Morgan (Onyx)
- R3 (Corda)
- Enterprise Ethereum
Meanwhile, the following are a few examples of notable public blockchains currently in use.
- Provenance blockchain
These public blockchains have been used to facilitate everything from corporate bonds to RWA tokenization and more. Whether a company chooses to use a private or public blockchain to meet its needs often depends on the need itself, with STA noting that ‘Private blockchains serve a very strong purpose on the institutional side of capital markets – one that doesn't necessarily need to access the general public or even need to be facilitated in a decentralized manner.'
Money Market Funds
A money market fund is a type of mutual fund that invests in highly liquid, short-term financial instruments with the goal of providing investors with a safe place to invest easily accessible cash-equivalent assets characterized as a low-risk, low-return investment. Given their low-risk profile, these funds are often used by investors as a place to park money in the short term, often while deciding on longer-term investment strategies or as a form of emergency or contingency fund.
With that in mind, money market funds are now being tokenized to bring enhanced returns when funds are idle or in escrow. For example, RealT has been earning 4-6% interest by placing reserves in a lending pool called Compound. Now, with the rise of high-interest products, this strategy can be expanded. Rather than keeping funds idle in cash or stablecoins, they can be invested to generate more income in fields like real estate, private equity, and private credit. Simply put, idle funds can now more easily be put to work to earn more – an enticing capability of tokenization.
As it stands, there are very few exchanges active in the United States that support the secondary market trading of security tokens. These include,
While there may only be a few platforms on which such assets can be traded in the United States, this is not a reflection of their performance. In fact, STA notes that when viewed as a bundle over the past year, the diversification of available security tokens allowed for them to outperform the Nasdaq, NYSE, and even Bitcoin. This diversification is derived from real estate, private equity, pre-IPO shares, digital asset mining notes, and more.
The downside to so few active exchanges is that there is often very poor liquidity for security tokens, as they are typically listed on a sole platform. STA notes that, for the select few that are listed on two or more exchanges, low liquidity often results in sizable arbitrage opportunities – which can be viewed as either good or bad, depending on one's approach to trading.
Near Term Opportunities
While it may take some time to sort through what type of assets should be used for settlements, and whether private blockchains should be used, STA notes that there is one use-case involving blockchain that stands to be quite lucrative in the near term – the tokenization of private credit.
“There is an extreme opportunity at the intersection of private credit and tokenization for some of the major alternative asset managers. With firms like Hamilton Lane and Apollo already active in tokenization and firms like BlackRock and Carlyle tangentially involved (i.e. through partners, subsidiaries, or portfolio companies such as Carlyle’s Calastone), this is one of the more promising near-term verticals to make use of blockchain-based securities.”
Traditionally, private credit – loans or debt provided to private companies – has been relatively illiquid. As a result, it may be difficult to buy or sell these loans once issued. However, by leveraging tokenization, these debt instruments can become more accessible and easy to trade, as fractionalization through tokenization allows for each token can be bought or sold independently.
The benefits of this process vary, including improved liquidity and greater accessibility. By allowing for fractional ownership of large credit assets, more investors can participate with less capital than what is typically required. Finally, since the entire process is facilitated through the use of blockchain technology, transparency is improved with every token being programmed to automatically record all transactions on the associated ledger.
STA Success Network
Interestingly, contributions to the digital asset sector in Q1 did not stop at banks and tokenization efforts. STA itself made a splash in recent weeks with the launch of its ‘Success Network'. This intriguing outlet is a curated platform meant for like-minded individuals and companies to connect, learn, and share anything pertaining to digital securities. More information one what the Success Network entails can be found HERE.
Overall, it appears as though Q1 2023 did well to highlight an increasing interest among institutions surrounding what digital securities have to offer. Simultaneously, it also highlighted that secondary markets have room to improve. As it stands, there are simply not enough companies lining up to issue security tokens set to be listed on Securitize, INX, etc. However, as the idea of tokenization becomes more commonplace, this should change over time. With the overall digital asset market rapidly maturing, and regulatory clarity being established, the coming months/years should bode well for those already taking the concept seriously.
To read the report discussed above in its entirety, State of Security Tokens 2023 Q1 Extended, click HERE.