Tokenization, which is the process by which real-world assets (RWA) are converted into blockchain-based tokens, is touted as a way to reduce costs and operational frictions. This is typically achieved through,
- Enhanced accessibility
- Increased liquidity
- Full transparency
Even more significant is the potential of tokenized investments to democratize finance and bring broader investment opportunities to the general population through fractionalization.
What it Means
Keeping the capabilities and potential of tokenization efforts in mind, industry participants are now reporting a surge in interest. For example, Digital asset management firm 21.co's report on tokenization notes that there has been an “unprecedented growth” witnessed in the convergence between crypto and traditional asset classes like equities, government bonds, real estate, and fiat currencies. While $10 trillion by 2030 is a bull case scenario, even in the bear scenario, the firm estimates the market value to be $3.5 trillion by the end of this decade.
According to the 21.co analysts, the crypto sector is undergoing a maturation phase, and more TradFi institutions will use blockchains and build products on top of them.
Speaking at the TokenizeThis Summit by Security Token Market (STM), Bob Yostpille, Head Of Business Management at Oasis Pro Markets, pointed out how, during the financial crisis of 2008, many large firms didn't understand where their counterparty risk truly lay, and that type of domino effect can be eliminated by perfecting the documentation of not just counterparty documents but also other agreements into smart contracts.
“Crypto is transitioning from frenzy to synergy,” and it is through this transition that “…crypto will increasingly integrate with existing financial software and bring RWAs on-chain via tokenization,“ argues the report.
Banking Giants Abuzz with Tokenization Trend
Global banks have already begun taking a special interest in tokenization. Just last week, JPMorgan said it carried out its first live blockchain-based collateral settlement transaction involving BlackRock and Barclays.
The megabank has actually been focused on tokenization since 2015 when it started its blockchain program and released its permissioned fork of the Ethereum code Quorum. The bank's Onyx Digital Assets platform, which involves tokenized fiat JPM Coin for settlement, has handled over $900 billion of transactions since going live a few years ago. This, however, is nowhere near trillions of dollars handled in payments each day by the bank.
Talking about JPMorgan's latest usage of tokenized money market funds as collateral, Yostpille noted that this has added utility to a traditional product that is typically underutilized as a collateral form, which “…is truly amazing and could be a game-changer.” And with that, margin calls will be completed in seconds rather than overnight, “…so this technology is trickling into one of the most important interactions between major financial institutions, which is the repo market,” said Yostpille.
Aside from JPMorgan, there are various other prominent players at the forefront of the tokenization movement. One example is the $1.4 trillion investment giant Franklin Templeton, which expanded support for the first U.S.-registered mutual fund (FOBXX) to Polygon blockchain and Ethereum.
Another example is Citi, which started working on blockchain years ago at its Innovation Lab. According to Ryan Rugg, Head of Digital Assets for Treasury and Trade Solutions at Citi, interoperability between banks' tokenized fiat offerings is the way forward because clients don't want a siloed system but rather the ability to move liquidity freely across a multitude of banks and optimize liquidity across their markets.
Deutsche Bank is also working with Swiss crypto startup Taurus to establish digital asset custody and tokenization services. Germany's biggest lender was also involved in Taurus's $65 million Series B round led by Credit Suisse and included Arab Bank, Switzerland, and Pictet Group.
At the time, Deutsche Bank's global head of securities services, Paul Maley, said that while the initial plan was to offer custody for selected crypto and some stablecoins, “…we see the opportunity in the broader emergence of tokenized financial assets.”
Hong Kong, too, is in the race, as it successfully tokenized $100 million green bond issuance. The central bank, the Hong Kong Monetary Authority (HKMA), also said in August this year that tokenization has the potential to improve liquidity, efficiency, and transparency in the bond market.
All these advances by traditional firms mean they “…are way ahead of where the market believes they are right now,” said Yostpille at the TokenizeThis summit.
Advancement within Crypto
TradFi's increasing interest in tokenization comes amidst the backdrop of a long list of predictions about the potential of tokenizing RWA, under which traditional financial products such as private equity, debt, and real estate are put on-chain. According to Bank of America, tokenization could transform the existing financial infrastructure, increase efficiencies, and optimize supply chains.
Meanwhile, Bernstein estimates that the size of the tokenization opportunity could be as much as $5 trillion over the next five years. This push is expected to be led by,
- Central Bank Digital Currencies (CBDCs)
- Private Market Funds
- Real Estate.
Interestingly, stablecoins constitute 97% of all tokenized assets and are the “first successful tokenization implementation.” However, other tokenized asset types like US government bonds have recorded over 450% growth this year, as per 21. co's report. This surge was driven by rising interest rates on these traditional instruments, which are surpassing DeFi yields.
As of right now, the tokenized asset market is valued at about $116 billion, with Ethereum (ETH) leading by hosting nearly $60 billion of these assets, followed by Tron (TRX) and Solana (SOL). Back in June, Avalanche Foundation also committed $50 million to bring more tokenized assets to blockchain in an attempt to grab a slice of the tokenized real-world assets pie, which Boston Consulting Group estimates to be a $16 trillion market by 2030.
Most recently, research firm K33 Research called decentralized oracle network Chainlink's LINK token the “safest bet” for investors who seek to profit from the hype. This is because Chainlink has positioned itself as a key piece of infrastructure to connect blockchains with the outside world through its system of oracles and wide range of partnerships.
“Eventually, the biggest market for real-world assets from banks will be public blockchain protocols that need diversified collateral,” – Chainlink Co-Founder Sergey Nazarov
A couple of months ago, Chainlink's tokenization experiments with the interbank messaging system Swift successfully transferred value across multiple blockchains.
Within crypto, industry heavyweights including crypto exchange Coinbase, stablecoin issuer Circle, and DeFi lending platform Aave have also built a working group called ‘The Tokenized Asset Coalition' to encourage others to bring the “next trillion dollars” of TradFi assets on-chain.
Looking forward, K33 analyst David Zimmerman notes that there are many hurdles before tokenized RWA's can reach their full potential; however, the “narrative will be compelling” enough to potentially kickstart a bubble in this sector “before there is widespread substantial impact from RWA on the real world.“
Obstacles to Wider Adoption
When it comes to obstacles impeding widespread, global accessibility of tokenized RWAs, regulatory restrictions are the most prominent one, followed by a lack of standardized processes and socioeconomic circumstances, such as low internet penetration.
On the regulatory front, last week, the UK's regulator, the Financial Conduct Authority (FCA), announced that it has been working with the Technology Working Group on a blueprint for fund tokenization. The FCA also published a discussion paper in February this year on updating and improving a regime for asset management in the UK. FCA Chair Ashley Alder touched on this in a recent speech, stating that “…fund managers might adopt distributed ledger technology to offer fully digitized funds to the public,“.
While the UK has been making advances in creating guidelines for the crypto sector, according to Yostpille of Oasis Pro Markets, Asia is well ahead of Europe and the US with respect to digital asset adoption. For instance, The Monetary Authority of Singapore (MAS) is running “Project Guardian” – a pilot that will test the guardrails and infrastructure around the issuance of various digital securities and different asset classes.
Even crypto skeptic Michael Hsu, the acting head of the US Office of the Comptroller of the Currency (OCC), has been positive towards the tokenization of assets, saying it is a serious advance into the future of finance. However, he believes tokenization “…does not require decentralization and trustlessness” and that “…the legal foundations for tokenization need to be developed.“
Commenting on the regulatory environment, Yostpille said it “remains unsettled” and that the “adoption of CBDC is coming.” He believes the SEC is still hesitant to recognize the blockchain as the authoritative ledger, even if it's an immutable record. Moreover, Yostpille emphasized that,
“…it's important for everybody to recognize the benefits of the digital security tokens with real custodians with a compliance framework”
This is what will provide the guide rails necessary to eliminate risks for asset managers raising capital. In fact, Yostpille believes using digital security tokens to raise funds “…will open up a new pool of investors who can participate” on a fractionalized basis.
As stated, the tokenized assets market is poised for exponential growth, with projections suggesting it could reach $10 trillion in this decade. Traditional financial institutions are increasingly embracing blockchain technology, utilizing tokenization to convert real-world assets into blockchain-based tokens. The reason for this stems from the benefits on offer, such as enhanced accessibility, increased liquidity, and full transparency.
Tokenization also has the potential to democratize finance by making investment opportunities more accessible through fractionalization. While $10 trillion is an optimistic scenario, even a bearish estimate places the market value at $3.5 trillion by the end of the decade. With traditional players like JPMorgan, Franklin Templeton, and Citi actively involved in the tokenization trend, it is clear that the industry is evolving rapidly despite lingering regulatory challenges.