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Crypto is getting back up, a change from the downtrend witnessed throughout 2022 and the sideways action seen in much of 2023. But now, the trajectory for the industry seems to be upward, with the Bitcoin spot exchange-traded fund (ETF) narrative at the forefront of this recovery. BlackRock CEO Larry Fink has described the recent rally in BTC as being driven by a “flight to quality” during the current times of uncertainty.
Besides ETFs and macro factors like the renewed threat of inflation and the instability in the Middle East due to the ongoing war, tokenization is another narrative driving this momentum. According to Herwig Konings, CEO of Security Token Advisors, with tokenization for real-world assets, “we now have a real opportunity to leverage this technology.”
Throughout this year, we have been seeing tokenization experimentation with the banking giants and massive fund managers' tokenizing products.
Most recently, major European clearinghouse Euroclear unveiled its tokenized securities issuance service for the World Bank's $106 million digital bond issuance, for which TD Securities acted as the dealer, and Citi was the issuer agent and investment manager. The bond was issued on the Corda blockchain with Euroclear's Digital Securities Issuance (D-SI) business assisting in issuing, distributing, and settling fully digital financial assets on distributed ledgers.
The bond is listed on the Luxembourg Stock Exchange and will be used by the World Bank Group's International Bank for Reconstruction and Development (IBRD) to finance sustainable development activities.
“A transition to digitization is underway in the capital markets,” said Anshula Kant, World Bank's managing director and chief financial officer, in the statement.
This is just the latest convergence of traditional financial (TradFi) services and digital assets as major institutions put real-world assets (RWA) on blockchain to increase efficiency, lower operational costs, and improve accessibility and transparency. From JPMorgan, Citi, Standard Chartered Bank, and UBS to Goldman Sachs, Franklin Templeton, BlackRock, Swift, and LSEG, several TradFi institutions have announced tokenized asset services and products.
In fact, a survey by EY-Parthenon, the global strategy consulting arm of Ernst & Young, has found that 83% of institutional investors and 91% of high net worth investors (HNWIs) “anticipate allocating funds to tokenized bonds” through 2026. Meanwhile, institutional investors are forecasted to allocate 5.6% of their portfolios to tokenized assets in the next three years.
While TradFi institutions are embracing blockchain and tokenization, they are not really here in terms of demand. Talking about investor profiles as of who's buying these money market funds or treasuries, Colin Cunningham, Head of Growth at Centrifuge, said:
“As much as we all like to talk about the institutional adoption of blockchain or crypto, that's not happening right now, at least on the buy side. So, for anyone who's thinking about this as a pathway to innovative or risk-seeking institutional investors, it doesn't even really exist. Risk-seeking institutional investors, that's not really happening right now.”
So, the pathways to on-chain and capital markets that do exist are through ecosystem-type partnerships — DAOs that amassed treasuries over the last two to three years, and large ecosystems like Polygon and Arbitrum that have been successful in front of traditional blockchain VC crowds have built incredible networks of users and have their own pools of capital, added Cunningham.
Growing Capital Markets On-Chain
In the crypto world, we have seen stablecoin issuer and DeFi protocol MakerDAO continue to expand its non-crypto portfolio with tokenized RWAs via crypto investment firm BlockTower. Currently, MakerDAO's cumulative RWA assets stand at about $2.7 billion, and they are predominantly allocated to short-term US Treasury bonds.
With this move, Maker aims to diversify the assets backing the $3.7 billion dollar-pegged stablecoin by ramping up the role of traditional financial assets such as government bonds in the reserve.
The protocol first started purchasing treasury bonds in October 2022, which helped it weather the slowdown in the broader DeFi ecosystem and generate revenue from the soaring global rates. Data suggests Maker is earning a significant portion (about 70-80% in mid-Sept.) via stability fees against RWAs.
This move has been a defining story for two reasons: one, “BlockTower has represented conviction around what a DeFi protocol can do versus having to go through the macro system where there are insular, private blockchains built within banks and TradFi,” said Cunningham at the TokenizeThis conference.
He explained how BlockTower, using blockchain technology to launch their own credit fund, showed people and traditional issuers and asset managers that this can actually be done. “It's not easy or right out of the box just yet, but it can be done,” he added.
Then he pointed out how this move also proves the “idea of growing capital markets on-chain” despite all that's happened in crypto over the past two years with the implosion of FTX, BlockFi, Terra, and other crypto firms along with the crypto winter. Not to mention, surging interest rates in the TradFi world combined with where the world is broadly heading, “crypto capital markets are probably the last thing on people's minds.”
The tokenization of RWAs is expected to be $10 trillion by the end of the decade, with analysts also predicting this trend to be a driving force for mainstream crypto adoption.
Early in Sept., DeFi leaders — Aave Companies, Circle, Coinbase, Base, Credix, Centrifuge, Goldfinch, and RWA.xyz — formed the Tokenized Asset Coalition (TAC) to help advance the adoption of public blockchains, asset tokenization, and institutional DeFi. The tokenization of RWAs, according to the advocacy group, represents the “best opportunity for the traditional and crypto financial systems to create a single source of truth.”
According to Cunningham, “we need more institutional thinking” and “rigor, and we need it across the board,” and he's encouraging people to look at the Tokenized Asset Coalition and help the group build the right frameworks and the right institutional practices within crypto around the tokenized asset movement to scale it over the next X amount of years.
Meanwhile, for a small asset or credit manager to grow, they will have to be innovative in order to compete with the massive multi-billion dollar credit funds, said Cunningham and pointed out that DeFi protocols are interacting with these smaller, innovative credit managers because they're willing to go on the journey and through the effort of understanding how these capital markets are forming and how to access them via tokenization platforms for primary issuance and investment.
The Path Forward for Financial Asset Tokenization
Currently, tokenization of Treasuries is spearheading the effort to put real-world assets on the chain. According to RWA monitoring platform RWA.xyz, the tokenized Treasury market has jumped to $698 million from around $100 million at the start of the year.
As crypto investors seek to capture higher returns in the wake of rising interest rates alongside declining DeFi yields, it has led to the growth of the existing platforms and the entry of new companies into the space.
“An outcome of what's happened over the past two years in crypto is that because yield has gone… it's created a vacuum for yield,” said Cunningham. “So, these tokenized money markets & tokenized treasury offerings have flourished and quite quickly relative to the rest of the market, and that represents that the capital is there.”
While the tokenization of Treasuries has only started gaining traction now, according to a recent Coinbase research, the tokenization of financial assets has been steadily gaining momentum since 2017. According to Coinbase research, over this period, counterparty risks have significantly decreased with the introduction of atomic settlements, and many misconceptions about tokenization have been debunked.
The growth is led by the existing high-yield environments — up from 0.50%-1.50% in 2017 to currently above 5.25%-5.50% — though legal and infrastructural obstacles continue to persist. EY-Parthenon's survey found that almost half (49%) of institutional investors see regulatory uncertainty as the primary perceived obstacle.
“We believe this could be a vital use case for traditional financial players and become a major part of the new crypto market cycle, though full implementation may take another 1-2 years,” noted the Coinbase report.
When it comes to regulations, while there are significant legal challenges with crypto and stablecoin within the US, regulators in the UK, Singapore, Japan, and Switzerland are planning asset tokenization tests for asset management, foreign exchange, and fixed-income products.
Through the policymaker group Project Guardian, set up by the Monetary Authority of Singapore (MAS), which also includes Japan's Financial Services Agency (FSA), the UK's Financial Conduct Authority (FCA), and the Swiss Financial Market Supervisory Authority (FINMA), these countries aim to advance cross-border collaboration in asset tokenization in addition to regulating crypto.
While regulation outside the US has begun to take shape, according to Cunningham:
“We still have a lot of work to do to close the educational gap and the understanding gap between the way the crypto native on-chain investor thinks versus the way the traditional offchain investor thinks.”
While the traditional off-chain investor has access to the entire world of investments, with crypto being just the smallest slice of the entire portfolio of assets that they could be investing into or building, the on-chain investor is to some degree limited by what's tokenized and what's brought to them.
The really big question for the on-chain investor right now is what kind of liquidity exists for long-duration products, where there is no redemption within the 12-month period, what's going to happen in the next year, and how to make a good investment decision without any liquidity around this investment.
“For the tokenization of traditional assets on-chain to really flourish, secondary market liquidity is absolutely critical,” said Cunningham.