Much like ourselves here at Securities.io, the team behind Security Token Advisors (STA) believe full-heartedly in the future of digital securities or ‘security tokens.' To that end, STA has, for the third year running, released its comprehensive ‘State of Security Tokens‘ report. Here we look at some of the key takeaways to be found in what is the first in a three-part series.
According to the report, public product issuers are not afraid of tokenization. In fact, they are even more eager than private asset managers. The rise in projects tokenizing assets is driven by the need for a broad spectrum of investors to gain greater exposure in the private markets. As for those who aren’t quite ready for client-facing investable products, STA advises them to at least familiarize themselves with blockchain operations and digitization.
A Paradigm Shift
A significant shift has occurred in the past few years, with asset tokenization players applying blockchain technology in private markets and alternative assets.
Blockchain is changing the game as it can be applied cheaply in private markets and alternative assets, where investors are fewer, though more affluent, and products are more customized.
Private-equity adoption of blockchain technology is speeding up as the asset class increasingly views it as a path to tap into trillions of dollars in investable capital held by wealthy people worldwide.
The technology is expanding the pool of investors in private equity, which is currently limited mostly to institutional investors and the very wealthy and ultra-high-net-worth (UNWI) individuals that can afford the minimum investment amounts, which typically begin in the millions of dollars.
Blockchain is being used to create digital securities, aka security tokens, that represent real-world underlying assets and enable token holders to trade with other markets, investors, and asset owners globally but with limited intermediary actions.
The development of secondary markets for tokens from private funds is also poised to become a major shift in private equity.
Increased On-Chain Tokenization
A report from global consultancy firm BCG and private-market digital exchange ADDX predicts that this tokenization of real-world assets will grow into a $16.1 trillion trade opportunity by 2030.
Titled “The relevance of asset tokenization in a cryptocurrency winter,” the report was written by Sumit Kumar, Rajaram Suresh, Bernhard Kronfellner, and Aaditya Kaul of global management consulting firm BCG, and Darius Liu from ADDX.
The report stated that a large chunk of the world’s wealth today is locked in illiquid assets such as real estate, natural resources, land, commodities, and public infrastructure. These illiquid assets typically trade at a discount and are characterized by lower trading volumes and imperfect price discovery.
Not to mention, these asset classes are only accessible to limited wealthy investors or institutions due to constraints on ticket size, such as pre-IPO stocks, hedge funds, infrastructure projects, and private credit.
This capital-constrained environment would act as a forcing function to eventually channel capital and talent pool to viable blockchain applications such as on-chain asset tokenization, which has the potential to dramatically unlock liquidity, access, and choice for multiple investment instruments at scale. Corporate incumbents and regulators are also increasingly recognizing and piloting the opportunity of asset tokenization.
The report points out the vital indicators of the rising prominence of on-chain asset tokenization, including the global on-chain asset tokenization market surpassing $2.3 billion in 2021 and reaching $5.6 billion by 2026. Additionally, the daily trading volume in digital assets globally grew fivefold to EUR 150 billion in 2022.
“Based on expert projections, the potential of on-chain asset tokenization in Asia alone is close to USD 3 trillion,” stated the report.
But of course, there are risks present in the form of increasing regulatory scrutiny, variance in regulations across crucial markets, lack of awareness in key markets like India, potentially slower adoption given the stickiness of users to existing incumbents, and risks inherent to DLT and smart contracts.
Private Securities Market to Grow to $30 trillion by 2030
Today, private asset digitization has been speeding up, especially equities and debt, alongside mainstream assets such as government stocks and fixed income. We have seen the digitization of non-tradable assets such as artwork, but none of those initial experiments has gained a lot of traction; these are essentially tokenizations of assets that are, for the most part, unattractive to institutional investors.
A survey of all the blockchain-based businesses that existed in 2017 — over 200 companies, including custodians, exchanges, developers, and others — shows that no firm at the time specialized in tokenization. But this is changing now, with the prominence of platforms like Securitize and Security Token Market.
And with that, the private securities market is set to grow from $7 trillion in 2021 to $30 trillion by 2030, according to STA’s report.
In private markets, currently, investors can only access deal flow via exchanges and IPOs, which involve a lot of opaqueness, complexity, rules, and regulations with private securities. The Alternative Trading System (ATS) offers a unique solution here. Once a project has raised capital, they come on to the ATS to allow issuers to monetize those shares.
STA’s report points out that private funds are the low-hanging fruit of the institutional asset tokenization side of capital markets. Companies like KKR, Apollo, and Hamilton Lane successfully launched tokenized fund products across three different platforms. Meanwhile, SPiCE VC has emerged as the first-ever tokenized Venture Capital fund, successfully making two investor payouts while being listed on multiple digital Alternative Trading Systems (ATSs).
“The megafunds are headed that way, and private equity and alternative asset managers can simply follow in their footsteps now,” the report added.
Bond Tokenization Predicted to Grow in 2023 and 2024
Besides the private securities market, bond tokenization is expected to be an influential segment in 2023 and 2024, according to STA’s report.
We have already seen the likes of Goldman Sachs and HSBC move from third-party solutions to their proprietary bond tokenization platforms. “This rarely happens unless the institutions smell money,” the report highlighted.
Goldman Sachs has been working with many parties and projects in this space, ranging from tens of millions to hundreds of millions of dollars. So, “it’s possible the industry sees a billion+ dollar tokenized bond issuance out of Goldman in the next calendar year,” as per the report.
Meanwhile, an institutional survey through Arca and Coalition Greenwich also found that 77% of capital markets participants believe traditional securities will be digitized within 5-10 years. This, in conjunction with the $30 trillion private securities estimate, can be used to triangulate an estimated tokenized securities market of $20+ trillion by the end of the decade.
While technology-led disruption of capital markets has been contemplated and implemented with limited success in the past, blockchain technology is making these changes a reality. Through tokenization, institutions can create increased liquidity by making it easier to allocate assets and exchange them between investors. These tokens could then be used to transfer tokenization, settle, and trade for another token representing a different asset, and so on.
The 108 respondents of the survey hailed from a variety of organization types, including Banks/Brokers/ Exchanges/Market Infrastructure, Technology, and Buy-side businesses with different functional roles, named transparency and real-time settlement the top benefits of blockchain.
Institutional investors regularly seek ways to reduce costs and streamline processes, and tokenization lower transaction costs, since the array of intermediaries is eliminated. 61% of participants surveyed said they would like to see traditional securities as tokenized assets because it enables peer-to-peer transfers, eliminates intermediaries, and enhances operational efficiencies.
Additionally, tokenized investment funds could allow issuers to access a wider variety of asset classes as well as offer to new investor cohorts. Fractional ownership, real-time settlement, liquidity, transparency, P2P transfer, and no need for a broker-dealer were all cited as key benefits of digital securities by respondents.
Overall, with more and more asset classes being tokenized, increasing interest from and adoption by institutions, and the talent pool of the sector growing, the digital securities space is set to grow at a fast pace, as noted by the STA’s report ‘The State of Security Tokens – 2023'.