The Rise of Tokenized T-Bills

Over the past couple of years, the macroeconomic backdrop has shifted dramatically, making investors turn to US Treasury bills. With the tokenization of real-world assets (RWAs) becoming a prominent trend, crypto is now shifting to tokenizing short-term US government bonds.

Amidst this backdrop, digital asset firms, protocol treasuries, and crypto investment funds, which often hold significant amounts in stablecoins, are looking for reliable investments. Tokenized treasuries appear to fit the bill, offering them both a shield from inflation and an opportunity to earn yield. This aligns with the broader attention tokenization has been receiving, particularly the tokenization of T-bills. The market value of these blockchain-based US Treasury, bonds, and money market fund-based tokens, according to RWA.xyz, is $684.7 million.

The dynamic of the investment environment is further emphasized by the changing yields in the market. The demand for tokenized Treasurys has been on the rise as US government bond yields have surpassed those in decentralized finance (DeFi). Meanwhile, DeFi yields declined after the 2022 crypto downturn. In contrast, traditional bond yields surged, influenced by the US Federal Reserve's actions.

Adding to this evolving landscape, new players are entering the scene, releasing blockchain-based Treasury products that function similarly to high-yield savings accounts. MakerDAO stands out among them, showing a strong inclination towards US Treasury bills with significant investments in short-term bonds.

Complementing this narrative, the broader financial community is taking note. Franklin Templeton discussed the importance of tokenization at the TokenizeThis conference hosted by Security Token Market (STM), a leading oracle for blockchain-based assets.

Why the Growing Interest in T-Bill Tokenization?

During the recent Tokenization Summit, STM held an impressive panel to talk about the rise of the tokenized T. Bill. Hosted by Peter Gaffney, head of research at Security Token Advisors, the panel included Jerald David, President at Arca; Philipp Pieper, Co-founder & CEO at Swarm Markets, and Sid Powell, CEO and co-founder of Maple Finance besides Muir of Franklin Templeton.

Talking about the increasing focus on Treasuries, Muir noted that it was “really just a prototypical choice.” He pointed out that up until recently, yields for Treasuries were basically zero. Hence, there was no commercial intention behind offering such a product, but in the current rising rates environment, “there is now some commercial opportunity around this.”

But the leading asset management firm isn't limited to just Treasuries; rather, they've built the technology to be used as a target state solution for all manner of pooled investment vehicles in tokenized form.

This is why, when Arca first started creating the US Treasury Fund, rates were not where they are right now. The idea was to use treasuries as a proof concept and create a new pool vehicle for markets that have low volatility and are “easily digestible” for regulators, said David. But now that rates are increasing, there is a lot of attention being focused on treasuries, and “crypto players in this market actually are obviously very keen to get yield-bearing assets,” he added.

For Maple Finance, though, T-bills were a natural choice because it's a simple product for everyone to understand. Currently, one of the interesting applications happening around this is trading firms using non-yield bearing collateral to collateralize their trades and are now interested in getting tokenized T-Bills accepted as eligible collateral to get better capital efficiency on their tied-up funds, noted Powell.

Talking about users' investment behavior, Powell provided insights into different types of investors. He noted that those who want to preserve their capital, say a startup that raised a series round, are relatively inactive and tend to spread exposure across a few different providers. On the other hand, it's the sophisticated investors, the high net worth or yield funds, who are involved in more active allocations as they're waiting for a better opportunity to pick up, he added.

What's Ahead for the Tokenization Trend?

Back in 2020, central banks around the world cut down rates to tackle the effects of COVID-19, and the Fed effectively sent them to virtually zero. Then, in May 2022, the Fed approved a 0.25% rate hike, the first increase since December 2018, to address the spiraling inflation. 

Since then, the Fed has raised benchmark borrowing costs by 525 basis points, and as of right now, it is in the range between 5.25%-5.5%, the highest in some 22 years. This liquidity tightening cycle was in part responsible for last year's crypto market crash.

But while high rates have their negative impact, this new environment can also lead to more use cases. According to Pieper of Swarm Markets, which is a hybrid organization that tokenizes public stocks and bonds, this environment would be beneficial for those “DeFi platforms that then can take the nucleus of actual T-bills and actually build derivative products out of it,” and it's not just limited to custodians on the institutional side. 

“We obviously have to go down to the nuts and bolts to make sure that it's actually insolvency protected,” so that people can rely on really that asset being there, the way that it's described, added Pieper.

But at the same time, this would only add to the importance of regulation with Arca's David noting that when working with T-Bills, one is dealing with fund accounting, distributor, and all the elements that are verifying real time, that the assets you actually are stating that you have are being held in a custodian, and they're being held where they are, with full transparency.

Adding to the regulatory aspect of this, Muir of Franklin Templeton noted that this will be a real obstacle for the tokenization space to overcome in the coming years. 

In terms of new features and capabilities, there is “sort of this concept brewing here, where there's new life being breathed into a rather old full investment vehicle construct, called the 40 Act Fund, at least in the case of the US,” said Muir, adding; while some of these features are completely new that really haven't been seen before, some of them are really just much, much faster and more granular versions of the same thing that's happened in the past. 

Muir illustrated how, in transfer ability, two authorized holders of a 40 Act fund can transfer shares between each other. However, the process of doing so in the traditional environment is quite cumbersome and time-consuming. 

Now, by utilizing blockchain technology, we have the same capability, but it's far faster, with lower latency and extensively less cost. But while technologically it's pretty simple to turn it on, “the regulatory environment is the real sticking point here, because the type of considerations that they make, and the type of threats that they consider, and the risks that they consider are quite different,” said Muir.

“When you take the same functionality and make it a lot faster and a lot quicker, a lot easier, that's really going to be an uphill battle over the next year to 3-year timeframe,” he added.

Obstacles to Overcome 

When it comes to the regulatory aspect, the cryptocurrency industry as a whole has been dealing with increased scrutiny, with governments around the world scrambling to put in a framework and bring it into their regulatory jurisdictions. But there is no uniformity. 

For instance, in Europe, MiCA introduced a comprehensive legal framework to harmonize the regulatory requirements for crypto-asset-related services across the region while US regulators have cracked down on crypto assets and exchanges. 

So, when it comes to tokenization, Muir believes we will continue to see the ongoing FOMO in the regulatory community, where some jurisdictions and their regulators will be more willing to allow experimentation and for products to go live broadly across their economies and enable greater capability for the investor. On the other hand, there are regulators who have been reluctant to adopt, and “there will be political pressure applied to regulators that lag in this affair.” 

According to Muir, currently, there's a huge disparity amongst regulators, globally, in terms of willingness to enable these capabilities and this new substrate of financial services as well as their understanding of how these things actually function mechanically. 

“So we're still, in my opinion, at the midpoint of that journey we're nowhere near the end state where you have common understanding amongst global regulators about how these things actually will function, let alone a common willingness to allow them to function,” he added.

While Pieper believes the industry needs to think more regionally due to currency constraints, Powell is hopeful that we'll see a lot more “cross border repo transactions now that you have these tokenized low risk or lower risk instruments.” 

Although local crypto native actors are currently the users of these products, Muir says, when the distribution community realizes the efficiency gains of stripping out intermediaries and regulators are permitted to distribute them through third parties—which is the norm in the cold investment and public vehicles industry—it will be a significant unlock.

But for now, there isn't enough regulatory clarity in the United States on what licensing exactly is needed for third-party distribution of technology securities. But “that's achievable,” Muir said, as it can be demonstrated quite simply that this is a more reliable and safer environment with better information than single databases held by a variety of different companies that have to be reconciled together and then get synced with each other periodically.

For now, regulators are taking baby steps to enable the capability brought forward by public blockchain so that they can fully understand the systemic risks and fully understand the actual ramifications of these products before they become a very significant part of the global economy, explained Muir, at the Tokenization Summit that caters to both retail and institutional audiences.

It's a Multi-Decade Journey

While regulation is certainly an obstacle the space has to overcome, there are other key infrastructure components that are missing. According to David, currently, there is a lack of standards that need to be adhered to.

But Powell is of the view that what we need is ubiquitous on and off ramps and the quantum of stablecoins to be about 10x higher. In agreement with Powell, Muir also believes it's certainly a challenge we are facing right now: the reliance upon the existing banking system, which makes subscription or redemption incredibly slow and painful. But that's “a pain that we're gonna have to deal with until there's a critical mass of activities taking place natively on blockchains, and you don't have to go back and forth through a banking system.”

At last, Muir said, “We're at an early innings of the entire journey,” from a capability perspective. As for uniformity across the globe of regulatory entities, it won't happen until we have a critical mass of existing instruments and products of all sorts using blockchain technology. 

“I think that's a multidecade journey at best. You're gonna see a lot of inertia there. As I said before, there'll be some kind of a hockey stick tipping point or inflection there when it becomes just abundantly obvious that certain capabilities and features are trivial to implement using these technologies and just vastly quicker, and in the end, a lot cheaper at scale. I don't know exactly when that will be, but it's not gonna be in the next couple of years,” Muir said.