Tokenization is taking the world by storm. The tokenized real-world asset (RWA) market, in particular, has been on a tear, with its total value reaching an all-time high of $2.75 billion in August.
Despite declining since then, the value still stands at around $2.49 billion as of September 30. Meanwhile, the valuation of tokenized U.S. Treasury bills, bonds, and money markets have scaled up to $685 million in recent months.
But this is just the beginning, as according to Boston Consulting Group, the tokenization of global illiquid assets is expected to be a $16 trillion industry by the end of the decade. Meanwhile, researchers at Bernstein Private Wealth Management believe that by 2028, about 2% of the global money supply could be tokenized, bringing the sector's valuation to $5 trillion.
This is not all, though. A joint survey by American banking behemoth BNY Mellon and research firm Celent revealed that 91% of institutional investors are interested in investing in tokenized assets, with a whopping 97% agreeing that tokenization can revolutionize asset management.
So, against this backdrop, STM arranged for a central forum for the industry thought leaders, innovators, and enthusiasts to exchange ideas, discuss challenges, and chart the course for the future of finance using tokenization.
Security Token Market (STM) is the largest repository of security token trading data, analytics tools, news, and top-tier analyst reports with a live-trading data feed for over 200 security tokens valued at over $25B in market cap.
STM's flagship conference took place from October 11 to 13 with an aim to unite global leaders in the field of tokenization, catering to both retail and institutional audiences. The 3-day long Tokenization Summit took place completely online, featuring speakers from the largest banks, marketplaces, & blockchains in the world.
The Core of a Tokenization Platform
At the inaugural TokenizeThis Summit by STM, held last week, Tyler Odean, a senior director of product management at Bitcoin technology company Blockstream, talked at length about the Liquid Network. Liquid provides end-to-end tokenization services.
One of the Blockstream projects, Liquid, is a federated open-source settlement network that allows people to issue, trade, and custody assets with strong privacy, audibility, and security guarantees. The platform allows businesses issuing and trading assets that have been tokenized on Liquid to enforce their own compliance without needing to supervise their counterparties or trust a centralized authority, explained Odean.
Despite there being no centralized authority to force the rules on the network, all the Liquid participants can have total cryptographic confidence that the rules that they need, in order for their tokenized assets to be compliant within their personal jurisdictions, can be true without needing to have any visibility into the jurisdictional responsibilities of their counterparties.
“Everyone sorts their own business out and remains perfectly private while doing so,” he said at the seminar.
What this means is those who issue assets on Liquid can perfectly audit their investor base, and they can enforce whatever compliance rules they need, not just the KYC and AML rules, but also potential rules about transfer sizes or accumulation of control of a particular asset without needing custodial control over that asset, and without needing the asset to be visible to the network at large.
This way, Odean explained at the event, the platform prevents rehypothecation — a practice whereby banks use, for their own purposes, assets that have been posted as collateral by their clients — and gives investors confidence in the share of the supply that they actually own, without needing to sacrifice the privacy or relinquishing custodial authority over their own assets.
On Liquid, all transactions are confidential by default, which means that the asset quantities and types that have been traded in a given transaction are obfuscated from the rest of the network, including the validators that actually operate the network, which means nobody can know what transactions one is making on the network or its economic nature. This means the user is protected both not just from front-running and leaking corporate intel but also from more complex systemic threats like MEV.
In general, the most valuable thing that the Liquid Network allows you to do is to self custody assets and to trade them without needing an escrow service and without having counterparty risk, which means you can eliminate counterparty and rehabilitation risks for the assets that are tokenized on the network, said Odean at the conference.
He further went on to talk about how what the tokens mean in the real world is a definitional agreement between the investor and the issuer, with the network itself not having any understanding of what tokens are meant to represent; rather, all that the network does is enforce the rules of how they behave, and guarantee that they are only transacted with in ways that are deemed valid by the rules of the token itself.
The purpose of the liquid network is to be a neutral ground that enforces transaction, ordering finality and validity but does not take a stance on what transactions mean or what the participants from the network are trying to achieve with them. It allows economic models to exist within totally independent jurisdictions, with totally different responsibilities, and still trade with each other fluidly, with confidence that both rules are accommodated without needing to have knowledge of each other's rules.
Compliance in the Focus
At the dynamic and informative virtual event, Blockstream's Odean talked about how, being a side chain of Bitcoin, Liquid inherits a lot of the battle-tested consensus logic of Bitcoin itself.
“Bitcoin is de facto the most secure code base in the world because it has had the most wealth stored behind it for the longest period of time, and that is the strength that Liquid is inheriting from by building off of that foundational framework,” he noted.
As for how it works, being side chain means anyone can deposit BTC from the original blockchain into an address controlled by the Liquid validators, and in exchange, they receive a secret that allows them to claim the equivalent amount in liquid Bitcoin and similarly, one can peg out Liquid Bitcoin (L-BTC) back into Bitcoin in the original chain.
What it all means is that L-BTC is functionally pegged to the value of Bitcoin and “is essentially just a receipt that allows you to cash your Bitcoin.”
Odeon further stated that because the network operates through a federated consensus, it has none of the environmental footprint of proof of work (PoW) mining and does not require any equity, like staking tokens, “which means it has regulatory clarity.”
Moreover, it was built from the ground up for regulatory clarity with no pre-mine, ICO, or equity-like token requiring additional regulatory definition.
When it comes to the regulatory aspect, Blockstream's asset management protocol (AMP) allows asset issuers to embed the rules of compliance into the asset itself. This system basically allows any asset issuer to have confidence that their compliance rules are being adhered to without needing to see control of some central authority of the network or without needing to supervise any counterparties or investors in any way.
But while Liquid enforces the validity of transactions in an absolute sense, AMP allows every asset to add its own idiosyncratic rules of validity on top of the base rules of the network that allows everyone to build custom compliance for their particular jurisdiction and still trade in a completely neutral field.
“The purpose of Liquid is to enable tokenization and digitization of assets that still want to maintain regulatory relevance,” be a part of the traditional finance (TradFi) system while taking advantage of the rapid settlement and the smart contracts, and the various other properties that are achievable such as rehypothecation protection and self custody, said Odean.
Talking about the “industrial grade security” of the network, Odeon pointed out how the DeFi space is plagued with a lot of security exploits because of the shortcuts taken, which, while helpful for building rapid prototypes and trying out wacky new things, are not helpful, for building sophisticated finance projects and having confidence that they will perform in the way that you expect.
“Liquid is intended, not for simple prototyping, but for really profound serious use cases,” he said.
In that regard, Liquid is currently working on a language called simplicity, which allows you to do fundamental mathematical validity proofs about the nature of that smart contract's behavior. It ensures that the smart contract is only capable of paying out to you or your counterparty.
Simplicity is “a future-looking thing we're developing,” but in general, Liquid and the UTXO architecture are built from the ground up to have a serious weight towards long-term security and confidentiality that you need to be able to put billions and trillions into the system, he said.
“Liquid is built to sustain the true economy of the world,” added Odean.
A Look at Tokenization Application
At the event that saw the likes of Jacobo Ochando Ortí, Head of Tokenization at Deloitte; Anthony Bassili, Head of Tokenization at Coinbase; Anthony Moro, CEO at Provenance Foundation; Oi-Yee Choo, CEO at ADDX, and Graham Rodford, CEO at Archax among other prominent names as speakers, Odeon pointed out that the Liquid network actually allows for a wide range of assets to be tokenize.
Talking about the interesting examples of what's being done with Liquid, he mentioned Miffiel, a company based out of Mexico that handles promissory notes, which are a form of debt in Mexico that happens to be particularly privileged by local debt loss.
While a particularly desirable way to hold debt, being a local paper instrument, it struggles to access global liquidity because in order for global lenders to have confidence that they're not dealing with rehypothecation risks, they must have an individual trust relationship with the issuer of that promissory note.
So, Mafiel is tokenizing promissory notes and then letting those tokens serve as collateral to global lenders who are now comfortable lending against those assets because they have greater confidence in the total supply and in the lack of rehabilitation risk, explained Odeal, adding that additional liquidity is then used to create more tokenized promissory notes in the country.
“So, there's like a flywheel there that basically amounts to a locally valuable but stranded asset that is able to access greater global liquidity by eliminating trust relationships and replacing them with cryptographic proofs,” he said. By doing that, they're sort of enabling both markets to access each other in a stronger way.
Another interesting use case Odeal pointed to was a Digital Garage in Japan, which has a product called SETTLENET, which, while currently used by exchanges, Odeal expects to be a much more widely needed banking service over time by exchanging pairs between Liquid Bitcoin (L-BTC) and their Canadian and Japanese yen peg stablecoins.
Fuji Money is yet another one, which is a stablecoin that is backed by Bitcoin itself, and the way that it works is that users who want some access to liquidity on their Bitcoin without relinquishing self-custody can lock some Bitcoin up as collateral and receive some Fuji money as a sort of loan against that collateral. And if the value of Bitcoin goes below a certain threshold, people can claim those vaults.
“What's cool about Liquid is that each of these different systems can have greater or lesser regulatory scrutiny,” or degrees of controls or restrictions on the nature of how the asset is used and still be able to all interoperate smoothly, and a user can choose to bridge across whatever suite of those assets is relevant to their portfolio, without there needing to be any centralized authority, said Odean.
The Future of Tokenization
As we saw, the tokenization service provider Liquid has been gaining a lot of traction thanks to the focus on compliance, confidentiality, and security. But, it is to be expected that the tokenization industry is gaining immense momentum.
Earlier this month, banking behemoth JPMorgan also rolled out its blockchain-based tokenization platform — the Tokenized Collateral Network (TCN) — with asset management giant BlackRock among its inaugural clientele. UBS meanwhile announced the live pilot of a tokenized variable capital company (VCC) fund under the moniker Project Guardian, steered by Singapore's central bank.
Even the Federal Reserve released a comprehensive working paper last month that delves into asset tokenization and estimates their market value at an impressive $2.15 billion as of May 2023. The paper explains that asset tokenization offers access to previously inaccessible or costly markets where investors can acquire shares in specific properties.
Most recently, Brad Jones, Assistant Governor (Financial System) at the Reserve Bank of Australia (RBA), said the future of money is most likely digital, with tokenization having the potential to be a critical part of the future monetary system.
But at the same time, governments around the world are scrambling to find the best way to regulate this new technology, as such projects that use tokens can encounter regulatory hurdles. One concern for regulators is how security tokens will remain tethered to their underlying assets. Moreover, many investors want specified protections as well as the ability to seek recourse.
During the Q&A round, when asked about how the regulators view the anonymous counterparties and assets, Odeon explained that the nature of the network is that it doesn't have any knowledge of its counterparties, but the user is entitled to enforce their discretion over what counterparties they want to be allowed in the assets that they issue.
So, if you are issuing an asset and you are concerned about the risk of anonymous counterparties, you can use the AMP system to basically restrict the set of addresses that are allowed to hold your address. This way, the network allows for anonymous interaction. But it's up to the asset issuers what they deem valid interaction for their asset.
Overall, tokenization continues to grow, even in the ongoing bear crypto market. Described by Jenny Johnson, CEO of Franklin Templeton, one of the world's largest asset managers, as akin to “securitization done on steroids,” tokenization is only at its initial phase with STA aiming to attract emerging players to the industry with long-term opportunities.