Tokenisation Talking Points
The $10 trillion opportunity?
Tokenisation is currently one of the hottest topics in the capital markets industry, with the influence and integration of blockchain among traditional finance systems becoming more apparent. In fact, the total market value of tokenised assets is predicted to reach in excess of $10 trillion by 2030.
Tokenisation involves representing the ownership rights of real-world assets as digital tokens on a blockchain/digital ledger. Tokenisation can be applied to a range of assets such as equities, bonds, real estate and even artwork. Tokenisation of securities and assets is not to be confused with cryptocurrency network tokens. Although tokenised securities do use technology infrastructure that originates from the crypto world, they are in no way cryptocurrencies, and should be thought of as an old traditional finance-based concept in a new wrapper.
In tokenising securities, which underpin the physical, real-world equivalent, the benefits of blockchain can be leveraged, including increased settlement times, peer-to-peer, 24/7 exchange and heightened security. In addition, tokenisation allows for the fractionalisation of assets, increasing market inclusivity on assets that are typically out of reach to ‘normal’ investors (such as private equity funds) while also improving liquidity in typically illiquid markets (such as real estate).
Tokens that represent traditional assets such as shares, debt or units in a fund, are issued through a security token offering. Here, you can be reminded of how this process works. The security token represents the specific right, such as participation in an investment fund, and are subject to federal laws. A tokenised fund is not a form of uncertificated security recorded by the fund itself, but by the DLT ledger. Because of this, the differences between investing in a fund and owning the tokens that represent shares or units in the fund are not that considerable. However, the costs associated with maintaining investor registers, for example, including where there is secondary market trading, should be greatly reduced where ownership is represented by a token.
In the capital markets industry, large financial institutions such as HSBC, Goldman Sachs, BNY Mellon and Citi have already started to embrace tokenisation, highlighting the growing popularity and viability of this trend. In particular, HSBC became the first bank to offer tokenised gold in November 2023, announcing tokenised, distributed ledger-based ownership functionality of physical gold held in its London vault. HSBC also announced custody services for tokenised securities.
Tokenisation is still early-stage and understandably, more questions than answers currently remain about the integration of asset tokenisation into the capital markets industry. In particular, there are regulatory, infrastructural and custody concerns that have yet to be fully addressed.
Currently, the regulatory landscape for tokenised assets is in flux and lacking a universal framework, with uncertainty toward the classification of tokenised securities.
Switzerland is emerging as a front runner in terms of asset tokenisation legislation, after coming up with a comprehensive, progressive set of regulations aimed specifically at asset tokenisation. In particular, the Swiss Financial Market Supervisory Authority (FINMA) approved the first retail tokenised securities trading platform.
In contrast, major economies such as the United States and United Kingdom have trailed further behind. The US has not yet issued formal tokenisation guidance, but indicates applying existing securities laws to tokenised assets. The UK has largely been the same, although in November 2023, UK asset managers were given the go ahead by the UK Treasury to create tokenised versions of their funds. In the APAC region, Singapore has emerged as a front runner in drafting regulations for asset tokenization. The Monetary Authority of Singapore (MAS) has outlined comprehensive guidelines for security token issuance and set up a testing environment for new tokenization initiatives. Nevertheless, a lack of regulatory development, especially across the major economies, could lead to a lack of cohesion and interoperability between tokenised securities markets.
In addition, as the figure below shows, trading a digital or tokenised asset requires new functionalities such as a digital custodian, new post-trade integrations and/or trading connectivity.
Source: The Investment Association
For a traditional financial firm to put a tokenisation roadmap in place, there has to be a strong commercial case for why they do so because the implementation procedure is timely, costly and expensive. The commercial case may be weak unless trust and clarity toward this new framework increases, which may be unlikely if regulations fail to evolve. Even so, there is a risk that tokenisation could lead to market fragmentation. As it stands, tokenised assets (including securities) are scattered across several platforms and exchanges that aren’t typically known by the mainstream, with many also housing cryptoassets. Arguably, market accessibility would need to be provided by major centralised securities exchanges in the fiat currency world for the security tokenisation trend to really catch alight.
Additionally, there are also ambiguities involved with asset tokenisation. As shown above, firms are implementing their own iterations of tokenised assets, with doubts around how interoperability of these assets will materialise. In many ways, it is down to the financial firm to determine their role in the tokenisation value chain. For example, the firm may prefer to be a custodian of the tokenised security, or instead, be more inclined towards trading them. If for example the firm wanted to custodise tokenised assets, this in itself would present a new paradigm. The custody of tokenised securities would involve holding the private keys denoting part ownership of a fund, which of course draws parallels to ownership of crypto assets, and not physically owning the security like in traditional capital markets. While the distributed ledgers implement a high degree of cybersecurity measures at their core, they are not hack-proof and the private keys which provide access to the funds will need to be safely stored.
Tokenisation represents an exciting new proposition for capital markets firms, providing new capabilities and benefits in terms of settlement, efficiency and liquidity but the technology is still as a nascent stage, with uncertainties around what a regulated tokenised securities market will look like. The recent institutional interest toward tokenisation, as outlined above suggests that something is in the air.