Asset tokenization on distributed ledgers offers multiple benefits, but requires more mature technology, risk management and regulation.
Since the advent of cryptocurrencies and the blockchains they operate on, financial industry professionals have been abuzz with the potential for distributed ledger technologies (DLTs) to transform traditional financial transactions, in the same way the Internet transformed information access and dissemination. Developments have come (and often gone), and with each successive discovery phase the use cases have evolved. Many have fallen short of expectations. But out of this creative destruction process, new investments, advances and applications continue to emerge.
Multiple advantages – in theory
“A token is an alternative way to represent an asset such as a currency or financial instrument”, explains Johann Palychata, Head of Partnerships and New Platforms with BNP Paribas Securities Services. Traditional asset classes can be issued in tokenised form. Tokenization involves the digital representation of real assets, allowing them to be recorded and exchanged on a DLT-based electronic bookkeeping infrastructure. Smart contracts built into the token can then be programmed to enforce rules, such as an equity token that includes a shareholder’s agreement rule.
“Asset tokenization using DLTs and smart contracts has the potential to deliver multiple benefits”, says Johann Palychata. The developments in decentralised finance (DeFi) – based on open, neutral infrastructures – show how more complex services are enabled by a large availability of tokens. Over time it could be a real game changer.”
Since no intermediary is required to hold or move the ownership of the asset, tokenization allows for efficiency gains through automation and disintermediation, and cheaper, almost real-time clearing and settlement, notes an OECD report on asset tokenization[1].
Tokenization can also enhance transactional data and pricing transparency, and improve the liquidity and tradability of illiquid assets. Divisibility allows investors to buy tokens representing a tiny percentage of the underlying assets[2]. By enabling such fractional ownership, tokenization could lower barriers to investment and give retail investors access to previously unaffordable asset classes. SMEs would also benefit from enhanced access to financing by easing the flow of private financing from capital owners, observes the OECD report.
These token attributes will potentially change the way organisations create and deliver financial products and services, says Johann Palychata. It would enable more direct, digital connectivity with the final beneficiary, and give users – whether the end-user or the solution builder – greater control. “Having more standardisation will enable people to build financial services without needing to meet or even know their counterparty”, he notes.
For asset managers, it would open up new distribution possibilities, enabling firms to increase their assets under management without incurring the fees of traditional distribution platforms. That could shift the focus from a B2B or sometimes B2B2C value chain to a more B2C environment.
“Asset managers will be able to directly distribute their products more widely and to a broader global audience”, notes Johann Palychata.
“With tokenization, firms don’t have to rely on specific geographic distribution. The end investor in turn could gain easier access to different investment vehicles, such as real estate or less liquid funds.”
Not there yet
But with the opportunities come concerns. At present, the technological base is unstable, and broad adoption will create risks, not least around cybersecurity, says Johann Palychata. How firms manage risk, including counterparty risk, will need to change. The infrastructure and business model transition must be carefully supervised and controlled to prevent market and operational risks and abuses, including guarding against illiquidity risks for less sophisticated investors.
So while tokenization of real world assets is the endgame, it is still early days, cautions Johann Palychata. Most tokenization projects by traditional players mimic current market models, with some relying on private or restricted networks that limit their interest and potential.
“If tokenization is to happen at scale, it requires more mature blockchain technology to be rolled out to the real world. The regulatory landscape will also need to evolve to reflect the new concepts, and in Europe a new regulation will only be fully operational near the end of the legislature in 2024.”
With thanks to Johann Palychata, Head of Partnerships and New Platforms, BNP Paribas Securities Services.
[1] OECD (2020), The Tokenization of Assets and Potential Implications for Financial Markets, OECD Blockchain Policy Series (www.oecd.org/finance/The-Tokenization-of-Assets-and-Potential-Implications-for-Financial-Markets.pdf)
[2] For example, in 2019 the luxury AnnA Villa in the Paris suburb of Boulogne-Billancourt became the first European property to be sold via a blockchain transaction. Individual shares of the building, which was valued at EUR 6.5 million, could be bought and sold for EUR 6.50.
