Buying securities like stocks and bonds is simpler than ever for consumers, but it’s still a painstaking process for the financial institutions performing the transactions. Tokenization, the process of creating digital representations of physical assets, can not only ease those efforts, but it can also make assets that were previously illiquid and expensive attainable to everyday investors.
Tokenization: Digitizing the Real World, a report from James Wester, Director of Cryptocurrency, and Joel Hugentobler, Cryptocurrency Analyst at Javelin Strategy & Research, explores the use cases of tokenization, the reasons it’s gaining traction, and the powerful future of the DeFi technology.
Digitizing Efficiency
One of the main benefits of tokenization is it makes the security creation process much more efficient. It’s blockchain foundation allows for faster settlement times because it eliminates intermediaries, facilitating near-real time transactions. Tokenization can support automation, drastically reducing the costs of issuing securities like bonds or private placements.
Compliance violations cost financial institutions billions each year. Blockchain can reduce errors because each individual token can be programmed to comply with regulations. The DeFi foundation can also mitigate disputes because all records are centralized. Blockchain is better suited for financial operations because it’s not reliant on public internet, and therefore more secure.
Digitizing assets can significantly lower barriers to entry because it allows for liquidity and fractionalization. Assets like real estate, which were not previously readily converted into cash, can be bought and sold much more efficiently.
Once converted into tokens, assets can easily be fractionalized. A property that was once only available to higher net-worth individuals could be digitized, fractionalized, and sold piecemeal to investors who realize returns on a pro rata basis.
Institutional Backing
Even though the concept of tokenization has been around for a decade, implementation has been slow. Over the last few years, however, adoption has gained momentum.
“What separates this go-around is there’s more institutional activity,” Hugentobler said. “Now they’re tokenizing money market funds in the EU. In the U.S., there’s more traction for tokenizing stocks, bonds, and private equity funds.”
Though financial institutions may be ready to move forward, there are still regulatory hurdles to clear. There hasn’t been a bipartisan effort among U.S. lawmakers that would push adoption forward at this point, but there’s increasing speculation that the upcoming election could put financial regulation back on legislators’ agendas and push innovation forward.
Sophisticated Infrastructure
Another reason tokenization is garnering more attention lately is more companies have the capability to support it.
“There have been huge advancements on the infrastructure side,” Hugentobler said. “We have custodians that have stepped up and substantially developed their infrastructure, their security, and their protocols for the institutional players who will drive this forward. That’s led to the most powerful companies in the industry getting involved, like Franklin Templeton and BlackRock.”
Those companies have created tokenized money market funds which, combined, crossed over $1 billion in value as of March 2024. The substantial investment by BlackRock, the largest asset manager in the world, is a telling show of faith in the emerging technology.
Following BlackRock’s lead are companies like BNY Mellon, Goldman Sachs, JP Morgan, and other leading financial institutions. Those companies are either building their own tokenization platforms or collaborating with technology providers to create them, and all that infrastructure has been built in just the past few years.
An Opaque Situation
The transparency of tokenization could be a major boon to both the bond and credit industries. Many financial institutions will buy bonds in massive amounts and then either lend or borrow using the securities as collateral.
“It becomes an opaque situation where institutions are taking a look at other institutions’ balance sheets and they’re having a hard time deciphering who owns what, who’s borrowing against what,” Hugentobler said. “In the great financial crisis of 2008-2009, that kind of situation turned out to be a massive issue. It’s not quite to that level now. However, increasing transparency, knowing who has what at any given time and who’s borrowing against it, it could have a big impact.”
First Movers
Especially in emerging markets, which tend to be less liquid, tokenization could instill investor confidence in credit markets and private equity funds. It could also illuminate more investment opportunities and create deeper liquidity in those markets. However, the technology has plenty of intriguing use cases in established financial systems.
“Money market funds and the credit side, that’s where we’re going to see the first movers,” Hugentobler said. “The diminished costs will be a big incentive for institutions to tokenize. Obviously, financial companies are in business to make fees. However, from a longevity standpoint if they can reduce their customers’ fees and maximize their margins it could have a lasting impact.”
Learn more about the benefits of tokenization and how institutions can prepare themselves for the coming digitization of assets.
