Trillions of Dollars will be tokenized
What JP Morgan, Goldman Sachs, Blackrock, and Citi are building
In the 90s, we were mailing handwritten, postage-stamped letters to each other.
We can thank digitization for making this sound like a practice from the Victorian age.
The contrast between today's world and two decades ago is just as great when looking at trade, media, communication, and how we consume information.
However, one sector has remained relatively shielded from digital disruption - our financial system. And this, too, is about to change.
What we know about money and currency is being tested by Bitcoin. The digital asset is designed to mimic the fundamentals that make gold valuable, taking aim at the US Dollar by becoming an upgraded reserve asset.
And then we have the tech railings it was built on, the blockchain, which makes legacy financial systems comparable to the steam engine.
This is no secret to the big banks. They know they’re toast if they don’t adapt.
That’s why names such as Citi, JP Morgan, Goldman Sachs, Blackrock, and Franklin Templeton are testing blockchain use cases that are about to upend the world of finance and investing.
By moving to the blockchain, everything of value in the physical world can take on a digital representation - tokens - that can be transacted in a democratic, transparent, and frictionless manner.
Money managers of assets worth trillions of dollars are moving on-chain, tokenizing their funds, and settling transactions more efficiently.
It’s a transformation of unprecedented scale, and we’re right at the beginning of this wave.
Here’s what you need to know.
The walled gardens of traditional finance
Today’s financial system lacks inclusion, keeping most of the world outside its high walls.
To access the financial markets you would need to set up a brokerage account, which requires sending sensitive private information to the unknown (for ‘KYC’), then hoping you’re approved to join.
If you’re allowed in, you will find that the best-performing assets are in private markets, only accessible to people with a net worth upwards of $1 million - what they call ‘accredited investors.’
For people outside the US and Europe, accessing certain equities and bonds is way more complex, if not impossible.
Adding to the frustration is how slow and expensive the financial system is. Trades must meet a litany of compliance measures, requiring bankers, tax specialists and lawyers - all adding to the time and costs.
This is all about to change.
What email did to the postal service is what Decentralized Finance (or ‘DeFi’) is about to do to the financial system.
DeFi and tokenization: Some theory
DeFi not only introduces efficiencies, but it unlocks capabilities we never imagined possible.
It democratizes investments, makes traditionally illiquid assets tradable, automates compliance, and delivers levels of audibility and transparency we’ve never believed possible.
DeFi is run on a ledger distributed across a network - a ‘blockchain’ - making all transactions publicly verifiable and tamperproof.
Blockchain technology also allows you to “tokenize” assets.
This means we can digitize anything of value - stocks, bonds, real estate, art, music rights, and fine whiskey. They sit on the blockchain as tokens backed by the assets they represent in the real world. Their value can then be fractioned and exchanged.
And then there’s the possibility of layering on smart contracts.
This allows embedding the tokens with rules and guidelines that govern each asset, making trades and ownership transfers significantly more cost-effective and settled almost instantaneously, 24/7.
Now that the theory is out of the way, here’s how it’s applied.
DeFi: Opening a new era in finance
Tokenization has been happening in the world of cryptocurrencies for a number of years, with Gold and the US Dollar dominating the real-world assets currently on-chain.
‘Stablecoins' like USDC and Tether are backed 1-1 by US Dollars.
Then there are coins like PAX Gold (’PAXG’) that hold physical gold in vaults to back the tokens they mint.
These are the earliest examples of creating tokens collateralized by real-world or off-chain assets, making them simple to transact.
This is a new world of finance.
Imagine purchasing a token backed by real estate assets in a country where you have no official presence. Ownership of the token is contingent upon meeting guidelines embedded in its smart contract, which meets all the requirements of the jurisdiction in which the real estate sits. The dividends you receive will arrive in your wallet after all taxes and fees are deducted - ensuring complete compliance.
Such capabilities allow everyday retail investors access to projects that would otherwise be impossible due to red tape and restrictions.
For institutional investors, like hedge funds, it makes it easier to move across asset classes and easily find liquidity - way faster and cheaper than in the current system.
The World Bank is piloting the tokenization of an infrastructure project.
Such fundraisers normally require a minimum investment of $1 million from each private investor, effectively locking out most of the public.
With the blockchain, they can now access capital from more people, and due to lowered costs, they will no longer require such elevated minimum investment sizes.
Adding to the possibilities is the transparency of building on blockchain networks. How the funds will be allocated for procurement and other costs will now be open for everyone.
The days of excessive intermediation by financial institutions are numbered as more assets and funds are tokenized on-chain.
The promise of tokenization is transactions that are faster, cheaper, transparent, and open to a broader pool of investors than ever before.
Real-world asset tokenization is happening right now
There has never been more collaboration between the world of Defi and traditional financial institutions.
It’s a necessary step to overcome hurdles with regulation and adoption.
Most recent developments in this space include strategic mergers, inter-bank settlements over the blockchain, the launch of exchanges for trading asset-backed tokens, and the development of bank-owned private blockchains for settling transactions:
Citi piloted tokenizing one of their funds. The distribution rules were encoded into the token’s smart contract and transferred to hypothetical clients; it was then used as collateral in an automated lending contract.
JP Morgan facilitated a collateral transaction between Goldman Sachs and Barclays via their internal decentralized application. They tokenized one of Goldman’s money market funds, then transfered it to Barclays for collateral in a derivatives trade between the two.
Franklin Templeton and WisdomTree have debuted funds whose transaction and ownership records are on the blockchain.
Goldman Sachs’ private and permissioned blockchain launched its first offering, a $100 million greenbond issued by Hong Kong’s government.
Siemen’s (not a bank, but a large German manufacturer) issued a $60 million bond on the Polygon blockchain because of its speed and cost efficiency
There have also been strategic mergers amongst blockchain-native (DeFi) providers to consolidate functionality and deliver a more streamlined tokenization service.
Investing in real-world asset tokenization
There’s a long way to go before we see this space mature.
There are regulatory hurdles to overcome and, of course, the market cycle tops and crashes which will be felt especially hard as investors over-estimate the timelines and potential of new innovations like this one.
As always, diligence and research is key before making any investment decision.
These opportunities are easy-to-access for any investor wanting some exposure to this theme -
Polygon (’MATIC’) has been the blockchain of choice for Siemen’s and Franklin Templeton. Avalanche (’AVAX’) is a prominent blockchain solution that was used by Citi for their pilot. Maker DAO (’MKR’) is an asset-backed stablecoin that is likely to see inflows as more assets come on-chain. All three are tradable on major centralized exchanges such as Coinbase, Binance, and others.
Smaller, less established projects are:
ONDO Finance - a crypto-native company that recently premiered a tokenized ETF and bond offerings on the Ethereum blockchain.
RealT (real-estate backed tokens), which may see more use of their networks as people adopt crypto tokens backed by commercial and residential spaces.
Did I miss anything? Do you think real-world assets going on-chain will revolutionize how the world invests? Leave me a comment or hit reply if you’re reading this from your inbox - I would love to hear from you!
Disclaimer:
The author owns the cryptocurrencies and financial assets mentioned in this article
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