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Tokenization, positioned at the intersection of finance and technology, emerges as a transformative force with sweeping implications. This groundbreaking process converts both physical and financial assets into digital tokens on a blockchain, fundamentally altering the dynamics of global finance. By doing so, it not only establishes a new paradigm for investors but also unlocks opportunities for 24/7 trading, fractional ownership, and addresses challenges such as the complex and expensive operational processes reliant on intermediaries, liquidity fragmentation, and protracted settlement times for financial institutions.
In a broader context, it is gaining remarkable momentum within Medium (M), Institutional (I), and Banking (B) institutions. The tokenization market, spanning various asset classes, has witnessed exponential growth and reached a staggering $310 billion in 2022. Notably, tokenizing existing assets in both wholesale and retail markets emerges as a linchpin for driving mass adoption in blockchain participation.
As the tokenization market evolves, traditional intermediaries like banks and asset managers face the prospect of disintermediation. To remain relevant and actively participate in this new ecosystem, these institutions are adapting and embracing tokenization. At a high level, a comprehensive tokenization stack comprises blockchain networks for processes and settlement, a tokenization platform for issuance, an institutional-grade blockchain wallet for asset custody, and additional secondary market infrastructure.
In the subsequent sections, we embark on an in-depth exploration of the tokenization landscape, its benefit and risk, diverse applications, what can be tokenized, a case study, the tokenization stack, and its adoption by key players in the financial industry. We meticulously examine all facets of the subject, arming you with the knowledge to navigate this ever-evolving landscape.
Traditional financial infrastructure faces notable constraints, relying on intermediaries with isolated proprietary infrastructures and jurisdiction considerations. This inherent structure can lead to potential fragmentation of liquidity and friction for capital flow. Additionally, the system involves complex processes with high operational costs and extended settlement times. These challenges drive institutions to explore more agile and efficient alternatives, making the case for tokenization highly compelling.
Figure 1: Limitations of Existing Financial Systems (Source: Blockdaemon)
Tokenization takes an asset's value or ownership rights and encodes it into a digital token on a blockchain. This translates to seamless buying, selling, or trading in a digitized environment. Far from mere industry jargon, tokenization holds significant weight in the development of Institutional Decentralized Finance (DeFi), serving as a catalyst for transformative financial solutions.
Figure 2: Tokenized Capital Flow (Source: Blockdaemon)
We observe that recent data emphasizes the importance of tokenization in the institutional landscape, considering both sentiment and market size. According to a BNY Mellon report, 97% of institutional investors believe that, "tokenization will revolutionize asset management" and view it as, "good for the industry." This statistic highlights the rising adoption rates and underscores the competitive advantage tokenization provides. The on-chain asset tokenization market, surpassing $2.3 billion in 2021, is projected to reach an impressive $5.6 billion by 2026, signaling not just financial viability but also paving the way for broader economic transformation. Notably, BlackRock and State Street express confidence in tokenization's transformative capabilities.
We have also observed that tokenization picked up steam in 2022 despite the market downturn. In the context of a dynamic global geopolitical and macro environment (i.e. Russian sanction, global inflation and rate hikes, USD global dominance challenged), various financial institutions have started experimenting with tokenization as on-chain infra building blocks.
Figure 4: Tracker of Tokenization from Large Institutions in 2022 (Source: Blockdaemon)
In this section, we outline our vision of the tokenized economy mirroring the structure of the real economy with money to transact and assets to be bought and sold. We provide an overview of the assets eligible for tokenization and delve into various types of tokenized money, distinguished by issuing methods and associated risks.
The tokenization landscape encompasses diverse asset classes. In the realm of securities, both equity and debt instruments contribute to a market cap surpassing ~$100 million. Real estate, too, sees significant tokenization, with a market cap reaching ~$200 million. The trend extends to funds, where tokenization is gaining traction among asset managers, with notable players such as KKR and Hamilton Lane entering the space. Commodities, including gold and grain, are also subject to tokenization, while forms of tokenized money include bank deposits and stablecoins.
Below are several real-world examples highlight the increasing trend of asset tokenization in 2023:
Programmable on-chain money tailored for a tokenized economy mirrors the functionalities of fiat currency, facilitating domestic and global payments, as well as activities like borrowing, lending, and investment. It functions as a seamless bridge between on-chain and off-chain economies. This section specifically explores Deposit Tokens and Stablecoins, among various types of on-chain money like CBDCs.
Figure 5: Utility of various on-chain money (Source: Blockdaemon)
Deposit Tokens involve the tokenization of a bank's deposit, backed by claims against the issuer and subject to existing banking regulations. The risks associated with Deposit Tokens are influenced by the bank's balance sheet and the broader domestic/global banking system. The on-off-ramp is controlled by the issuing bank, resulting in endogenous risks within a closed system.
Real-world examples include the MAS <> JPM Project Guardian, a collaboration between the Monetary Authority of Singapore (MAS) and JP Morgan, focusing on institutional DeFi through the tokenization of deposits and bonds starting from November 2022. Additionally, the Swiss Bankers Association has proposed a Swiss franc "joint" deposit token, potentially built on a layer-2 solution for institutional DeFi with self or bank custody.
Stablecoins are issued against a basket of collaterals, including cash and liquid assets, by centralized or decentralized entities. This involves portfolio management from the issuer, encompassing earning, liquidity, and system design risk. The stability of the stablecoin is informed by the types of collateral and the associated ratio. The on-off-ramp for stablecoins is controlled by the issuer, introducing exogenous risks within an open system.
Real-world examples include Tether and USDC, with a combined market cap of $109 billion and a 24-hour trading volume of $33.6 billion as of 10/18/23. USDC is utilized for trading various digital assets on Decentralized Exchanges and serves as an early form of payment settlement. Notably, Visa is experimenting with USDC payments and payouts on Ethereum and Solana.
KKR, a global investment firm, set out in September 2022 to unlock broader access to private market investing. Their multifaceted goal aims to unlock broader access to private market investing, improve digital investor onboarding, compliance protocols, and increase potential for liquidity through a regulated alternative trading system. KKR partnered with Securitize, a tokenization platform seasoned in KYC/KYB and user on-off ramping. Here is a high-level tokenization stack, encompassing an asset issuer, a tokenization platform, a wallet for custody, and an execution platform/blockchain.
Figure 6: KKR Tokenized Fund Stack (Source: Blockdaemon)
Essential factors worth highlighting include the division of responsibilities and prospective advantages:
Figure 7: Transaction Processing under Blockchain vs DAG Architecture (Source: Central Blockchain Council of America)
The dominance of tokenized funds in primary markets signals a thriving space ripe for diversification and expansion. This case study offers a compelling glimpse into how traditional financial institutions can and probably will evolve in the emerging landscape of asset tokenization. As such, it is worth keeping an eye on similar initiatives that aim to shape the future of investment in this digital age.
To further enhance an institution’s leadership role in a highly efficient, interconnected and automated global financial system, an institution will benefit from a more seamless transaction flow and wider reach, and tokenization presents itself as the first building block towards such a vision. Here is our proposed tokenization stack with Blockdaemon’s Institutional Wallet to facilitate a customizable end-to-end on-chain journey for buying, selling, and storing tokenized assets, enabling institutions to retain a central role in this burgeoning ecosystem.
Figure 8: Conceptual Blockdaemon (BD) Wallet Powered Tokenization Stack (Source: Blockdaemon)
Blockdaemon specializes in providing MPC wallet infrastructure, catering to both self-custody and custody scenarios, along with offering expertise in blockchain infrastructure.
The Tokenization Issuing Entity, typically a bank, collaborates with a chosen Tokenization Platform for a closed-loop Primary Market Offering. They facilitate user on-boarding and on-chain transactions with various options, including using traditional currency (USD) or deposit tokens/stablecoin, depending on the Tokenization Platform selected.The utilization of on-chain money, such as deposit tokens and stablecoins, serves to streamline operational processes, reducing complexity and laying the groundwork for payment systems and potential secondary market offerings.
The choice of blockchain for transaction processing and finality involves careful consideration of factors such as throughput, scalability, security, costs, and interoperability, especially in the context of intra-bank interoperability.
It is also worth noting that secondary markets currently operate on the tokenization platform's Orderbook, incurring higher costs, complexity and liquidity friction due to lack of interoperability between systems. Depending on technology maturity and liquidity factors in volume and depth, future adoption of Automated Market Maker (DEX) and Smart Contract Automation Platforms could further enhance capital flow and operational efficiency.
Tokenization is not a fleeting trend—it's a technological revolution that financial institutions can't afford to ignore. Whether it's enhancing liquidity or automating processes, tokenization offers a gamut of benefits with minimal downsides if navigated carefully.
If your business is considering exploring tokenization, book a call with Blockdaemon today. Our team of industry experts are on-hand to help you navigate the intricacies of the blockchain landscape.