Unleashing the Power of Digital Assets with Tokenization
Tokenization is the process of representing real-world assets, illiquid assets, or data as unique digital tokens on distributed ledger technology and is gaining serious momentum in the financial world.
Those that realize the power of digital assets now will see benefits from access to new markets, further product innovation, collateral mobility, cost efficiencies and better liquidity management.
Consequently, this ground-breaking technology is sparking innovation and driving significant changes in how financial products are created, traded, and managed. From central bank digital currencies (CBDCs) to tokenized deposits and regulated digital assets, tokenization will drastically change the future financial landscape.
What are the barriers to tokenization?
Despite the many advantages of tokenization, distribution complexity and industry standards remain core challenges. Integrating tokenized assets into existing financial systems requires collaboration among various stakeholders, including regulators, institutions, and technology providers.
As with any new technology, there is always a battle between the regulatory context and the tech itself; regulators are always trying their best to keep up with the speed of technological innovation. Specifically, the banking industry faces regulatory hurdles when dealing with tokenized deposits and public chains. Basel rules place exposure limits on crypto assets, necessitating careful adherence to compliance guidelines. Ongoing fragmented private blockchain infrastructure also creates interoperability challenges across financial institutions.
There must be close collaboration between government and industry to develop a regulatory regime that can encourage innovation, the interoperability of solutions and the development of international standards that will regulate industry activity globally. Governments and industry leaders must act in partnership to ensure all relevant regional tokenization markets are a success.
Reaping the full the benefits of tokenization will require leading jurisdictions to be focus primarily on putting the necessary legal and regulatory frameworks in place to give industry participants the confidence to interact with tokenized securities.
Implementing The Correct Protocols
The financial world is rocketing towards one filled with digital assets. $5 trillion in assets could be tokenized on blockchains in the next five years. The potential is huge – if the correct tokenization solutions and frameworks are in place such as control location services, custody, and control frameworks, and most crucially, interoperability. This will all come down to the evolution of industry standards.
Ensuring known ownership and beneficial ownership is essential for building trust and mitigating risks in tokenized assets, and ensuring custody and control frameworks are crucial for the efficient and secure management of tokenized assets. Building standardized frameworks and market structures helps ensure the integrity of transactions and ownership.
One potential key market structure is the interoperability of previously siloed ledgers, which would enable wholesale institutions to use these technologies to tokenize previously illiquid assets. Considering this, blockchain or DLT interoperability has come to the forefront in recent years. As different distributed ledger technologies and regulated networks are used to solve various tokenization use cases, interoperability becomes vital in bringing all the pieces together. Interoperable systems facilitate seamless asset transfer and exchange across open distributed ledger technologies and platforms.
Although there is an understanding of what technical protocols must be in place to unlock the full potential of digital assets, ongoing vagueness surrounding industry standards will continue to remain a barrier. Whilst there is still a certain lack of principles to guide market participants interested in reaping the benefits of tokenization, private industry players can play a critical role in shaping these standards from the inside, by openly collaborating. For example, R3 and Adhara have launched the Hyperledger Lab, Harmonia. Harmonia will enable open conversation towards building industry standards around enterprise blockchain interoperability – and shape the future of financial instrument innovations, like tokenization.
The rise of tokenization was never intended to be dominated by a small number of market players, and now, thankfully, the industry is realizing that permissioned and permissionless protocols can and should work together. By tapping into diverse market and technological expertise, the industry can draw closer to empowering market participants to control their assets across different networks securely, seamlessly, and in a streamlined way.
Regulatory sandboxes, such as the EU’s DLT Pilot Regime, or the UK’s FMI Sandbox can act as exploratory frameworks that provide regulatory certainty and encourage experimentation. This will enable market participants to implement new technologies that support the tokenization of financial and digital assets, in turn helping shape future enduring and trusted industry standards.
By promoting the correct protocols and exploratory frameworks, as well as working on the development of secure interoperability, new digital markets can flourish, and market participants can innovate at scale.
Why do financial institutions need tokenization?
$5 trillion in assets could be tokenized on blockchains in the next five years, according to a June 2023 report from Bernstein.
If those thinking about unleashing the full potential of digital assets use the correct underlying distributed technologies and implement key tokenization frameworks, they will witness incredible benefits. These include being able to settle in real time, utilize global markets 24/7, implement programmable and immutable transactions, lower transaction and asset servicing costs, access new sources of liquidity and new asset classes, as well as better manage counterpart and credit risk.
As tokenization can enable fractional ownership, investors will be able to access assets previously considered out of reach. It democratizes investment opportunities and expands the market to a broader range of participants and broadens access to entirely new markets. With this, the industry can witness further product innovation. The tokenization of digital assets also streamlines the asset’s life cycle, reducing administrative costs and operational inefficiencies.
In recent months, key global bodies have increased the discussion surrounding the importance of collateral management. For example, the Eurosystem’s Advisory Group on Market Infrastructures for Securities and Collateral (AMI-SeCo) is working towards developing a Single Collateral Management Rulebook for Europe (SCoRE), which defines common rules for managing collateral, part of a mandate to foster European financial market integration and promote a truly domestic single market in Europe. By tokenizing assets, their mobility as collateral is enhanced. This has implications for borrowing, lending, and risk management in the financial ecosystem.
A digital future for finance
Tokenization is reshaping the financial industry and unlocking new possibilities, helping to progress the development of central bank digital currencies (CBDCs) and other regulated digital currencies. It is transforming how assets are created, traded, and managed, in addition to democratizing access to financial markets, improve cost efficiency, and enhance collateral mobility.
However, addressing challenges such as distribution complexity and regulatory compliance is crucial for widespread adoption.
Open collaboration among various stakeholders across both public and private industries, including financial institutions, regulators, and technology providers, will be key to unlocking the full potential of digital assets and tokenization. By working together and adopting comprehensive frameworks, the finance industry can harness the benefits of tokenization and create a more inclusive and efficient financial ecosystem. Tokenization is not just a trend; it is a transformative force that will continue to shape the future of finance and drive innovation across industries.