Tokenized deposits: unlocking the future of banking

How banks can leverage tokenized deposits to stay ahead in a rapidly evolving financial landscape.

With demand for tokenized RWAs expected to grow to over $30tn by 2034, it is imperative that commercial banks and other regulated financial institutions prepare their existing operational systems to offer the digital services their clients will come to expect. While the industry has recognized that distributed ledger technology (DLT) is an excellent tool for improving and automating collateral management, payment, trade settlement, and cross-party reconciliation processes –and ultimately for overcoming the silos entrenched in financial markets’ legacy systems – improvements in regulatory clarity and the growing maturity of both permissioned and public blockchain ecosystems means that  banks are increasingly incorporating digital assets into their client offerings.

With the banking sector rapidly evolving, many commercial banks are facing a challenge: attracting and retaining customers in a market that has become increasingly dominated by digital-first challenger banks. Neo-banks like Revolut and Starling which launched as cloud-based digital platforms have lower fixed costs compared to incumbent banks, along with greater operational flexibility and perceived accessibility for consumers. 

However, challenges exist for incumbent financial institutions. Complex infrastructure demands, regulatory constraints, and the risk of creating siloed assets, means that incumbent firms need to proceed carefully in this process. The introduction of novel digital product offerings for regulated financial markets necessarily require advanced privacy, security, and control, as well as scalability and distributive flexibility. 

Tokenized deposits: banking’s next innovation

Deposits are an essential part of any banking model. Commercial banks rely on customer deposits as the basis on which to create credit and extend loans, generate revenue, and produce returns for their depositors. The Current Account Switching Scheme in the UK has made it easier and less expensive for customers to move their deposits between banks, making it all the more crucial for banks to stay ahead of competition through efficient resource usage and innovative product offerings for both retail and wholesale clients.

Tokenized deposits are the next evolution of digital money in financial markets, enabling banks and other institutions to optimize liquidity and treasury management, enhancing their capital efficiency to unlock significant value. Tokenized deposits are digital representations of bank deposits recorded on a DLT or Blockchain, issued and maintained by depository institutions. Tokenized deposits support banks in providing their clients with:

• Faster and more efficient transactions – Tokenized deposits enable real-time, programmable settlement, reducing delays and enhancing liquidity management.
• Reduced counterparty risk – By minimizing reliance on traditional payment rails, tokenized deposits mitigate counterparty and settlement risks.
• Enhanced security and transparency – Built on secure, permissioned DLT infrastructure, tokenized deposits provide improved auditability and regulatory compliance while ensuring privacy and control.
• Greater security and trust – Improved transparency helps protect customers from fraud and financial crime, ensuring safer and more reliable transactions.

Tokenized deposits also have the potential to significantly advance the repo market, enabling banks to bypass traditional payment rails, delay final settlement, and facilitate atomic transactions on their preferred schedule. In the traditional repo market, every transaction must be settled before the next one can take place, meaning that liquidity is locked up until payment processing is completed. Delaying final settlement with tokenized deposits allows banks to optimize liquidity and execute repo transactions more flexibly throughout the day. This flexibility and optimization supports both internal and client trading activity, with reconciliation over traditional rails consolidated into a single transaction at the end of the day, reducing counterparty and settlement risk, as well as generating potential cost savings.

Furthermore, active management of intraday liquidity is poised to unlock up to $150mn in annual cost savings for every $100bn in deposits.

Integrating digital assets in regulated markets

Financial institutions often face several significant pain points in adopting DLT:

• Infrastructure demands: The integration of digital assets requires a robust infrastructure that can securely manage high transaction volumes and complex operations.
• Complex user experience needs: Balancing user-friendliness with regulatory requirements and security can be challenging, especially in a fast-evolving digital ecosystem.
• Interoperability with existing systems: Integrating with legacy financial systems can lead to complications in operations and data flows.
• Security and compliance: Digital solutions need to ensure end-to-end security and meet stringent regulatory requirements across jurisdictions.

While these challenges might seem daunting, there are ways to address them effectively to seamlessly integrate DLT into existing operations.

Both wholesale and retail clients expect intuitive interfaces that make transactions easy, transparent, and secure. However, combining simplicity with compliance and security measures can be difficult. Building a solution that feels seamless to users while safeguarding data and complying with regulatory standards is essential. 

Integrating new digital capabilities with existing systems and workflows is a top concern for institutions, especially as digital currencies need to interact with legacy banking systems. Without seamless interoperability, institutions may face slow transaction times, fragmented data, and limited scalability. Prioritizing interoperability when prototyping digital solutions can minimize integration issues later on. Solutions that facilitate cross-network compatibility and support the movement of assets across various ledger systems offer significant advantages. APIs, standardized protocols, and partnership with DLT experts can be valuable here, ensuring digital assets don’t get siloed within specific networks.

Retail use cases for digital currencies are multiplying – from stablecoins to retail central bank digital currencies (rCBDCs) – and financial institutions are being challenged to innovate at a rapid pace. Increasingly, this means turning to the DeFi ecosystem; Blackrock, Franklin Templeton, and UBS have all successfully leveraged public blockchain infrastructure to issue tokenized money market funds, while the SEC recently approved the first yield-bearing stablecoin. While these products primarily target crypto and institutional investors currently, greater regulatory clarity and the start of the maturation of the public blockchain ecosystem signals that a convergence is coming. Financial institutions may soon be issuing tokenized deposits with a guaranteed APY, just like a high yield savings account, with some returns generated through DeFi solutions like Ethereum staking. Meanwhile, retail adoption is also progressing through new payment innovations. For example, WisdomTree has introduced a Pay as You Earn Visa debit card, which integrates tokenized money market funds into everyday transactions, allowing users to earn yield on their funds while maintaining spending flexibility. This model represents a bridge between traditional banking, digital assets, and programmable money, setting the stage for broader consumer adoption of digital currencies.

Digital assets at a tipping point

The advent of retail CBDCs (rCBDCs) and stablecoins have added to the growing pressure on commercial banks initiated by challenger banks. Digital currencies issued by central banks and reserve-backed, well-regulated stablecoins can be perceived as having lower risk profiles than commercial bank deposits which aren’t fully backed by reserves and are only protected up to deposit guarantee limits which vary by jurisdiction. Deposit outflows to these assets, particularly during periods of market instability, could exacerbate or even cause bank runs. While regulators in some regions may seek to address this risk by prohibiting issuers from providing yields to holders, introducing holding limits for rCBDCS, or by requiring a certain portion of reserves backing stablecoins to be held within the jurisdiction’s banking system, there are limits to these approaches.

Notably, tokenized deposits offer the same benefits as stablecoins and rCBDCs – transparency, programmability, and instant value transfer to enable more efficient collateral management, payment, and settlement – without posing the same potential risks to financial market stability in times of crisis. As such, banks can be seen as having both a commercial incentive and existential imperative to explore tokenised deposits.

With the most live, in-production DLT use cases already implemented by leading financial institutions globally, R3 is now launching the Tokenized Deposits Early Access Lab. This initiative offers banks and other financial institutions the opportunity to trial our Tokenized Deposit Solution via the R3 Digital Lab for FREE! Our lab framework simplifies digital use cases, making it the fastest and most cost-effective path to production on the market. 

As the financial landscape continues to evolve, banks that embrace tokenized deposits today will be best positioned to lead the future of digital finance—delivering enhanced efficiency, security, and innovation to meet the demands of a rapidly changing market.