Faster, cheaper, safer: how tokenisation can change investing
Digital tokens authenticated on blockchain ledgers offer the potential to make buying and selling assets much easier
To some investors, the term “tokenisation” may conjure up images of colourful monkeys. But the same technology that created Bored Ape Yacht Club Non-Fungible Tokens — unique digital cartoon artworks, authenticated on a blockchain ledger — also promises to shake the tree of global finance.
What crypto mania and the digital art craze have both highlighted is that blockchains and other distributed ledger technologies can tokenise almost any asset — real or imaginary.
The finance industry may stand to be one of the biggest beneficiaries of this stage of the digital revolution. So far, adoption has been slow. However, clear benefits are beginning to overcome the establishment’s inertia. For example, the largest ever digital bond issuance, worth about $750mn, was carried out by the Hong Kong government in February. Notably, the bonds were issued directly on to HSBC’s private blockchain, Orion, providing the benefits of digital tokenisation — such as cheaper, quicker trading — from the outset.
Of these benefits, the largest, and most immediately obvious, is short settlement time. For the recent Hong Kong bond issue, this fell to just one day (referred to as T+1), compared with the traditional five days for a conventional Hong Kong bond issuance.
“What we can see with digital bonds is shorter and more efficient settlements that will free up capital and can eventually alter the underlying structure of markets,” says John O’Neill, HSBC’s Global Head of Digital Assets Strategy.
O’Neill thinks tokenised bonds have moved from trial phase to implementation and are on a par with conventional bond markets, in terms of liquidity and demand.
Shorter settlement time, and the lower costs associated with that, are not the only benefit of a tokenised issue, though. For the Hong Kong bond, coupon payments and secondary-market trading settlement will take place on the more efficient private blockchain.
Traditional securities, such as bonds and equities, are just the tip of the iceberg when it comes to the potential use of digital token technology by big finance.
“Digital art and NFTs showed us how tokenisation can be used for fractionalisation, which can in principle be applied to any fungible or non-fungible asset, from gold to real estate” says Michael Silberberg, head of investor relations at hedge fund AltTab Capital. Fractionalisation enables a single asset to be divided up into a large number of smaller parts, with ownership of each part certified by a digital token.
However, breaking assets down into smaller chunks is just the first step to unlocking tokenisation’s potential. A token that contains details of ownership corresponding with a blockchain — and backed with the proper legal protection — then becomes a bearer instrument for whoever owns the private key that controls that token.
“Tokenisation extends the entire universe of collateralisable assets,” says Ralf Kubli of the Casper Association, a decentralised blockchain project. It means that lenders become able to accept all kinds of tangible and intangible assets in return for financing — and they can do so with greater certainty that the collateral exists and that their claim on it is legitimate.
Everything from manufacturing machinery to pharmaceutical recipes or software could be collateralised efficiently, and without the costs of escrow or other security guarantees. To fully unlock the technology, though, Kubli thinks the smart contracts need to become much more sophisticated.
Information on the liability side of the equation needs to be embedded with tokens; namely getting the cash flows that the collateral generates into a machine-readable and executable format. Blockchain technology then comes into its own with the ability to observe and verify this information which creditors can act upon, if needed.
In essence, that would produce close to real-time balance sheet information. When combined with the ability to fractionalise assets, it could have huge implications for financial services. Securitisations would move beyond today’s black box instruments, that are priced on snapshots of data from six months ago, into instruments that are easier and faster to monitor, trade and price.
That extends the list of potential benefits well beyond more efficient and cheaper settlement times. Standardisation could mean that legal and other advisory fees all fall, because all that information is contained within the token itself. Secondary trading liquidity should also then increase, and market data would be made more readily available, and timely.
But that end goal may be further away than many hope. “Technology does not change human behaviour overnight, and tokenisation cannot guarantee liquidity or create markets out of thin air,” says Tim Bevan, founder and CEO of ETF provider ETC Group.
The full potential of tokenisation to reinvent financial services may therefore be the factor that stops the establishment from embracing it fully.