In this new series, we explore the mechanics of tokenization and the steps that financial institutions should take to capitalize on the benefits. In this first article, we assess whether tokenization has progressed beyond the exploratory startup phase (Day 0) and moved into its deployment phase (Day 1), and explore key use cases across alternative assets, money market funds, and bonds & equity markets to highlight how tokenization is delivering value today.
Tokenization uses blockchain technology to create digital representations of traditional financial instruments and real-world assets. By operating against a distributed ledger with embedded smart contracts, these products allow transparent, nearly instantaneous, and highly automated execution of complex transactions across organizations. This offers many benefits over legacy approaches for both investors and issuers promising to create more secure, faster, and accessible markets.
Tokenization has been steadily progressing towards widespread adoption in financial markets. After many proof-of-concepts and incremental innovations, major financial institutions are bringing real platforms and products to market, suggesting that tokenization may be close to achieving a significant milestone in terms of maturity.
Benefits of Tokenization
Unlike crypto, where most advocates focus on benefits such privacy and resistance to censorship, tokenization offers a better set of rails that enhances the existing financial system through operational efficiency and other benefits:
Alternative assets continue to be a primary target for tokenization. With the ability to fractionalize assets like artwork and real estate, tokenization promises to lower barriers to entry and significantly increase liquidity for asset classes that have historically been highly illiquid. For example, a leading permissionless blockchain group recently announced a deal to tokenize over $500 million worth of real estate in Dubai.1 Even for certain assets that have been liquid, such as gold, tokenization can improve efficiency by providing transparent proof of ownership and real time settlement while abstracting away the complexity of physically holding the asset. Tokenized gold has reached a market cap of over $1 billion according to a leading tokenization data company.2
Established financial players appear most focused on products such as money market funds that can maximize the benefits of tokenization while avoiding areas that might be more challenging from a regulatory perspective. A leading global wealth manager recently announced the creation of a money market fund strengthening the trend of large financial institutions offering similar products. Tokenized money market funds make it possible to operationalize the asset as collateral for derivative trading and repo markets.3 Additionally, they allow investors to receive the yield of the underlying assets, a feature stablecoins lack. The leading global tokenization data company estimated the value of tokenized treasuries to be almost $2.4 billion prior to the global wealth manager announcement.
Given the option for 24/7 trading, it only makes sense that the bond and equity markets would be seen as a natural next step in terms of tokenization. However, most institutions are moving cautiously and focusing on security products for institutional investors. Additionally, integrating DLT into existing equity markets would involve massive integration efforts and displacement of deeply entrenched systems.
Roadblocks for Adoption
Regulatory compliance – the biggest challenge for tokenized assets is a fragmented, and in some cases antiquated, regulatory structure. From a global perspective, regulation of digital assets has been caught in a patchwork of regional regulation such as the E.U.’s Markets in Crypto Assets (MiCA) regulation, the EU DLT pilot regime (see our insights on this topic in the ‘Related Content’ section at the end of this article), the US Securities Act and Regulation D. Ambiguity around certain aspects of tokenization including staking can add elevated risk for firms looking to introduce novel products.
Legacy infrastructure – especially impacts large, incumbent industry players. Firms continue to depend on legacy systems that lack the capability for real-time processing. The integration of new technologies with these outdated systems presents significant complexity and cost challenges.
Defining Maturity of Tokenization
Below, we evaluate the maturity of tokenization based on its adoption across different products as well as integration with core systems and processes. If tokenization truly delivers on its promises of operational cost efficiency and automation, we expect it to be a core part of banks’ product offering, technology stack, and operating model.
| Maturity Indicator | Achieved Maturity? |
|---|---|
|
Custody Options |
Not yet – Financial institutions and fintechs have partnered with custody and wallet vendors such as Anchorage, Fireblocks, and Coinbase to support in-house offerings but few offer options for digital asset custody directly to their customers. |
| Risk & Regulatory Harmony
Token protocols align with compliance rules. Regulations have addressed new challenges and issues raised by digital assets. |
Not yet – While regulations like MiCA and friendly regulations in some jurisdictions exist, the uncertainty around staking and other SEC action shows there are still gaps and significant questions around the US and global approaches. |
| On-Chain Insights
Analysis of blockchain data allows enforcement action for financial crime measures. |
Yes – Vendors like Chainalysis are routinely able to identify wallets and track funds. FBI and other government agencies use existing laws to seize illicit funds. |
| Core Systems Integration
Blockchain operations are deeply integrated with other core systems in institutions to enable frictionless transaction. |
Not yet – Financial institutions have yet to deeply integrate their blockchain products with their core systems. While some are creating roadmaps and strategies, production seems far from reality. |
| Interoperability
Assets are interoperable across blockchains and platforms. Assets issued by an institution can be managed on third party platforms. |
Not yet - While progress is being made in terms of bridging common token standards, most product launches are limited to ‘walled garden’ platforms. |
What’s Next?
The frequency of major product announcements from major financial players clearly demonstrates that tokenization is making major progress. Yet as explored in this article, we have not seen Day 1 for tokenization in the financial services industry. As tokenized products gain foothold in the wider financial system, we expect the surrounding ecosystem to continue to mature.
While we cannot say for certain when the breakout will occur, the availability of tokenized products is consistently accelerating. Financial services firms should have a clear strategy that aligns business opportunities with the technical capabilities of tokenization to capitalize on these trends. Firms should continue to work with the regulatory community to ensure safe, transparent and accessible products, and modernize their legacy infrastructure to reap benefits and accelerate maturity.
If you would like to discuss where your firm is currently positioned in the tokenization journey, please contact us via the form below.
This article was originally published by Traders Magazine.
References
1 CoinDesk
2 RWA.xyz
3 The Investment Association
