Digital Assets: The Role of the Banks

Tokenization allows any ownership rights for an asset can be recorded in a ledger as a digital token and traded. From bonds, stocks and funds, to private markets, real estate and intellectual property, banks have now the opportunity to create new business lines or make the existing ones more transparent, efficient and profitable.

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Tokenization is a word that has attracted strong attention in the financial industry. With blockchain technology, any ownership rights for an asset can be recorded in a ledger as a digital token and traded. This promises increased liquidity and traceability for financial assets (equities, bonds and syndicated loans), tangible assets (real estate, fine art and commodities) and even intellectual property (music). Therefore, banks and other financial actors are currently looking at the technology to create new business lines to exploit these new opportunities.

A token economy will reduce current friction involved in the creation and trading of securities, which will lead to a more efficient financial sector. According to a study conducted by Capgemini, certain assets such as syndicated loans that nowadays take 20 business days to issue and settle, with blockchain technology, settlement can happen in only 6-10 days. The reduction in time comes from the removal of many manual processes during book building and real-time access to a common immutable ledger. Furthermore, for subsequent trading blockchain ensures that up-to-date price quotes and the bid-ask spread are available and accessible to all counterparties, without relying on a centralized third party.

With blockchain technology, syndicated loans that currently settle in 20 days, could be settled in 6-10 days.

Bonds would also benefit from tokenization. Currently, to issue bonds a bank needs to create certificates and split the bond in legal and beneficial titles. When the bond is sold, the institution who bought it holds one title, while the clearing system/registrar holds the other. All these certificates, relationships and positions need to be agreed, documented and reconciled creating legal and operational costs. In addition, bonds are often still traded over-the-counter and investors need to be individually informed. With blockchain and smart contracts, investors could be notified automatically.

Bonds issued on blocckhain create large savings in legal and operational costs

Within equity markets it is good to differentiate between stock public markets and private equity and venture capital markets. Stock markets are more centralized with trades and price discovery happening in an exchange, making them more efficient than private markets. However, public equity markets exchanges are still bound by trading hours, T+2 settlement times and many still do not allow fractional interests, all of which can be improved with blockchain. While the objective long-term may be to issue securities on chain, not all entities are currently ready to jump on this wagon. Therefore, other innovations include tokenizing existing securities and EFTs.

Some important efforts in the public markets have been put forward by financial market infrastructures and private players. The Australia Stock Exchange (ASX) has been working on replacing its current clearing system with another that will include a permissioned, private DLT system as an optional way to trade. The private company Securitize has built an end-to-end digital platform for issuing tokenized securities on the blockchain and managing their entire life cycle (dividends, distributions and buy-backs).

Australia Stock Exchange (ASX) and companies such as Securitize and ArCoin are replacing the technology behind stocks

Another project worth mentioning is ArCoin, the first Ethereum blockchain-native investment fund registered under the Investment Company Act of 1940. The fund invests a majority of its assets in short-term U.S Treasury bills and notes and will be available to investors. Another company, Sologenic, is waiting to obtain its MiFID license to allow trading between crypto and non-blockchain assets such as stocks, ETFs, and commodities from some of the top global stock exchanges.

Blockchain-native investments funds made of bonds are already reality and trading between crypto and traditional assets could be possible soon

Regarding private markets, given their opacity, blockchain carries a much bigger promise of liquidity and tradability gains. Moreover, the solution becomes more relevant lately given that in the past few years most businesses have preferred not to take the IPO route and staying with private capital. Blockchain can provide real-time updates for its investors, and enhanced investment analytics which preserves data integrity and reduces costs. European Private Equity Partner Group has been one of the early adopters.

The real estate market is highly illiquid due to the many siloed and independent networks that participate in it. In addition, real estate often involves large transactions, which leaves people with lower capital out of the market. If real estate assets are tokenized the participants could be better linked and the assets can be divided into more granular pieces, making it accessible to a wider pool of investors. Several companies have tried to tokenize this market in the past with limited success, but advances are coming. On September 2020, a fintech startup called Reinno just launched an investment platform covering $237 million worth of property of United States commercial real estate.

The fine art sector, on top of being highly illiquid and segmented, it is opaque. Investors do not easily know what is available, the true provenance and the value a piece. In addition, the best pieces are sold for extremely high prices limiting access to quality investments to high net worth individuals or funds. To democratize this sector, companies are using blockchain technology to increase transparency on an artwork’s history and to trade artwork without auction houses and galleries as intermediaries. For example, the online platform Maecenas tokenized a multi-billion dollar Andy Warhol painting and sold it using blockchain.

Iliquid markets such as private equity, real estate and fine art will benefit from the real-time updates, data integrity and transparency of blockchains.

The commodities sector also would benefit from being represented digitally, tracked and traded using blockchain technology. Companies such as Digix, Oilcoin, and Wepower are tokenizing gold, oil, and green energy sources allowing an easier division of assets, increasing transparency and removing the need for intermediaries.

Finally, tokenization has also attracted attention around intellectual property. An artist could issue tokens that represent shares of copyright of certain future work in order to get funding to start a project. If the work is successful, investors get a share of the profits. However, the difficulty here is that copyright laws differ around the world.

In conclusion, the trend appears that eventually all assets will be tokenized to increase transparency and accessibility for investments. This opens avenues for banks to facilitate issuance and trading of traditional assets, but also creates the possibility to explore less traditional ones. Furthermore, the modernization of the definition of accredited investors in the US based on financial sophistication will increase individuals’ demands for these alternative assets.