How Tokenization Upgrades the Utility of $650T in Traditional Assets

#How Tokenization Upgrades the Utility of $650T in Traditional Assets

Traditional financial markets are in desperate need of an upgrade.

Over $650 trillion of traditional assets are recorded manually using black ink, white paper, and spreadsheets.

Moreover, the outdated record-keeping process that supports our global financial system only happens in eight-hour windows, five days a week.

And that downtime doesn’t help speed up settlement periods. Investors can wait days for settlement confirmation, and regulators consistently grapple with squaring the circle of transaction speed and market fairness.

Traditional finance’s plumbing isn’t exactly broken, but it is shockingly antiquated. As calls for greater speed, transparency, and integration of new technologies into the global financial system grow louder, traditional financial infrastructure increasingly shows its age.

Almost a quarter-century later, it’s finally time to move traditional assets into the future. Issuers, regulators, and investors of all types are already celebrating the many advantages of blockchain tokenization for financial markets and beyond.

#Advantages of Blockchain Tokenization

Asset tokenization involves mirroring existing ledgers, or creating new ledgers based on established industry principles, using a technology like blockchain.

While the process of mirroring or creating this onchain data differs across industries, the resulting benefits are largely uniform.

Programmability / Automation

Automation isn’t new, but smart contracts, an essential feature for asset tokenization projects, are. They make today’s financial automation feel like a dial-up internet connection.

Most traditional automated systems require a human to ensure that things proceed without issue. Whether clicking “confirm” to start the next automated process or sipping coffee while monitoring for potential errors, someone has to ensure that things stay automated for the end user.

Smart contracts are different. They only require a human for deployment, allowing for truly automated, interoperable financial processes. In fact, most smart contracts are designed to disallow human intervention outside of specific events or situations.

Bond sales, asset transfers, and dividend payments are already being tokenized using smart contracts, facilitating serious cost and time savings.

Example: The Swiss city of St. Gallen issued a $113 million bond to be settled in the Swiss wholesale CBDC or tokenized euros. With a three-year maturation period, the bond’s information is tokenized by a third-party agent, SDX, and stored onchain.

Speed / Settlement

Fast settlements are crucial for financial efficiency. However, they also introduce fraud risk. Whether gold bars or Bitcoin, no bad actor wants to make a slow getaway.

The speed of today’s legacy financial system is measured in days, not minutes or hours. The standard “T+x” calculation takes the transaction day (T) and adds (+) the number of days allotted by financial regulations (x) to settle the purchase. If that sounds slow, you’re correct.

Conversely, blockchain systems settle near instantaneously and with near finality. By using incentivized mechanisms, such as Proof of Stake on Ethereum, blockchain networks leverage the rational economic incentives of their participants to ensure the network’s security and speed. These features make them the clear choice when considering speed, security, and settlement requirements.

It’s no wonder major financial institutions like JP Morgan, which started its blockchain initiative Onyx in 2015, are actively exploring how distributed ledger technologies (DLTs) can impact interbank settlements and transform the exchange of real-world assets.

Example: Rabobank is testing blockchain-based smart contracts to execute over €2 billion worth of commercial paper transactions. The industry-standard T+2 settlement time is unviable for short-term commercial paper, making DLT solutions a promising alternative to traditional systems.

Composability

If blockchain networks and smart contracts are going to be the backbone of the global financial system, there can’t be gaps. Composability, the concept of snapping together blockchain applications like Legos, is a cornerstone of blockchain architecture.

Leading blockchain applications, such as automated market makers (AMMs) like Uniswap, design their blockchain-native applications to be as composable as possible. This approach maximizes applications’ usability and encourages rapid innovation.

Major financial institutions are resistant in building composable products because it would introduce competition for their capital removing a competitive advantage. Composability means encouraging cross-use and removing the walled garden, an ethos foreign to most Wall Street majors. But times are quickly changing.

Blockchain offers programmable automation and a speed of settlement, among other benefits, that transforms composability into a benefit for financial institutions deploying and building in blockchain environments. Thus far, blockchains have established innovative controls where needed while removing redundant blockers to financial innovation resulting from the cross-use of products and services.

Example: Supported by 45 major global financial institutions, including BNY Melon and Goldman Sachs, the Canton Network has launched an extensive pilot of enterprise-grade, cross-institution DLT settlements, including tokenized securities, money market funds, and cash.

Image attributed to xkcd.com.

Transparency / Compliance

The transparent nature of public blockchains makes them powerful tools for real-time reporting and compliance. Anyone can view any transactions on a public blockchain at any time.

However, this accessibility doesn’t mean your bank records are on display for the world to see. Thanks to blockchain’s time stamping and record-keeping, encryption can keep your onchain financial records safe from prying eyes while the data remains easily retrievable and provably unmanipulated.

This data immutability means that falsifying records now takes more than just a convincing digital forgery. Just in time, too—the proliferation of digital technologies and lack of fraud-proofing is costing global markets (and their insurers) dearly. Equity fraud alone amounts to 1.6% annually, the equivalent of $830 billion in 2021.

Example: OpenEden tokenizes U.S. Treasuries, putting them onchain as T-Bill tokens. This product, aimed at crypto users and funds rather than institutional investors, is part of the growing cohort of real-world assets crypto projects. It is developing a continuously updating, onchain “proof-of-reserves feed” from Chainlink, a third party oracle that provides real-time price data to enhance transparency.

Accessibility

The 40-hour business week of traditional markets starkly contrasts the 24/7 nature of public blockchains. This new technology doesn’t sleep, nor does it recognize international borders. You can access it from anywhere in the world at any time.

This accessibility has significant implications for market access—for the first time in history, humanity has a genuinely global digital market. The demand for easy access to markets and financial services is everywhere.

In Kenya, most banked citizens use 24/7 e-money accounts rather than traditional banks. And this isn’t a trend exclusive to recent modernizers. In the United States, customer loyalty rates for fintech banking are 83%—contrast this with an abysmal 23% for traditional banks.

By tokenizing real-world assets, financial firms are experimenting with the implications of a 24/7-a-day, 365-day-a-year global payment network and how to offer global clientele the appropriate financial instruments based on their unique needs.

Example: As the global reserve currency and the most liquid medium of exchange on the market, the U.S. Dollar remains a highly sought-after currency in many international regions. Dollar-pegged stablecoins such as Circle’s USDC enable smaller businesses in such countries to access stable currencies.

#What Assets Can Be Tokenized?

At the time of writing, blockchain-native assets like Bitcoin and Ethereum have a current market value of around $2 trillion. This figure is impressive for an asset class that didn’t exist two decades ago and whose demise is regularly celebrated by detractors and naysayers.

However, this is a drop in the bucket compared to the $650 trillion value of real-world assets found across global real estate, equities, debt, and commodities. While this figure doesn’t count public infrastructure, insurance markets, or financial services and payments, which would push the valuation north of $1 quadrillion, the market segments identified are currently most impacted by real-world asset tokenization.

As this process continues to unfold, we witness the creation of entirely new frameworks for asset management, valuation, and movements.

Currencies

At the time of writing, the global market cap for stablecoins is around $150 billion, with 98.9% of all stablecoins denominated in U.S. Dollars.

The first major stablecoin, USDT, launched in 2014 and retains stablecoin market dominance. However, the more compliant-focused USDC, issued by Circle in partnership with Coinbase, has grown significantly and remains the preferred choice for compliant onchain stablecoin usage.

The early success and rapid rise of stablecoins can be attributed to their timely market entry and subsequent product-market fit. Between 2008 and the early 2020s, global interest rates remained at or near zero. There is little difference between cash and investment-grade sovereign debt in this environment—neither bears a yield.

In a zero-yield environment, stablecoins are the perfect instrument for taking cash onchain to pursue the significantly higher yields found in decentralized finance (DeFi.)

Stablecoins are now becoming the preferred method for remitting money, with transaction volumes on par with global payment giant Visa, while payment giant Paypal is launching its own stablecoin.

Government Debt

With rising rates, the trend of capital moving onchain in search of yield has begun reversing. Investors are now seeking what Superstate CEO and Co-founder Robert Leshner calls “low-risk, highly liquid sources of yield.”

Investment-grade sovereign debt is the perfect fit. U.S. 1-Year Treasury Bills are trading with a coupon of around 5% at the time of writing, and a risk-free return backed by the largest economy in the world is hard to beat.

In response to this change in rate environment, waves of yield-bearing Treasuries have begun to make their way on-chain as tokenized instruments. Demand is significant, and the nascent asset class is already rapidly approaching $1 billion in total tokenized assets.

Superstate’s first fund, the Superstate Short Duration US Government Securities Fund (USTB), is one example of a Treasury tokenizer entering the market with a blend of security, efficiency, and full regulatory compliance. Its USTB approach offers granular asset level compliance, affording the speed and composability of DeFi with the liquidity and assurance of traditional markets.

Equities

Global equity valuations topped $109 trillion in 2023, and the well-recognized sector is a prime candidate for tokenization.

Smart contracts allow for automated, provably fair order fulfillment and facilitate more efficient and orderly markets for tokenized equities. Blockchain’s near real-time settlement capabilities rapidly accelerate settlement times, benefiting end users.

Retail-facing brokerages like Robinhood already offer expanded digital functionality to the retail market, and equities are looking toward the future.

Security tokens have emerged as regulated, onchain equivalents of traditional instruments. These tokens function similarly to other blockchain assets but retain the legal status of securities, including investor protections and compliance requirements.

These requirements and liquidity challenges remain the most significant problems facing the tokenized equity landscape. However, with Citibank tokenizing private equity on the Avalanche public blockchain, major financial entities have begun laying the groundwork for global markets.

Commodities

The diverse world of commodities, including gold, agricultural products, and diamonds, includes several trillion-dollar markets. The aggregate market value of all gold is around $12 trillion, while agricultural exports amounted to $1.75 trillion in 2021. These essential producer goods are the bedrock of our modern global economy.

Commodities fall under the large umbrella of alternative investments, a sector with an aggregate market of $145 trillion and increasingly featured in well-balanced portfolios.

However, this economic sector remains notoriously difficult to access, featuring diverse instruments and levels of market sophistication. Securing exposure to a gold ETF is simple. Conversely, due to the contract-based pricing and counterparty relationships, exposure to uranium as a commodity is nearly impossible.

Tokenization is already widening the doorways to the alternative investment landscape and, with it, commodities. HSBC now affords retail investors exposure to tokenized gold custodied in its London vault. Farmers can tokenize crop yields of any size and participate in the global commodity futures market.

Commodity tokenization is already improving market access for producers as well as price discovery and liquidity for financial portfolios.

Real Estate

Global real estate remains the world’s largest single asset class, with a valuation of around $326.5T. Whether for financial exposure to an underlying target market or ownership of the underlying property, tokenization provides immense benefits to the real estate sector.

Real estate markets are already sophisticated, boasting Real Estate Investment Trusts (REITs) and similar structures. Accessibility remains an ongoing issue, however, with minimum investments reaching into the six figures. Tokenizing a property enables fractional shares for that property, significantly reducing minimum investment requirements. Additionally, investors can select properties within their desired target market, facilitating more customizable exposure.

Intermediaries providing home equity lines of credit are also experiencing early signs of disintermediation from peer-to-peer tokenized real estate markets. The ability for retail lenders to access competitive yields from investment-grade real estate equity is changing the face of financialized home ownership.

Consulting giant McKinsey estimates that the value of tokenized real estate and property management will top $5 trillion by the end of this decade.

#Final Thoughts

The benefits of asset tokenization are manifold. From programmable automation allowing for truly trustless market infrastructure to accessibility providing financial access to the 1.5 billion unbanked people, the benefits are hard to overstate.

However, we’re just starting down the road towards the future of global finance. From tokenized funds to Treasury assets, there’s no limit to the number and types of assets that benefit from being brought onchain. As regulatory clarity continues to emerge alongside product-market fits, the dawn of real-world asset tokenization suggests increasing capital inflows to the onchain economy for years to come.