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How tokenization can democratize the world of finance

The digital asset market is growing fast. Are we looking at a tokenized future that could benefit the many not just the few?

By 2027, it is estimated that USD 24 trillion worth of bankable assets will be tokenized. And that is only the tip of the iceberg. There is a growing consensus that asset and fund tokenization will create a whole new world of opportunity, transform traditional banking models, create new revenue streams, and open up ownership of practically any asset to almost everyone.

So, what would that look like in practice?

Lowering the barriers

Looking at the fund industry today, many potential investors are put off by the cost and minimum investment required by most funds. The industry in general is plagued by high barriers to entry and a fragmentation of liquidity. In addition, it is resource intensive, relying on inefficient manual processes characterized by the lack of technical and regulatory standards. Together, this often deters all but the biggest investors. Tokenization could help remedy this. It can reduce entry barriers by enabling shares in a fund to be traded efficiently on a distributed ledger and lower the minimum investment required to participate.

Furthermore, reduced liquidity premiums would help create better liquidity and market depth. This, in turn, will lower transaction costs when transferring private, low-liquidity assets such as venture capital or private equity before maturity. For instance, tokenization would allow venture capital to remain locked-in without locking in the investors. Similarly, tokenized funds will allow fund managers to invest in illiquid assets without risking redemptions. In addition to increased liquidity, the fact that operational processes would be automated to a far greater extent would help increase efficiency and reduce costs.

Examining the practical implications of all this, we would see, for example, reduced issuance costs for securities, with ownership claims and cap tables automatically reconciled in real-time through smart contracts hardwired by code. This has the additional advantage of eliminating the all-too real risk of human error in assuming the contracts themselves are well designed. As all ownership transfers would be stored on a decentralized, immutable ledger without a single point of attack, the risk posed by malicious actors and bookkeeping errors would be reduced. If they did occur, they would be easily traceable. Migrating a shareholder registry to a public ledger would also reduce transaction costs through the automated tracking of asset ownership changes. This creates immutable audit trails that improve overall accountability through authentication links to verified digital identities of natural and legal persons, which are stored off-chain. And, bearing in mind that the technology underpinning tokenization would enable markets to trade all day, every day – this would further increase volume and liquidity while lowering costs.

New investors, fresh liquidity

Apart from the tokenization of traditional, bankable securities, DLT and smart contracts have also cleared the path for the securitization of non-bankable assets such as luxury goods, fine arts or gemstones. One good example here would be small- and mid-sized Swiss enterprises, which constitute 95% of the national economy. These firms will eventually be able to raise capital at low cost from a global investor pool, who benefit from an almost frictionless investment experience and exposure to a market which was previously relatively inaccessible.

So, from fractionalized real estate, SME private equity, to hard assets such as artworks and gems, to fan engagement – anything that has a tradable value can and will be tokenized as long as there is a demand to trade it. Particularly for assets that are not yet bankable due to limited accessibility and liquidity, we expect tokenization to spur the growth of entire new markets when they suddenly become accessible to an international investor base through this new, global tokenized trading floor.

The fact that tokenized assets can be fractionalized could also attract retail investors, who may have previously been deterred by the cost and complexity of entry. By utilizing distributed ledger technology, both trading and post-trade processes become almost frictionless and far less costly. This would serve to open the market to a wider pool of investors as buying into a fund becomes as easy as purchasing a new item of clothing online. As we have seen, these collective investments would also allow these new investors partial access to illiquid assets with typically higher yields, something that would be a big draw in the current low-yield market environment. Opening such private markets could help inject vast quantities of liquidity into illiquid asset classes.

Standardization is key

But before we get too carried away, there is one issue that must be addressed if tokenization is to thrive: standardization. Standardization is needed to ensure interoperability across myriad platforms and infrastructures. It will help create secondary markets, and reassure investors who are tentative. Some regulators remain hostile to digital assets generally, but others have adopted a more forward-looking approach: The Monetary Authority of Singapore (MAS), the UK Financial Conduct Authority (FCA), Switzerland’s Financial Market Supervisory Authority (FINMA), and Germany’s Federal Financial Supervisory Authority (BaFin) among them. And, as more regulatory authorities come on board, we will start to gain the regulatory clarity needed.

Now, let’s turn to other areas where tokenization is set to make an impact. Put simply, tokenization has the ability to create global markets for assets that have so far been unbankable due to issues such as limited liquidity, geographical inaccessibility, and cost. And it is not just assets that can be tokenized. Ownership and voting rights may also be tokenized if the demand exists. And that brings us neatly to the much-discussed issue of security tokens, which tokenize tangible and intangible financial assets such as traditional securities like stocks, bonds or other liabilities.

Maturing regulatory landscape

DLT can digitize the ownership of a security and any rights that come with it, through the issuance of a cryptographic token. But it is worth pointing out that such tokens must comply with existing securities laws and financial regulatory requirements. This is the only way they can be issued and traded on secondary markets. And all the signs point to the fact that this trend is gaining traction with the emergence of competing liquidity venues such as the Swiss Six Digital Exchange, Germany’s Börse Stuttgart, and the Fusang exchange in the APAC market. While these projects are still in their infancy, they reflect growing confidence in tokenization among some of the major players of traditional finance. Exchange interoperability will be one of the main enablers of large-scale asset tokenization. Asset trading could converge towards merged marketplaces between licensed, centralized exchanges and decentralized trading infrastructures that use encoded regulatory compliance.

Final thought

So, will tokenization be the catalyst that helps create a more democratic world of finance? Let’s leave the last word to the Canadian business executive Don Tapscott “Everyone with access to the internet will be able to hold and trade stocks, cryptocurrencies, debt securities, fractionalized real estate, and even gemstones from a single hardware wallet which is connected to multiple custody providers across the globe and by a swarm of digital wires connecting all market participants in a unified way. Integrations in social communication platforms will break the current boundaries of the asset and rights transfer by making it as simple as sending a text message whilst being regulatory compliant by design.“

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