Title of the original article: "From ripples to waves: The transformational power of tokenizing assets"

Author: Anutosh Banerjee, Matt Higginson, Julian Sevillano, Matt Higginson

Compiled by Chris, Techub News

Tokenized financial assets are moving from the pilot phase to large-scale deployment. Although adoption is not yet widespread, financial institutions involved in blockchain will have a strategic advantage.

Tokenization refers to the process of creating tokenized assets on the blockchain network, which has become relatively mature after years of development. The benefits of tokenization include programmability, composability, and enhanced transparency. Tokenization can enable financial institutions to improve operational efficiency, increase liquidity, and create new revenue opportunities through innovative means. These benefits have already been realized today, with the first batch of tokenized applications trading trillions of dollars worth of assets on-chain every month. However, there are still some loopholes in tokenization itself so far. To further integrate these technologies into traditional finance, it requires the cooperation of all relevant stakeholders and a robust, secure, and compliant approach. As infrastructure participants transition from proof of concept to robust, large-scale solutions, reimagining the future operation of financial services will face many opportunities and challenges (see 'What is Tokenization?').

If we were to design the financial services of the future, we would probably design those that encompass many of the features of tokenized digital assets: 24-hour availability, instant liquidity of global collateral, fair access, composability thanks to a common technology stack, and controlled transparency. BlackRock Chairman and CEO Larry Fink said in January 2024, "We believe the next step will be the tokenization of financial assets, which means that every stock, every bond will be recorded on a general ledger." More and more institutions are launching and expanding tokenized products, from tokenized bonds and funds to private equity and cash.

As tokenization technology matures and demonstrates significant economic benefits, the digitization of assets now seems more inevitable. However, the widespread adoption of tokenization is still a long way off. The current infrastructure is not yet perfect, especially in heavily regulated industries such as Financial Service. Therefore, we expect the adoption of tokenization to proceed in multiple stages: The first stage will be driven by companies or projects that can demonstrate investment returns and have a certain scale. Next will be companies or projects with a smaller market size, less obvious returns, or more challenging technical problems to solve.

Based on our analysis, we expect the total tokenization market capitalization to reach about $20 trillion by 2030 (excluding cryptocurrencies like Bitcoin and stablecoins like USDT), thanks to adoption in mutual funds, bonds, exchange-traded notes (ETNs), loans and securitization, and alternative funds. In an optimistic scenario, this value could double to about $40 trillion.

In this article, we provide our perspective on the adoption of tokenization. We describe the current state of tokenization applications (primarily focused on limited asset sets), as well as the broader benefits and feasibility of tokenization. We then examine use cases currently targeting meaningful market share and provide rationale for growth across different asset classes. For the remaining major financial asset classes, we examine the 'cold start' problem and suggest possible steps towards resolution. Finally, we consider the risks and rewards of being an early adopter and issue a 'call to action' for future participants in financial market infrastructure.

Tokenization in Phases

Due to differences in expected returns, feasibility, time impact, and risk preferences of market participants, the adoption speed and timing of tokenization in various asset classes will vary. We expect these factors to determine when tokenization can be widely adopted. Asset classes with high market value, current value chain friction, less mature traditional infrastructure, or lower liquidity are more likely to achieve returns beyond expectations from tokenization. For example, we believe that asset classes with lower technical complexity and regulatory considerations have the highest feasibility for tokenization.

Interest in tokenized investments may be inversely proportional to the level of fees obtained in the current inefficient process, depending on whether the functionality is handled internally or outsourced, and the degree of concentration of the main participants and their fees. Outsourcing activities often achieve economies of scale, reducing the incentive for disruption. The speed of returns on tokenization-related investments can enhance the business case, increasing interest in pursuing tokenization.

The adoption of specific asset classes can lay the foundation for the subsequent asset classes by introducing clearer regulation, more mature infrastructure, and investment. Adoption will also vary by geographical location, influenced by constantly changing macro environment, including market conditions, regulatory frameworks, and buyer demand. Finally, high-profile success or failure may drive or limit further adoption.

Asset Categories Most Likely to Adopt Tokenization

Tokenization is gradually advancing, and with the enhancement of network effects, it is expected to accelerate. Given its characteristics, certain asset categories utilizing tokenization may become popular within a decade or even faster, with the total market value of tokenization potentially exceeding 100 billion US dollars in the future. We expect the most prominent categories to include cash and deposits, bonds and ETNs, mutual funds and exchange-traded funds (ETFs), as well as loans and securitization. For many of these asset categories, the adoption rate is already high, benefiting from the efficiency and rapid value growth brought by blockchain, as well as increased technical and regulatory feasibility.

We estimate that by 2030, the total market value of tokenized assets could reach approximately $20 trillion (excluding cryptocurrencies and stablecoins), mainly driven by the assets within the diagram below. We expect the total market value of tokenized assets to be between approximately $10 trillion and $40 trillion. Our estimate does not include stablecoins, including tokenized deposits, wholesale stablecoins, and central bank digital currencies (CBDCs), to avoid double counting, as these are typically considered as the corresponding cash involved in the settlement of transactions involving tokenized assets.

Mutual Fund

Tokenized market funds have amassed over US $1 billion in assets, indicating demand for on-chain capital among investors in a high-interest-rate environment. Investors can choose funds managed by well-known companies such as BlackRock, WisdomTree, and Franklin Templeton, or funds managed by Web3-native companies such as Ondo Finance, Superstate, and Maple Finance. Tokenized market funds may have sustained demand in a high-interest-rate environment, as well as potentially offsetting the role of stablecoins as an on-chain store of value. Other types of mutual funds and ETFs can provide diversified on-chain capital options for traditional financial tools.

Turning to on-chain funds can greatly enhance their utility, including real-time 24-hour settlement and the ability to use tokenized funds as a payment tool. As the size of tokenized funds grows, more revenue related to product and operational aspects will gradually emerge. For example, highly customized investment strategies can be achieved through the combinability of hundreds of tokenized assets. Using data on shared ledgers can reduce errors related to manual reconciliation and increase transparency, thus reducing operating and technical costs. While the overall demand for tokenized currency market funds partly depends on the interest rate environment, it has now shown great appeal.

Loans and Securitization

Blockchain-supported lending is still in its early stages, but some institutions have already found success in this field: Figure Technologies is one of the largest non-bank home equity line of credit (HELOC) lenders in the United States, with an initial loan amount of billions of dollars. Web3-native companies such as Centrifuge and Maple Finance, as well as other companies such as Figure, have already facilitated the issuance of over $10 billion in blockchain loans.

We expect more tokenization of loans, especially in the areas of warehouse loans and on-chain loan securitization. Traditional loans typically have complex processes and highly centralized features. Blockchain-supported loans provide an alternative with many benefits: real-time on-chain data stored in a unified ledger as the sole source of data promotes transparency and standardization throughout the entire loan lifecycle. Payment calculations supported by smart contracts and simplified reporting reduce the required costs and labor. Shortened settlement cycles and access to a broader capital pool can accelerate transaction flows and potentially lower borrowing costs.

In the future, tokenizing the borrower's financial metadata or monitoring their on-chain cash flow can achieve fully automated, fairer, and more accurate underwriting. As more loans shift to private credit channels, incremental cost savings and speed are attractive benefits for borrowers. With the overall rise of digital assets adoption, demand will also increase for Web3 native companies.

Bonds and Exchange Traded Notes

In the past decade, tokenized bonds with a total face value of more than 10 billion US dollars have been issued globally. Prominent recent issuers include Siemens, the city of Lugano, the World Bank, as well as other companies, government-related entities, and international organizations. In addition, blockchain-based repurchase agreement (repo) has been adopted, resulting in a monthly trading volume of trillions of US dollars in North America, creating operational and capital efficiency value from existing liquidity.

Digital bond issuance is likely to continue because of the very high potential returns and relatively low difficulty of achieving a certain scale, partly due to the need to stimulate capital markets in some regions. For example, in Thailand and the Philippines, the issuance of tokenized bonds has made investors inclusive through small investments. While the gains to date have been primarily in the issuance, the end-to-end tokenized bond lifecycle can achieve at least a 40% improvement in operational efficiency through data clarity, automation, embedded compliance (e.g., transferability rules encoded at the token level), and streamlined processes (e.g., asset servicing). In addition, reducing costs, faster issuance, or diversification can improve financing for smaller issuers by raising "just-in-time" funding (i.e., optimizing borrowing costs by raising a specific amount of money at a specific time) and leveraging a global pool of capital to expand the investor base.

Key Points of Repurchase Protocol

The repurchase agreement, or "repos," is an observable example of tokenization. Broadridge Financial Solutions, Goldman Sachs, and JPMorgan currently trade trillions of dollars in repurchase volume each month. Unlike some use cases for tokenization, repurchase achieves substantive benefits without the tokenization of the entire value chain.

Financial institutions improve operational efficiency and capital utilization through tokenization repo. From an operational perspective, smart contract-supported automation of routine operational management (e.g., collateral valuation and margin replenishment). It reduces errors and settlement failures, simplifies disclosures; 24/7 instant settlement and on-chain data also enhance capital efficiency through intraday liquidity and enhanced collateral utilization of short-term borrowing.

Most repurchase agreements are for 24 hours or longer. Intraday liquidity can reduce counterparty risk, lower borrowing costs, lend out idle cash in the short term, and reduce liquidity buffers. Real-time, 24/7, cross-jurisdictional collateral liquidity can provide access to higher-yielding, high-quality liquid assets and optimize the flow of these collateral assets among market participants, thereby maximizing their availability.

Subsequent Stage

In the eyes of many market participants, tokenized assets with tremendous potential are alternative funds, which may drive the growth of asset management and simplify fund administration. Smart contracts and interoperable networks can make the management of large-scale autonomous portfolios more efficient through automated portfolio rebalancing. They may also provide new sources of capital for private assets. Decentralization and secondary market liquidity may help private funds obtain new capital from smaller retail and high-net-worth individuals. Additionally, transparent data and automation on a unified ledger can improve operational efficiency in the backend. Several established companies, including Apollo and JPMorgan, are conducting experiments and testing portfolio management on the blockchain. However, in order to fully realize the benefits of tokenization, underlying assets must also be tokenized.

For some other asset classes, tokenization may be slower, either due to feasibility issues such as compliance obligations or lack of adoption incentives from key market participants (see Figure 2). These asset classes include publicly traded and unlisted stocks, real estate, and precious metals.

Figure 2

Overcoming Cold Start Problem

The cold start problem is a common challenge when using tokenization. In the world of tokenized financial assets, issuance is relatively easy and replicable, but it can only achieve a certain scale when it meets user needs, whether it is cost-saving, good liquidity, compliance, or other aspects.

In fact, despite some progress in concept verification experiments and single-fund issuance, token issuers and investors still face the cold start problem: limited liquidity will hinder the issuance process due to insufficient trading volume to establish a robust market; concerns about losing market share may lead pioneers to incur additional costs by supporting parallel issuance of traditional technologies;

For example, the tokenization of bonds announces new tokenized bond issuances almost every week. Although there are already billions of dollars in tokenized bonds outstanding today, the yield is not as attractive as that of traditional bond issuances, and the secondary trading volume is still low. Here, overcoming the cold start problem requires building a use case where the digital representation of collateral brings substantial benefits, including greater liquidity, faster settlement, and higher liquidity. Achieving true, sustained long-term value requires coordination across multiple value chains and broad participation by new digital asset categories participants.

Given the complexity of upgrading the basic operational platform of the financial services industry, we believe that a Minimum Viable Value Chain (MVVC) (by asset class) is needed to support the scalability of tokenization solutions and overcome some of the challenges involved. In order to fully realize the benefits proposed in this article, financial institutions and partner organizations must collaborate on a shared or interoperable blockchain network. This interconnected infrastructure represents a new paradigm and raises regulatory concerns and some feasibility challenges (see Figure 3).

Figure 3

Currently, multiple projects are working to establish universal or interoperable blockchains for institutional financial services, including the Monetary Authority of Singapore's Guardian Programme and Regulated Settlement Network. In the first quarter of 2024, the Canton Network pilot project brought together 15 asset management companies, 13 banks, as well as multiple custodians, exchanges, and a financial infrastructure provider for paper trading. The pilot project validated that traditionally isolated financial systems can be successfully connected and synchronized using public permissioned blockchains while maintaining privacy controls.

While there have been successful examples on both public and private blockchains, it remains unclear which blockchain will carry the most volume of transactions. Currently in the United States, most federally regulated entities are discouraged from tokenization on public blockchains. However, globally, many institutions choose Ethereum for the liquidity and composability it offers. As the construction and testing of unified ledgers continue, the debate between public and private networks is far from over.

The Road Ahead

Comparing the current tokenization status of financial assets with the rise of other disruptive technologies, it can be seen that we are still in the early stages of adoption. Consumer technologies (such as the Internet, smartphones, and social media) and financial innovations (such as credit cards and ETFs) typically exhibit the fastest growth in the first five years after their emergence (with an annual growth rate of over 100%). Subsequently, the annual growth rate slows to about 50%, and eventually achieves a relatively moderate compound annual growth rate of 10% to 15% in more than a decade. Although experiments began as early as 2017, the large-scale issuance of tokenized assets only emerged in recent years. Our market capitalization estimate for 2030 assumes an average annual compound growth rate of 75% for each asset class, and the first wave of tokenized assets will lead this trend.

While it is reasonable to expect tokenization to drive the transformation of the financial industry, there may be additional benefits for early adopters who are able to 'ride the wave'. Early adopters can capture a large market share (especially in markets benefiting from economies of scale), improve their own efficiency, set agendas for formatting and standards, and benefit from the reputation halo of embracing emerging innovations. Early adopters of tokenized cash payments and on-chain repurchases have already proven this.

But more institutions are in a 'wait-and-see' mode, waiting for clearer market signals. Our view is that tokenization is at a critical point, which indicates that once some important signs are seen, institutions still in a 'wait-and-see' mode may risk falling behind the times. Important signs include the following aspects:

• • Infrastructure: Blockchain technology capable of supporting trillions of dollars in transaction volume
• • Integration: Different blockchains can seamlessly connect with each other.
• • Supported factors: widespread availability of tokenized cash (such as CBDCs, stablecoins, tokenized deposits) for instant settlement of transactions.
• • Demand: The buyer participant is willing to invest heavily in on-chain capital products
• • Supervision: Providing certainty and supporting actions that make the cross-jurisdictional financial system more fair, transparent, and efficient, clarifying data access and security

While we have not yet seen the emergence of all these signs, we expect the wave of tokenization adoption to come soon. The adoption of tokenization will be led by financial institutions and market infrastructure participants who will come together to take the lead. We refer to these collaborations as the Minimum Viable Value Chain (MVVC). Examples of MVVC include the blockchain-based repo ecosystem operated by Broadridge, as well as Onyx, a collaboration between JPMorgan Chase, Goldman Sachs, and Bank of New York Mellon.

In the coming years, we expect to see more MVVCs emerge to capture value from other use cases, such as enabling instant business-to-business payments through tokenizing cash; enabling dynamic 'smart' management of on-chain funds by asset managers; or facilitating efficient lifecycle management of government and corporate bonds. These MVVCs may be supported by network platforms created by existing companies and fintech disruptors.

For pioneers, there are both risks and rewards: the risks of early investment and investing in new technologies can be significant. Pioneers not only receive attention, but also need to develop infrastructure and run parallel processes on traditional platforms, which is both time-consuming and resource-intensive. In addition, in many jurisdictions, regulation and legal certainty regarding any form of interaction with digital assets are insufficient, and key supporting factors, such as widely available wholesale tokenized cash and deposits for settlement, have not yet been met.

The history of blockchain applications is full of losers facing such challenges. This history may prevent existing companies that feel safer operating on traditional platforms from taking conventional business operations. However, this strategy carries risks, including significant loss of market share. Given the current high interest rate environment, some tokenized products (such as repurchases) have clear use cases, and market conditions may quickly impact demand. As indicators of tokenization adoption emerge, such as regulatory clarity or infrastructure maturity, trillions of dollars in value can be transferred on-chain, creating a significant value pool for pioneers and disruptors (see Figure 4).

Figure 4

Short-term Action Plan

In the short term, institutions, including banks, asset management companies, and market infrastructure participants, should assess their product portfolios and determine which assets are most likely to benefit from the shift to tokenized products. We suggest considering whether tokenization can accelerate strategic priorities, such as entering new markets, launching new products, and/or attracting new customers. Are there potential use cases to create value in the short term? And what internal capabilities or partnerships are needed to seize the opportunities brought about by market transformation?

By aligning the pain points of both buyers and sellers with buyer and market conditions, stakeholders can assess in which areas tokenization poses the greatest risk to their market share. However, to realize the full benefits, it requires collaboration to create a minimum viable value chain. Addressing these issues now can help existing participants avoid awkward situations when demand surges.