Mentioning “tokenization of real-world assets” to some of my longer-serving colleagues at CoinDesk can elicit eye rolls – they’ve heard it all before.
But at the risk of falling into the “this time is different” optimism trap, I would say the current buzz around “RWA” feels more real and impactful than the 2018 chatter about “security tokens” and “tokenized securities” (which, as Noelle Acheson reminded us recently, are not the same thing.)
The idea that blockchain technology and native tokens can represent off-chain assets – financial securities such as stocks and bonds, or commercial rights such as trade receivables and fractionalized real estate or art – has been around for a while. The concept tends to find favor around market crash moments, when a public backlash arises against native crypto tokens like bitcoin and ether – as happened after the bursting of the initial coin offering bubble in 2018 and, now, in the post-FTX era. At such times, a mindset emerges that it’s more palatable to the mainstream to convert familiar, relatively stable, pre-regulated assets into blockchain-based digital assets than to bet on pure crypto.
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Blockchain purists often reject this model in both good and bad times, pointing out that it breaks the “trustless” structure of decentralized blockchains because someone or some centralized institution must now be trusted to identify, represent and attest to the value of the assets on chain. Also, many were dismissive of the underlying models used in early tokenization projects, which were built on permissioned blockchains run by consortia of banks or other companies, a centralized framework that crypto advocates view as adding no more value than the more efficient, less expensive option of a SQL database.
Time will tell whether the latest wave of tokenization – which has drawn in large Wall Street banks, the Singaporean government and asset managers such as Wisdom Tree and Hamilton Lane – moves this idea beyond the fringe into the mainstream. But there are reasons to believe it has momentum.
One is that technological advances in cryptography since 2018 have encouraged tokenization projects to migrate from those closed, permissioned projects onto public, permissionless blockchain platforms such as Polygon. And that has, in turn, allowed them to tap into the more rapid pace of innovation happening on those chains, including in areas such as zero-knowledge proofs, which enable a balance between the privacy that investors and issuers demand and the advantages of programmability, instant settlement and data transparency.
Another driver behind this advance lies in economic conditions. Inflation and higher interest rates are forcing entities to seek out new markets and trading efficiencies and to free up dormant capital. The pitch behind tokenization is that it achieves all of that.
One leader in this field is Pennsylvania-based fund manager Hamilton Lane, which recently partnered with security token provider Securitize to tokenize some of it $2.1 billion flagship Equity Opportunities Fund V. By making smaller portions of the fund available, the firm invited individuals who can’t write giant-sized checks into a portfolio of illiquid but high-return private equity assets typically reserved for institutional investors.
Other big fund managers are eyeing different, democratizing opportunities. Franklin Templeton CEO Jenny Johnson, a keynote speaker at CoinDesk’s Consensus event in April, talks about tokenization offering the opportunity to customize individual investors’ portfolios around their interests – including adding exotic new assets such as tokenized royalty streams from their favorite musical artists.
Wisdom Tree, which includes among its offerings exchange-trade products on bitcoin and other cryptocurrencies, threw its hat in this ring too in December, when it announced nine new, Securities and Exchange Commission-approved blockchain-enabled funds.
The trend is not just seen in consumer-facing deals, either. A clique of big banks, including Citibank, HSBC, BNY Mellon and Wells Fargo, partnered in November with the Federal Reserve Bank of New York to tokenize dollars used in wholesale interbank transfers. The intent here is to speed up the clearing and settlement time in the daily netting out of payments across each others’ customer account and to reduce the risk of failed payments.
Regulators missing an opportunity
It’s worth noting, however, that the Fed’s de facto endorsement here is an isolated case among government agencies, one that’s limited to working with a few highly regulated institutions with which it is deeply involved on a daily basis. If anything, governments are the ones that are now swimming against the tide in the tokenization drive.
That, too, is a reaction to the market crash and the FTX debacle. Last month, the Financial Stability Board (FSB) – a multilateral body charged with coordinating regulation to contain systemic risks in international finance – warned that when decentralized finance (DeFi) attempts to “replicate some of the functions of the traditional financial system, [it] inherits and may amplify the vulnerabilities of that system.” The point was read by some to say that tokenization of real-world assets, which would allow those tokens to interface with the hurly-burly DeFi markets of crypto, could introduce the latter’s systemic risks to the entire global economy.
It’s one reason why the FSB, the Bank for International Settlements and the International Monetary Fund are all calling for international coordination of the crypto industry.
It would be a real pity if such a regulatory mission were to kill off tokenization altogether because, if managed properly, putting the world’s stocks, bonds and commercial assets on-chain could well reduce systemic risk, not raise it. A tokenized financial system with traceable, instantly settled transactions would be a more transparent and efficient one, with lower risks of the trade failures that happen when settlement is delayed.
That digital assets are a solution to instability might seem strange to those who wrongfully equate the contagion seen across crypto exchanges and lenders last year as a function of blockchain tech. But the reality is that the fallout from the collapse of FTX, Voyager Digital, Celsius Network et al. stemmed from abuses by centralized entities whose opaque token management practices were possible because they operated off-chain like all other traditional financial institutions. Putting transactions on-chain should, in theory, offset such risks while widening access to investment opportunities.
As former Treasury official John Rizzo argued in a recent opinion piece for CoinDesk, policymakers need to be looking at how tokenization can help foster generational wealth in assets such as real estate by making them available to a wider group. In tokenization, Rizzo wrote, “public officials in Washington [D.C.] have an opportunity to come together and focus on powering a revolution in alternative assets that unlocks the storied American Dream for millions.”
CORRECTION March 6, 00:26 UTC: Corrects to remove reference to an earlier art fund. Hamilton Lane was not the the entity behind that project. Also corrects to remove description of the tokenized assets in the recent Hamilton Lane offering as tradeable. They are not.