(Bloomberg) -- Cryptocurrencies were invented in the heat of the 2008-2009 financial crisis to provide an alternative to banks. Many banks and financial institutions on Wall Street that initially scoffed at the dreams of devotees known as “cypherpunks” some 15 years ago are now not only in the cryptocurrency business, they’re also beginning to adopt the underlying blockchain technology.
While this may strike crypto enthusiasts as undermining a fundamental reason for the technology, banks are looking at the bottom line and see money to be made. They are drawn to blockchain technology for its ability to “tokenize” traditional assets such as stocks and Treasury bills, which makes trading them faster and cheaper. Critics say Wall Street institutions aren’t just adopting, but co-opting the technology to generate fees — similar to how financial firms turned low-cost, low-touch exchange traded funds into a healthy business.
How are traditional assets turned into tokens?
“Real-world asset tokenization” is the process of representing assets like bonds, stocks, art or even ownership shares in office buildings as digital tokens on a blockchain. Anyone who owns the token owns the asset. Ownership can be moved easily and almost instantly by simply moving it from one crypto wallet to another. It allows assets to be broken down into smaller parts, potentially widening the pool of ownership and easing the ability to trade.
Why do that?
The tokenization process can eliminate settlement delays from having to clear transactions that often use a slew of intermediaries, and record them across multiple systems. By placing contractual information, such as the terms of ownership and conditions of transfer, on a blockchain, assets can be bought and sold in pieces and traded outside of market hours. Tokens can be programmed to automatically behave in certain ways: For example, to be released to a seller once goods are delivered to a buyer. Tokenized assets could attract those who might not have a brokerage account but already trade crypto.
What other kinds of assets could be tokenized?
Stocks, art, houses, golf courses, exclusive memberships — you name it. All assets under the sun could theoretically be tokenized and many proponents believe they will be. Even pricey sneakers are being represented on blockchains to prove their authenticity when the physical pair is traded. McKinsey estimates the total tokenized market — excluding stablecoins, which are tokens pegged to fiat — could reach around $2 trillion by 2030, driven by usage in mutual funds, bonds and exchange-traded notes, loans and securitizations, and alternative funds. That’s roughly equal to the size of the entire crypto market today.
Are any financial companies on Wall Street doing this?
Yes, and here are some of the big names in the business:
- BlackRock Inc., the world’s biggest asset manager, in March unveiled its first tokenized mutual fund, the BlackRock USD Institutional Digital Liquidity Fund, which now has a market value of more than $500 million. It holds assets in cash, US Treasury bills and repurchase agreements — a kind of short-term loan. It keeps records on the public Ethereum blockchain.
- Brokers FalconX and Hidden Road have started accepting BlackRock’s BUIDL token as collateral.
- BlackRock used JPMorgan’s Tokenized Collateral Network in October 2023 to turn shares in one of its money market funds into digital tokens, which were then transferred to Barclays Plc as collateral for an over-the-counter derivatives trade between the two institutions. Banks say this setup allows customers to use assets as collateral and even tap assets that may have previously been unusable.
- Franklin Templeton already manages a tokenized money-market fund with about $435 million in assets.
- JPMorgan Chase & Co., Goldman Sachs Group Inc. and other banks are experimenting with, or already offering, private blockchain services.
- Bank of New York Mellon Corp., State Street Corp. and other financial institutions are already providing or working on new tokenization-related services.
How did this start?
The inventor or inventors of Bitcoin, who went by the pseudonym Satoshi Nakamoto, envisioned a financial system that didn’t depend on “trusted third parties” they said couldn’t be trusted in the first place. Instead, they would use cryptography and a decentralized ledger called a blockchain to record transactions and provide irrefutable proof of ownership. Crypto evangelists said this would democratize finance and lower the cost of holding and using money. Who exactly Nakamoto is — either a single person or a group — has been subject of speculation since Bitcoin’s launch in January 2009.
What do financial regulators have to say?
US banking regulators are yet to greenlight innovations such as deposit tokens and have worried that instant settlement could spur bank runs. That’s because customers would be able to use the programmable tokens to automatically withdraw funds from banks when bad news hits. But regulators in other parts of the world, such as Singapore, are working with financial institutions on tokenization pilots for, among other things, cross-border payments. By the end of the year in the US, a subcommittee in the Commodity Futures Trading Commission — whose members include Citadel, BlackRock and even Bloomberg LP — has made recommendations to a full committee on how registered firms can use distributed ledger technology for holding and transferring non-cash collateral — an important tokenization-use case. These recommendations are likely to provide a legal and regulatory framework for how market participants can apply existing policies and procedures to support the use of blockchain for non-cash collateral in a manner consistent with the margin requirements of the agency, other US regulators and derivatives clearing organizations.
What are some concerns?
Tokenization could take some companies, such as broker-dealers, out of the loop for facilitating financial transactions. The exact setup of a tokenization project matters as well: With blockchain, there’s only one record for each asset, and the holder of that asset owns it. So, if a token is transferred to the wrong address or stolen, it may be lost forever if a public blockchain is used. That’s why many banks are developing or have developed their own private blockchains. BNY is hoping to soon get regulatory approval to launch a digital transfer agent service to do record-keeping for digital assets. Private blockchains would need to learn to talk to one another if the banks want to be able to handle any substantial interbank transactions. That’s why many financial companies, including banks, are also working on multi-company blockchains. Given how much money and talent banks are pouring into the functionality, that’s probably a matter of when, not if.
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