The Year of Institutional Investment in Real World Assets

https://www.coindesk.com/consensus-magazine/2023/12/18/the-year-of-institutional-investment-in-real-world-assets/

The tokenization of real world assets (RWAs) has been a use case for blockchain technology for years, and yet we haven’t seen substantial institutional interest in RWAs until now.

The value of tokenized assets across all public blockchains has already reached $118.57 billion and could reach $10 trillion by 2030. In other words, the potential upside for investing in RWAs is enormous.

Recent macroeconomic shifts and improvements in technology for secure custody, trading and settlement have made investment in tokenized treasuries, private equity and debt that much more attractive. Ultimately, it’s regulatory clarity and property rights enforcement that will make 2024 the year of RWAs.

This post is part of CoinDesk’s “Crypto 2024” predictions package. Sanchit Pande is the head of prime brokerage in Prime at BitGo.

Stablecoins are currently the most familiar tokenization projects. The most common form is a direct claim on fiat currency held by a custodian. Today the global market cap for stablecoins stands at around $124 billion; according to a report by brokerage firm Alliance Bernstein, it is expected to grow to almost $3 trillion in the next five years as private firms such as PayPal begin issuing them.

Central bank digital currencies (CBDCs) are another form of tokenization. According to data from the Atlantic Council, 11 countries have already launched CBDCs, and 19 of the G20 countries are in the advanced stages of development.

But it’s the tokenization of stocks, bonds and other traditional investment products that’s been gaining the most traction.

In the spring of 2022, JPMorgan announced the first trade on its private Onyx network, and as we head into winter 2023, it has already processed nearly a trillion dollars in notional collateral value. Just last week, JPMorgan announced that Onyx will do a proof-of-concept under the auspices of the Singapore Monetary Authority to connect portfolios to tokenized assets offered by WisdomTree.

The London Stock Exchange Group, UBS Asset Management, ABN AMRO and Citigroup have all also launched tokenization initiatives in 2023. Hong Kong, Singapore, Japan and Thailand have all been working out regulatory regimes to support tokenization.

Analysts at Citigroup have projected that $5 trillion worth of financial assets could be tokenized by 2030. Analysts at Bank of America predict that tokenized assets will become so ubiquitous over the next 5-15 years that “tokenized asset portfolios” will simply become “portfolios.”

Why the surge of interest?

Atomic settlement, the ability to settle even complex transactions instantaneously, is particularly appealing in the current high interest rate environment. If you’re trading assets worth hundreds of millions of dollars, speed matters. Delays in settlement carry an opportunity cost that scales directly with the notional value involved.

Near-instantaneous settlement via smart contracts eliminates the need for middlemen and the fees associated with their services while also reducing the potential for human error.

Big banks are also seeing margins for the private asset part of their business consistently decreasing. Programmable smart contracts built into tokenized assets can automate a number of transactional functions over the life of the asset. That removes a number of intermediaries and manual steps, creating new efficiencies that reduce overhead and boost margins.

Ultimately the biggest winners will be investors, as transactions become more efficient and costs decrease across the asset lifecycle.

Today’s robust stablecoin market further strengthens the use case for tokenizing traditional financial assets. Trades are ultimately finalized in fiat currency, which doesn’t move at atomic speed due to requirements to comply with banking rules such as anti-money laundering (AML) and know-your-customer (KYC).

But if both the asset you’re buying and the currency you’re using are tokenized on chain, now you can start using the programmability capabilities of the blockchain to make the transactions even faster and more efficient, reducing settlement risk.

There are other benefits as well. Transparency of the blockchain can reduce information asymmetry, leading to more efficient pricing and increased liquidity. By nature, public blockchains make auditing simpler and more easily allow law enforcement officers to track the flow of illicit funds. Public ledgers provide a wealth of data for quantitative researchers, economists and government statisticians studying market and economic behaviors.

There is certainly much work left to be done to develop the market. Regulation is probably the biggest piece. The Hong Kong circular broadly outlines four key areas that must be addressed: tokenization arrangement, disclosures, intermediaries and staff competence.

Ultimately, global standards will have to be determined for tokenization of real-world assets to reach its full potential. But at least in the U.S., tokenization won’t be held up by the unresolved debate around whether digital assets are securities, who should regulate them, and how.

Tokenized stocks, bonds, etc. clearly fall under existing U.S. securities regulations. Disclosures, consumer protections, KYC, AML and qualified custody requirements will all be in force.

Law around smart contracts is far from settled. Questions of ownership rights, liability and enforceability will have to be hashed out. Interoperability is also a challenge. Right now, a lot of this tokenization activity is taking place on private blockchains because of banks’ duties around compliance and controls, but the public blockchains are the ones that are becoming faster and innovating around interoperability.

That’s likely to continue, and public blockchains may prevail the same way that public clouds have come to dominate private ones. As that happens, more institutions may follow in the footsteps of Franklin Templeton, which in April of 2023 became the first U.S. registered mutual fund to launch a money market fund on a public blockchain (Polygon).

The market infrastructure supporting tokenization will have to be developed. In the current landscape there are many niche technologies, and few end to end solutions providers that can offer a seamless process for creation and management. This is in large part due to a scarcity of qualified custodians with the security chops to support these types of assets across the full lifecycle.

The market cap for traditional financial assets dwarfs that of digital assets. Tokenizing these assets is an extremely compelling growth opportunity for the digital asset industry. Today’s high interest rates and difficult banking climate, combined with the maturation of the stablecoin market and the digital asset industry as a whole, have made the business case for tokenization a lot more compelling for TradFi firms.

Ultimately the biggest winners will be investors, as transactions become more efficient and costs decrease across the asset lifecycle.