Tokenization: The Next Financial Engineer’s Dream

Tokenization has been a significant component of the cryptocurrency world. Although crypto is still challenged by the aftermath of the FTX exchange collapse, tokenization has its separate momentum.

That momentum is very much in the established financial sector, in funds management, private banking and credit cards through a new initiative involving card giant Visa. 

In all of these, tokenization is helpful because it promotes greater liquidity. It allows fractional ownership and the buying and selling of small amounts while stripping out costs. When applied through blockchain, there is also a security and privacy advantage.

In its early stages, financial institutions have been experimenting with tokenization on private blockchains. The creation of public blockchains is a game changer. It can drive scale and reach by allowing small investors, who are currently locked out of sophisticated wholesale investing because it's too expensive and they lack the access, to participate. 

Slice of property

One example is in the property market, where tokenization enables the division of the value of a property into much smaller tokens which add up to the total value. Many people would like to buy into a commercial property. Currently, the only way they might be able to do that without paying for the whole asset is by buying shares in a property trust.

A physical asset can be divided into tokens that can be bought, sold and traded. It enables more people to participate in the property market, creates a win for small investors and vendors, and builds a more vibrant market. 

One Australian example of this is the startup HeroX. It aims to “bring the [USD280 trillion] global real estate market on-chain with fractionalization and enhanced liquidity.”

"The next generation of markets and securities will be tokenization of securities”

As we begin 2023, tokenization is a key buzzword in the institutional investment community. Larry Fink, the chief executive officer of BlackRock, the world’s largest funds group with USD10 trillion in assets under management, recently said that "the next generation of markets and securities will be tokenization of securities."

U.S. bank BNY Mellon recently did a survey and found that 97% of institutional investors agree with Fink that tokenization will revolutionize asset management. 70% of the respondents expressed willingness to pay for increased liquidity and faster asset turnover, even as tokenization strips out the cost from processing. 

“Engaging and competitive”

Calastone, the world’s largest funds management network, processes around USD500 billion in funds monthly on the global markets and agrees that tokens are the future. 

Visiting Sydney late last year, Edward Glyn, Calastone’s managing director and head of global markets, told a forum that the industry was looking to provide a “more engaging, competitive, digital buying experience.” This would take the fund management industry out of the 20th century and mark a radical change to a structure that had not changed substantially since the advent of the first mutual fund in 1924.

Tokenization of the fund industry built on distributed ledger technology (DLT), Glyn said, would see funds represented on a blockchain that was accessible and transparent to all players in the fund’s eco-system, from asset manager through to the customer.

 “We are applying the latest technology to build the next-generation infrastructure for the distribution and trading of a new type of collective investment product powered by a DLT platform covering the entire fund supply chain,” he added.

The technology would strip out layers of ‘intermediation,’ reduce costs and drive better access to global funds in markets such as Australia, where the funds industry remained comparatively domestically focused.

“If I look at the people we are talking to at the moment, there is one particular asset manager who is about providing an institutional style product, a separately managed account that is typically the preserve of the institutional or ultra-high-net-worth individual, and you can have a fund of one tailored to your individual needs,” said Glyn.

“They want to take that and provide it to the mass market so that the “fund of one” style personal investment is provided at an ultra-low cost, and it’s not just a product, it’s a solution distributed to the mass market.”

Beyond funds

The investment industry is not just looking at funds management and property as fertile grounds for tokenization. Assets such as precious metals, artworks, collectibles and intangible assets such as intellectual property rights can be packaged up in tokens and sold on a market, backed by a blockchain and exchanged through smart contracts.  

Many people liken the tokenization revolution to securitization, the innovative financial engineering which created the market for asset-backed securities based on revenue streams from mortgages, car loans and credit card payments.

That market, of course, ended in tears in the subprime crash that brought on the global financial crisis of 2008. 

This time, the financial engineers tell us that the immutability and transparency of blockchain will maintain the system's integrity and prevent history from repeating itself.

While retaining the right to be wary of these claims, particularly given the crypto market in 2022, there’s little doubt that 2023 will be a significant year for more mainstream case studies for tokenization.

Driven by big players such as BlackRock and Calastone, tokenization is coming fast and could arrive soon at an investment opportunity close to you. 

Lachlan Colquhoun is the Australia and New Zealand correspondent for CDOTrends and the NextGenConnectivity editor. He remains fascinated with how businesses reinvent themselves through digital technology to solve existing issues and change their entire business models. You can reach him at [email protected].

Image credit: iStockphoto/Rodrigo