The advent of blockchain technology brought one unexpected benefit with itself – the tokenization of assets. With the rise of asset tokenization and DeFi (decentralized finance), we are starting to see the real impact that asset tokenization can have on financial markets.
But what will the implications from the use of asset tokenization in financial markets be?
It would be difficult to name all of them in just one article but tokenizing real-world assets certainly has the potential to affect liquidity, trading, asset pricing, transaction clearing and settlement.
Let’s look at why this can happen.
The reason why traditional financial markets and the “digital assets” space are beginning to converge lies in the very technology that supports asset tokenization.
The 21st century is the period when we’re experiencing the Fourth Industrial Revolution, which consists of the ‘ongoing automation of traditional manufacturing and industrial practices, using modern smart technology. Enterprises, institutions, and regulatory bodies are constantly working to expand the capacity of existing technology as well as develop new ones that will drive further automation, inclusion, and integration.
And in an increasingly globalized world, the tokenization of assets in a way that ensures trust, transparency, and contractual obligations are guaranteed, is becoming paramount.
In a recent report by Greenwich Associates: “Security Tokens: Cryptonite for Stock Certificates” – 70% see this automation of the asset lifecycle as the catalyst to create additional value through greater transparency and fewer disagreements over data. This is where Blockchain, or better, Distributed Ledger Technology or (DLT) comes in.
DLT enables transactions in which trust is distributed among the nodes participating in the network, without the need for a central authority or intermediary to validate a relationship between two parties carrying out a transaction.
Transactions are thus validated and confirmed by participants in the decentralized network in exchange for a certain transaction fee.
So what does this mean for financial markets?
This automation of the asset lifecycle can act as the catalyst to create additional value through greater transparency and fewer disagreements over data. By embedding codified policies could be embedded into digital assets, would impact businesses positively.
The tokenization of assets such as small and medium-sized enterprise (SME) stocks or private equity/venture capital (PE/VC) funds can have tremendous benefits for increasing liquidity to nearly illiquid asset classes. In a similar manner, the tokenization of assets with limited liquidity, such as private placements of unlisted securities, can improve liquidity as well. Some industry experts estimate that tokenization could “unlock trillions of euros currently in illiquid assets, significantly increasing trading volumes”(Deloitte, 2019).
Because trading of tokenized assets takes place 24/7 across multiple networks in a decentralized manner, financial markets are able to achieve better synergy.
By leveraging smart contracts, the complex compliance rules can be programmed into the token protocol to ensure compliant transactions.
In this way, frictions can be removed from the secondary market trading process, allowing more liquid marketplaces to develop.
As a result, asset tokenization is able to create more transparent, accessible, cheaper, faster, and easier financial markets
Another component worth mentioning is that DLT technology has the potential to significantly reduce market manipulation.
Because of the immutable nature of the blockchain where every transaction is recorded transparently, tokenized assets are immutable, verifiable, and always accessible to all interested parties. Given this quality of DLTs, it’s not surprising that asset tokenization is becoming the preferred method of generating value for enterprises, institutional and retail investors. In fact, more and more governments are choosing this new option in an attempt to democratise their capital markets and this may give them a strategic advantage in the years to come.
We are standing at the precipice of a new technological phenomenon. As is with every new advancement – the potential for improvement of the current paradigm is tremendous. But we must also acknowledge and be prepared to tackle the risks and challenges surrounding asset tokenization. An objective approach will allow everyone involved to retain their enthusiasm for the potential of smart contracts all the while continuing to ask the right questions to craft the regulatory framework and standards we need to govern this new technology.