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Digitization will improve efficiency and open new markets — but the revolution won’t happen overnight.
Published: January 13, 2023
The creation of a digital representation of a broadening array of rights and assets will enable a new scale of market efficiencies and democratize access to previously unavailable investment asset classes.
The crypto downturn and failure of FTX may impact general perceptions and policy formation, but they should not undermine the longer-term potential of tokenization; cryptocurrencies are a minor, though much-publicized, part of the potential tokenized universe.
The pace of transformation will be affected by the need for material investments and an evolution in laws and regulations.
The business models of numerous intermediaries will evolve or even disappear, but new types of service providers will emerge.
Tokenization — the conversion of assets and rights into a digital token on a blockchain — will likely upend by 2030 the transaction methods of many well-established asset classes, tangible or intangible. It will also enhance the accessibility of established asset classes, and allow the creation of new ones, for a broader range of investors in underserved frontier markets. It will spur growth in some corners and displace existing intermediaries in others. The investments in technology and skills as well as the changes in law and regulations that these shifts will require represent necessary hurdles in the transition. And while automation will eliminate certain intermediaries, new types of service providers should emerge to help manage the evolution in attendant risks.
Tokenization is the process of issuing a digital token that represents a tradable asset. The digital token can then be owned, used and transferred through a blockchain, reducing the need for third-party intermediaries. Higher profile tokens are often “native” ones, such as bitcoin and ether. But increasingly, tokenization is reaching a broad range of “real-world assets,” generally at very early stages of pilot schemes. In principle, anything featuring property rights and economic value can be tokenized. That includes tangible assets, such as property or physical works of art; intangible assets, such as intellectual property, digital art or wireless internet access; private equity (e.g., fund shares) or alternative investments (e.g., carbon credits); and debt and equity, whether listed or private (see chart).
In principle, anything featuring property rights and economic value can be tokenized.
The key expected benefits include the following.
¹ Sources: Total debt securities at March-end 2022, BIS; total equity market – market capitalization as of October 2022, World Federation of Exchanges.
Cryptocurrencies are a fraction of the potential tokenized ecosystem. The crypto winter and default of several protocols and players do not impact the prospects of tokenization by 2030, but they have affected perceptions and short-term activity levels. The total value locked in protocols averaged about $50 billion in the second half of 2022, a fraction of its 2021 peak.
Stakeholders are using this period to advance policies and technology. Absent more progress, both elements will represent long-term bottlenecks. Fundamental questions include whether an asset can be foreclosed on if owned through a token. Progress among jurisdictions varies. Regulators will focus on maintaining financial stability, protecting consumers and ensuring responsible market conduct in the face of new products, processes and players. For example, the fractional ownership of assets previously reserved for institutional investors could expose retail investors to new risks. Fractionalization may therefore not be the impending revolution sometimes portrayed.
The fractional ownership of assets previously reserved for institutional investors could expose retail investors to new risks.
New technology will also advance, requiring large capex investments. Otherwise, capacity will constrain prospects for high-volume applications. In parallel, a tokenized central bank currency or stablecoin will be needed for payments. The lack of interoperability may also limit the fungibility of liquidity across blockchains, introduce an additional element of vulnerability and increase the risk of fragmentation in liquidity.
Some intermediaries will disappear, some will evolve and new ones will materialize. For tokenized bonds and equities, the need for a central counterparty to engage in clearing, settlement and custodian activities may disappear or be reduced. An agent will still be needed to provide a regulatorily approved platform, and know-your-customer and anti-money laundering obligations will remain. In addition, increased transparency in the price discovery mechanism may come at the expense of greater volatility in times of stress absent the current market makers.
Agents will impose themselves by 2030 to address the novel risks in the connection between off- and on-chain worlds. The role of reputable custodians guaranteeing the permanence of the link between tokens and the real assets they represent will be paramount. Also, as in the “real world,” governance is key to ensure stability, and evolutions such as fractionalized ownership will pose challenges. New investment opportunities and technologies will also require new advisory services, particularly around risks.
A tokenized future does not mean the emergence of a separate, virtual and totally decentralized ecosystem. For tokenization and its attendant benefits to scale up while containing risks, compromises and hybrid solutions are necessary. Intermediaries will still exist, even if they take new forms, and stakeholders must remain mindful of the emergence of new forms of concentration in some of these agents.
Regulating Crypto: The Bid To Frame, Tame Or Game The Ecosystem, July 13, 2022
Exploring Crypto and DeFi Risks in Credit Ratings, June 30, 2022
Stablecoins: Common Promises, Diverging Outcomes, June 15, 2022
A Pragmatic World (Re)order >
This article was authored by a cross-section of representatives from S&P Global and in certain circumstances external guest authors. The views expressed are those of the authors and do not necessarily reflect the views or positions of any entities they represent and are not necessarily reflected in the products and services those entities offer. This research is a publication of S&P Global and does not comment on current or future credit ratings or credit rating methodologies.