Author: Olga Kharif, Elijah Nicholson-Messmer, Bloomberg; Translated by: Tao Zhu, Golden Finance
Cryptocurrencies were invented at the height of the 2008-2009 financial crisis to offer an alternative to banks. Many of Wall Street’s banks and financial institutions, which initially scoffed at the dreams of enthusiasts known as “cypherpunks” about 15 years ago, are now not only getting into the cryptocurrency business but also adopting the underlying blockchain technology.
While that might strike cryptocurrency enthusiasts as undermining the technology, banks are looking at the bottom line and seeing where to make money. They are attracted to blockchain technology because of its ability to "tokenize" traditional assets such as stocks and Treasuries, making them faster and cheaper to trade. Critics say Wall Street institutions are not only adopting but also using the technology to generate fees - similar to how financial firms turned low-cost, low-touch exchange-traded funds into a healthy business.
How do traditional assets become tokens?
“Tokenization of real-world assets” is the process of representing assets such as bonds, stocks, art, and even shares of ownership in office buildings as digital tokens on a blockchain. Anyone who owns a token owns that asset. Ownership can be easily and almost instantly transferred simply by transferring it from one crypto wallet to another. It allows assets to be broken down into smaller pieces, potentially expanding ownership and simplifying trading capabilities.
Why do this?
The tokenization process can eliminate settlement delays that come with having to clear transactions that often use a large number of intermediaries and record them in multiple systems. By placing contract information such as ownership terms and transfer conditions on the 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, once the goods are delivered to the buyer, they are released to the seller. Tokenized assets can appeal to people who may not have a brokerage account but already trade cryptocurrencies.
What other types of assets can be tokenized?
Stocks, art, homes, golf courses, exclusive memberships—you name it. In theory, every asset under the sun can be tokenized, and many backers believe they will be. Even expensive sneakers will appear on the blockchain to prove their authenticity when the physical item is traded. McKinsey estimates that the total tokenization market (excluding stablecoins pegged to fiat currencies) could reach about $2 trillion by 2030, driven by mutual funds, bonds and exchange-traded notes, loans and securitizations, and alternative funds. That’s roughly the size of today’s entire cryptocurrency market.
Are there any financial companies on Wall Street doing this?
Yes, here are some of the biggest names in the industry:
BlackRock Inc., the world’s largest asset manager, launched its first tokenized mutual fund, the BlackRock USD Institutional Digital Liquidity Fund, in March, which now has a market value of more than $500 million. It holds assets in cash, U.S. Treasury bills and repurchase agreements (a type of short-term loan). It keeps records on the public Ethereum blockchain.
Brokerage firms FalconX and Hidden Road have begun accepting BlackRock’s BUIDL token as collateral.
BlackRock used JPMorgan’s Tokenized Collateral Network in October 2023 to convert shares of one of its money market funds into digital tokens, which it then transferred to Barclays as collateral for over-the-counter derivatives trades between the two institutions. The bank said the setup allows clients to use assets as collateral and even tap into assets that might not have been available before.
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 offer private blockchain services.
Bank of New York Mellon, State Street and other financial institutions are already offering or working on new tokenization-related services.
Where did it start?
Bitcoin's inventors, who go by the pseudonym Satoshi Nakamoto, envisioned a financial system that didn't rely on "trusted third parties" that they said were untrustworthy from the start. Instead, they would use cryptography and a decentralized ledger called a blockchain to record transactions and provide irrefutable proof of ownership. Cryptocurrency evangelists say this will democratize finance and lower the cost of holding and using money. Exactly who Nakamoto was - whether the person or group - has been the subject of speculation since Bitcoin was launched in January 2009.
What do financial regulators have to say?
U.S. bank regulators have yet to approve innovations like deposit tokens, fearing that instant settlements could spur bank runs. That’s because customers would be able to use programmable tokens to automatically withdraw money from their 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 things like cross-border payments. By the end of the year, a subcommittee of the U.S. Commodity Futures Trading Commission, whose members include Citadel, BlackRock and even Bloomberg LP, had made recommendations to the full committee on how registered firms could use distributed ledger technology to hold and transfer noncash collateral — an important tokenization use case. The recommendations could provide a legal and regulatory framework for how market participants can apply existing policies and procedures to support the use of blockchain for noncash collateral organization in a way that complies with margin requirements of the agency, other U.S. regulators and derivatives clearing houses.
What are the concerns?
Tokenization could take some companies, such as broker-dealers, out of the loop of facilitating financial transactions. The exact setup of a tokenization project is also important: With a blockchain, there is only one record of each asset, and the holder of that asset owns it. So if a token is transferred to the wrong address or stolen, it could be lost forever if a public blockchain is used. That’s why many banks are developing or have already developed their own private blockchains. The Bank of New York hopes to soon receive regulatory approval to launch a digital transfer agent service to keep records of digital assets. If banks hope to be able to handle any significant volume of interbank transactions, then private blockchains will need to learn to communicate with each other. That’s why many financial companies, including banks, are also looking into multi-company blockchains. Given that banks are investing a lot of money and talent into the function, it may be a matter of when, not if.
