By James Hiester, Ervinas Janavicius and Bhavik Domadia, Capco
Tokenization uses blockchain technology to create digital representations of traditional financial instruments and real-world assets. By operating against a distributed ledger with embedded smart contracts, these products allow transparent, nearly instantaneous, and highly automated execution of complex transactions across organizations. This offers many benefits over legacy approaches for both investors and issuers promising to create more secure, faster, and accessible markets.
Tokenization has been steadily progressing towards widespread adoption in financial markets. After many proof-of-concepts and incremental innovations, major financial institutions are bringing real platforms and products to market, suggesting that tokenization may be close to achieving a significant milestone in terms of maturity.
Benefits of tokenization
Unlike crypto, where most advocates focus on benefits such privacy and resistance to censorship, tokenization offers a better set of rails that enhances the existing financial system through operational efficiency and other benefits:
- Fractionalization: By enabling investors to purchase a portion of the asset, capital requirements are no longer such a significant barrier to entry.
- Real-time settlement: Blockchain transactions can be completed in seconds while including automatic compliance checks, asset transfers, and other events.
- Transparency: Tokens are tracked on an immutable ledger providing verifiable proof of ownership as well as an auditable history.
- Eliminate intermediaries: Smart Contracts allow transactions to be executed automatically and transfer funds when conditions are met.
- Accessibility: As many of the associated operations are automated, digital assets can be traded 24/7 across a variety of exchanges.
- Bundling: Tokens allow different assets to be bundled together in baskets, creating greater diversification and new product opportunities.
- Automation: Activities that have typically been cumbersome and labor intensive – such as distributing dividends and other lifecycle events – can be automated using Smart Contracts.
Where is the shift happening?
The financial Services industry has centered around a core set of tokenization use cases that stand to benefit most with greater economic viability.
Alternative assets continue to be a primary target for tokenization. With the ability to fractionalize assets like artwork and real estate, tokenization promises to lower barriers to entry and significantly increase liquidity for asset classes that have historically been highly illiquid. For example, a leading permissionless blockchain group recently announced a deal to tokenize over $500 million worth of real estate in Dubai.1 Even for certain assets that have been liquid, such as gold, tokenization can improve efficiency by providing transparent proof of ownership and real time settlement while abstracting away the complexity of physically holding the asset. Tokenized gold has reached a market cap of over $1 billion according to a leading tokenization data company.2
Established financial players appear most focused on products such as money market funds that can maximize the benefits of tokenization while avoiding areas that might be more challenging from a regulatory perspective. A leading global wealth manager recently announced the creation of a money market fund strengthening the trend of large financial institutions offering similar products. Tokenized money market funds make it possible to operationalize the asset as collateral for derivative trading and repo markets.3 Additionally, they allow investors to receive the yield of the underlying assets, a feature stablecoins lack. The leading global tokenization data company estimated the value of tokenized treasuries to be almost $2.4 billion prior to the global wealth manager announcement.
Given the option for 24/7 trading, it only makes sense that the bond and equity markets would be seen as a natural next step in terms of tokenization. However, most institutions are moving cautiously and focusing on security products for institutional investors. Additionally, integrating DLT into existing equity markets would involve massive integration efforts and displacement of deeply entrenched systems.
Roadblocks for adoption
Regulatory compliance – the biggest challenge for tokenized assets is a fragmented, and in some cases antiquated, regulatory structure. From a global perspective, regulation of digital assets has been caught in a patchwork of regional regulation such as the E.U.’s Markets in Crypto Assets (MiCA) regulation, the EU DLT pilot regime (see our insights on this topic in the ‘Related Content’ section at the end of this article), the US Securities Act and Regulation D. Ambiguity around certain aspects of tokenization including staking can add elevated risk for firms looking to introduce novel products.
Legacy infrastructure – especially impacts large, incumbent industry players. Firms continue to depend on legacy systems that lack the capability for real-time processing. The integration of new technologies with these outdated systems presents significant complexity and cost challenges.
Defining maturity of tokenization
Below, we evaluate the maturity of tokenization based on its adoption across different products as well as integration with core systems and processes. If tokenization truly delivers on its promises of operational cost efficiency and automation, we expect it to be a core part of banks’ product offering, technology stack, and operating model.
| Maturity Indicator | Achieved Maturity? |
| Custody Options Widespread availability of reliable digital asset custody options, including financial institutions offering custody of their tokenized assets with their bank of choice. | Not yet – Financial institutions and fintechs have partnered with custody and wallet vendors such as Anchorage, Fireblocks, and Coinbase to support in-house offerings but few offer options for digital asset custody directly to their customers. |
| Risk & Regulatory Harmony Token protocols align with compliance rules. Regulations have addressed new challenges and issues raised by digital assets. | Not yet – While regulations like MiCA and friendly regulations in some jurisdictions exist, the uncertainty around staking and other SEC action shows there are still gaps and significant questions around the US and global approaches. |
| On-Chain Insights Analysis of blockchain data allows enforcement action for financial crime measures. | Yes – Vendors like Chainalysis are routinely able to identify wallets and track funds. FBI and other government agencies use existing laws to seize illicit funds. |
| Core Systems Integration Blockchain operations are deeply integrated with other core systems in institutions to enable frictionless transaction. | Not yet – Financial institutions have yet to deeply integrate their blockchain products with their core systems. While some are creating roadmaps and strategies, production seems far from reality. |
| Interoperability Assets are interoperable across blockchains and platforms. Assets issued by an institution can be managed on third party platforms. | Not yet – While progress is being made in terms of bridging common token standards, most product launches are limited to ‘walled garden’ platforms. |
What’s Next?
The frequency of major product announcements from major financial players clearly demonstrates that tokenization is making major progress. Yet as explored in this article, we have not seen Day 1 for tokenization in the financial services industry. As tokenized products gain foothold in the wider financial system, we expect the surrounding ecosystem to continue to mature.
While we cannot say for certain when the breakout will occur, the availability of tokenized products is consistently accelerating. Financial services firms should have a clear strategy that aligns business opportunities with the technical capabilities of tokenization to capitalize on these trends. Firms should continue to work with the regulatory community to ensure safe, transparent and accessible products, and modernize their legacy infrastructure to reap benefits and accelerate maturity.
Ervinas Janavicus is passionate about innovation and growth, and helps financial services organizations design and implement growth, technology and cost takeout strategies. As a Managing Principal with a proven track record in the US and UK, he has led teams, launched initiatives and new products/offerings, supported COO/CIO client teams, and explored opportunities across geographies, markets and sectors.
Bhavik Domadia is a Principal Consultant at Capco based out of New York City, and he has over 13 years of extensive experience in consulting for executive clients across the Capital Markets, and Wealth and Asset Management domains.
Bhavik’s diversified consulting experience encompasses Enterprise Payments, Investment Banking, Digital Transformation and Blockchain Engineering driven by his ability to conceptualize and identify alternatives, selecting efficient technical and business solutions, improving business processes as well as managing and delivering complex applications.
He also holds Master of Science in Information Systems (MSIS) from Pace University, NY, and is also a certified Product Owner/Product Manager.
James Hiester is a Principal Consultant with Capco who possesses nine years of experience. He possesses extensive in blockchain and as a web developer, building web and cloud-based solutions. James has worked with large financial institutions and energy companies to deliver high performance applications that combine blockchain and cloud technology. James also plays a key role in the digital assets practice at Capco, spearheading the development of prototypes focused on different use cases including tokenization, digital identity, and ESG.
References
1 CoinDesk
2 RWA.xyz
4 CoinDesk
