Forming a tokenised economy
04 April 2023
Industry bodies are working to create a safe environment for the mainstream adoption of digital assets. Carmella Haswell reflects on how market practice changes, regulation and advances in technology and standards will define this journey
Image: stock.adobe.com/immimagery
The coexistence of digital assets and traditional finance is creating a new world of opportunities for the industry. Firms are continuing to adapt to the changing landscape, where institutional adoption of tokenised and digitised assets is on the rise.
Weaving through the challenges of implementation, the market calls for further education and refined regulatory frameworks to provide a safe environment for this migration, and hopes that these factors will act as a catalyst for moves towards a more tokenised economy.
“Blockchain is much more than crypto assets,” says Bhavna Haswani, vice president of product management and digital assets lead at J.P. Morgan. “On the other side of the spectrum of blockchain, we have digital assets, where we are seeing growing utilisation in the collateral and securities finance space.”
A digital representation
According to Simon Squire, managing director, global head of product development for Clearance and Collateral Management at BNY Mellon, tokenised traditional assets are assets that encompass a digital representation of a traditional asset class set on distributed ledger technology (DLT) or blockchain.
There are two main areas of tokenised traditional assets — one is tokenising a specific security and the second is tokenising a pool of assets. Tokenised traditional assets are only one of the non-cryptocurrency aspects of digital assets; securities or other assets may also be issued digitally on a blockchain or DLT. Squire explains that, in this construct, the asset is digitally or originally listed, recorded and then kept on the blockchain or DLT.
As an example, the European Investment Bank (EIB) launched its first ever digital bond issuance on a blockchain platform in 2021, deploying this DLT for the registration and settlement of digital bonds, in collaboration with Goldman Sachs, Santander and Societe Generale.
At the time, the EIB said that the digitalisation of capital markets could bring a range of benefits to market participants in coming years, including eliminating the requirement for certain financial intermediaries, reducing fixed costs, delivering faster settlement speeds and promoting better market transparency by improving their ability to monitor trading flows and the identity of asset owners.
Rina Azumi, executive director of digital assets, Global Banking and Markets, at Goldman Sachs pinpoints an uptick in enterprise readiness and increased institutional adoption of tokenised and natively digitalised assets in recent years. In addition, an acceleration in the representation of traditional financial assets on blockchain has also been evident.
This integration of the digital asset world and the traditional finance world is proving beneficial for market participants. According to Azumi, this evolution provides enhanced functionality — for instance, the speed efficiency in which DLT allows for trading to the nearest minute. Further, it provides potential for fractionalisation — the ability to split an asset into smaller fractions on blockchain and distribute to a wider investor base.
For Azumi, risk reduction is a key additional feature, whereby participants are able to settle with greater precision on blockchain, therefore enabling greater liquidity and capital efficiency. “There are operational efficiencies associated with being able to leverage blockchain and it carries cost savings as it removes the need for intermediaries,” she continues. “We have a single source of truth that is shared by all parties, which also removes the need for reconciliation.”
According to Digital Asset president Shane Akeroyd, a smart contract contains all of the information that an existing contract does, including an issue date, maturity date and coupon payment date. Smart contracts also include details of workflow or lifecycle events.
“We have checkpoints to ensure that rules, regulations and market standards are adhered to and we have connectors such as SWIFT to allow communication between market counterparties, particularly for the payments leg of the transaction,” Akeroyd notes. “What is lacking, and what smart contracts bring to the table, is evidence that this is being done, providing one neutralised view.
“Although we have different roles, responsibilities and permissioning, we will all, using a smart contract, own parts of this process at any moment in time and over time. Multiple parties using a smart contract will have a real-time view of everything that is going on.”
Further, Akeroyd says that blockchains are designed to guarantee the integrity of data across multiple counterparties using consensus protocol. There will be various validators on the network that will verify their own information, releasing it to the network on a permission basis or in real time. “One of the benefits,” he adds, “is that it will do away with the need to reconcile by replacing it with this consensus mechanism.”
The reality of tokenisation
A published report by the Boston Consulting Group (BCG) in September 2022 indicated that the projected growth of asset tokenisation would expand into a US$16 trillion business opportunity by 2030.
The report states there is an impending shift from traditional fractionalisation to on-chain tokenisation, which expands the scope of asset classes, stakeholder groups and regulatory scope for tokenisation. It adds: “Therefore, it is crucial to understand and appreciate the incremental benefit from fractionalising assets on blockchain-based platforms.”
Asset tokensiation is opening up a new world of opportunities to revolutionise how assets are issued, managed and transacted, says Yuka Hasumi, head of EquiLend Japan. For Hasumi, “the possibilities are endless”, to tokenise almost anything from personal to business, from property to equity. “Tokenisation is already a reality.”
Focusing on collateralisation and tokenisation — as it continues to evolve towards “a more proactive approach”, with collateral becoming more of a centralised global function for market participants — Hasumi says that though the positives for successful technology adoptions are “obvious”, implementation is always a challenge. Greater efficiency and increased transparency are two benefits of successful technology.
In May 2022, J.P. Morgan announced the transfer of tokenised money market funds (MMFs) shares on blockchain as collateral — stating it was the first firm globally to do so. The firm confirmed that both collateral provider and collateral receiver must be present on the blockchain-based application, known as the Tokenised Collateral Network (TCN), enabling participants to transfer ownership of the collateral without the need to transfer the underlying asset.
“It was a big moment for the industry,” says Hasumi, “in demonstrating how the technology works and to further drive more transparency, diversity and efficient scalability.”
According to Squire, a common problem that the industry faces is getting the right securities in the right place at the right time — an issue that is becoming increasingly important given evolving regulation and the current environment. Squire predicts that this is costing the industry tens, if not hundreds of millions of dollars on an annual basis.
Liquid assets get “stuck” in the real world all of the time, Squire indicates. He uses as an example a European government bond that settles five minutes before market cut off. “Ideally, you have lined up some secured financing for that asset, with five minutes before the market closes, the likelihood of being able to mobilise that asset into the right place is very difficult. The result is that the asset is going to be trapped or unencumbered in that location and not being utilised.
“Imagine a world where that asset is on a DLT and those assets can move seamlessly 24/7, the efficiencies that could be created for our industry is very exciting. Today, global banks hold liquidity buffers in Asia-Pacific, EMEA or the US. Imagine that you could take a US asset as part of the inventory pool and mobilise that around the timezones.” Squire indicates that DLT gives market participants an opportunity to make assets easier to mobilise.
The next quantum leap
In Q3 2022, EquiLend launched a new DLT solution to combat reconciliation inefficiencies called 1Source. The programme, which is currently in the design phase, aims to use emerging technologies to develop a common record, or “single source of truth”, to support trade processing across the transaction lifecycle. EquiLend indicates that, in building this solution, it will deliver a centralised DLT-based platform that will act as a “single source of truth” for securities finance lifecycle events and a universal source of data for the industry.
Shortly after this announcement, BNY Mellon and Goldman Sachs International settled agency securities lending transactions using the HQLAX DLT platform. HQLAX created ISIN-level securities trackers called Digital Collateral Records (DCRs), from loaned securities it received from BNY Mellon, giving Goldman Sachs a digital copy of those trades. Those records enable holders and agents to transfer ownership of any security on the HQLAX distributed ledger, without the need for conventional settlement mechanisms.
Squire finds a “real value” for DLT in the inventory and collateral management space, noting that the technology can be used to reduce friction associated with the fragmented settlement environments, especially in Europe, where there are a number of different markets. However, there are concerns. Squire highlights: “I do worry a little bit that we are building to create an ecosystem of disparate DLTs and that we end up creating an even more fragmented ecosystem for DLTs and the traditional world.
“We are going to need to take very thoughtful approaches as an industry. We might need to change our approach in the way that we think about competition and the way that we work together to make these worlds really come together and create a collaborative ecosystem.”
Assessing the next move for the industry, Akeroyd believes that there will be an increase in asset tagging — when collateral eligibility details are embedded in smart contracts, similar to how lifecycle events may be embedded into smart contracts. Akeroyd says that this will allow firms to look at the availability of collateral in real time. “A key new functionality is the locking of collateral to secure a party in one location against a liability in another, without having to move the collateral around,” he notes.
“A real-time view of our collateral and our positions will allow us to optimise our collateral and manage risk in a more efficient way. Going forward we will see more asset tagging, embedding eligibility criteria into smart contracts, we are going to be able to do this with many more assets than we are currently doing. We are potentially going to open up the world of collateral to assets that were previously not eligible,” Akeroyd explains.
Many within the financial industry look positively toward the adoption of digital assets and for this to become a part of an industry standard operating model. However, market participants remain mindful of potential complications and have recommended further education and regulatory frameworks as tools to promote the safe development of a tokenised economy.
Hasumi suggests that a clear regulatory framework is of key importance — ideally, a global alignment of regulatory framework and complimentary standards — to help force all market participants and vendors to think carefully about the best possible outcome and impact on the economy by creating real value.
In terms of regulatory framework, Akeroyd states that the perimeters for digital assets have been drawn “fairly widely” and, therefore, these perimeters need to be narrowed. This comes as no surprise given the broad definition of a digital asset. As stated by the Internal Revenue Service (IRS): “Digital assets are broadly defined as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.” Akeroyd notes that there are “obvious” differences in the risks presented by different types of digital asset, for example cryptocurrency and a tokenised government bond. Scalability, interoperability, composability are important to consider in this journey.
He adds: “Education will remain a focus. Like all new technologies there will have to be a translation layer between the market participants who will fund initial application and network development and technology providers. Full benefits will be realised once fast followers join the network as cost and operational efficiencies become obvious.”
As the industry looks towards the mainstream adoption of digital assets, industry bodies such as the International Securities Lending Association (ISLA) and the Pan Asia Securities Lending Association (PASLA) are working towards specific objectives to facilitate this journey.
“Firstly, standardisation has been mentioned as something which is very important, we are looking to clearly define what a digital asset is and the risk profile of each of them,” explains J.P. Morgan's Haswani. She indicates that the Common Domain Model (CDM) will play an important role in delivering this standardisation, essentially representing a dictionary of common terms. She anticipates that this will produce a clearer understanding of what a digital asset is and how to fit digital assets into the lifecycle of the business.
Secondly, ISLA, PASLA and their members continue their efforts to digitalise the Global Master Securities Lending Agreement (GMSLA) onto the CDM, allowing the standard GMSLA to be used for standard product and digital transactions.
Exploring this further, Haswani says: “For example, in the future, we are going to be seeing clients with a hybrid pool of assets — with traditional assets and digital assets. This portion of digital assets is going to grow in the future. How should clients account for a hybrid pool of portfolios going forward?”
Technology is evolving on a day-to-day basis and new ways are emerging to issue and structure digital assets, says Haswani.
Hasumi adds: “We are not quite tokenised. Ultimate nirvana would be interconnectivity of value and data. There are two segments of DLT — one is DLT of data, which is 1Source, and DLT of value, which is tokenisation. I personally feel this is the next quantum leap for the industry.”
“One of the really interesting things with this space is that you don't know what is going to happen next week, let alone in three or five years' time,” Squire concludes, “the immediate focus is going to be on-ramp and off-ramp.” To clarify, an on-ramp is any platform that facilitates users to acquire crypto assets or enter their markets. An off-ramp is a platform that facilitates a user to dispose of crypto assets or exit their markets.
He continues: “At BNY Mellon, we serve an interesting space where we can issue service custody and help finance those assets. As we talked about the fragmentation in this space, we are going to start to see complete solutions and more collaborations. It is going to be really exciting.”
Weaving through the challenges of implementation, the market calls for further education and refined regulatory frameworks to provide a safe environment for this migration, and hopes that these factors will act as a catalyst for moves towards a more tokenised economy.
“Blockchain is much more than crypto assets,” says Bhavna Haswani, vice president of product management and digital assets lead at J.P. Morgan. “On the other side of the spectrum of blockchain, we have digital assets, where we are seeing growing utilisation in the collateral and securities finance space.”
A digital representation
According to Simon Squire, managing director, global head of product development for Clearance and Collateral Management at BNY Mellon, tokenised traditional assets are assets that encompass a digital representation of a traditional asset class set on distributed ledger technology (DLT) or blockchain.
There are two main areas of tokenised traditional assets — one is tokenising a specific security and the second is tokenising a pool of assets. Tokenised traditional assets are only one of the non-cryptocurrency aspects of digital assets; securities or other assets may also be issued digitally on a blockchain or DLT. Squire explains that, in this construct, the asset is digitally or originally listed, recorded and then kept on the blockchain or DLT.
As an example, the European Investment Bank (EIB) launched its first ever digital bond issuance on a blockchain platform in 2021, deploying this DLT for the registration and settlement of digital bonds, in collaboration with Goldman Sachs, Santander and Societe Generale.
At the time, the EIB said that the digitalisation of capital markets could bring a range of benefits to market participants in coming years, including eliminating the requirement for certain financial intermediaries, reducing fixed costs, delivering faster settlement speeds and promoting better market transparency by improving their ability to monitor trading flows and the identity of asset owners.
Rina Azumi, executive director of digital assets, Global Banking and Markets, at Goldman Sachs pinpoints an uptick in enterprise readiness and increased institutional adoption of tokenised and natively digitalised assets in recent years. In addition, an acceleration in the representation of traditional financial assets on blockchain has also been evident.
This integration of the digital asset world and the traditional finance world is proving beneficial for market participants. According to Azumi, this evolution provides enhanced functionality — for instance, the speed efficiency in which DLT allows for trading to the nearest minute. Further, it provides potential for fractionalisation — the ability to split an asset into smaller fractions on blockchain and distribute to a wider investor base.
For Azumi, risk reduction is a key additional feature, whereby participants are able to settle with greater precision on blockchain, therefore enabling greater liquidity and capital efficiency. “There are operational efficiencies associated with being able to leverage blockchain and it carries cost savings as it removes the need for intermediaries,” she continues. “We have a single source of truth that is shared by all parties, which also removes the need for reconciliation.”
According to Digital Asset president Shane Akeroyd, a smart contract contains all of the information that an existing contract does, including an issue date, maturity date and coupon payment date. Smart contracts also include details of workflow or lifecycle events.
“We have checkpoints to ensure that rules, regulations and market standards are adhered to and we have connectors such as SWIFT to allow communication between market counterparties, particularly for the payments leg of the transaction,” Akeroyd notes. “What is lacking, and what smart contracts bring to the table, is evidence that this is being done, providing one neutralised view.
“Although we have different roles, responsibilities and permissioning, we will all, using a smart contract, own parts of this process at any moment in time and over time. Multiple parties using a smart contract will have a real-time view of everything that is going on.”
Further, Akeroyd says that blockchains are designed to guarantee the integrity of data across multiple counterparties using consensus protocol. There will be various validators on the network that will verify their own information, releasing it to the network on a permission basis or in real time. “One of the benefits,” he adds, “is that it will do away with the need to reconcile by replacing it with this consensus mechanism.”
The reality of tokenisation
A published report by the Boston Consulting Group (BCG) in September 2022 indicated that the projected growth of asset tokenisation would expand into a US$16 trillion business opportunity by 2030.
The report states there is an impending shift from traditional fractionalisation to on-chain tokenisation, which expands the scope of asset classes, stakeholder groups and regulatory scope for tokenisation. It adds: “Therefore, it is crucial to understand and appreciate the incremental benefit from fractionalising assets on blockchain-based platforms.”
Asset tokensiation is opening up a new world of opportunities to revolutionise how assets are issued, managed and transacted, says Yuka Hasumi, head of EquiLend Japan. For Hasumi, “the possibilities are endless”, to tokenise almost anything from personal to business, from property to equity. “Tokenisation is already a reality.”
Focusing on collateralisation and tokenisation — as it continues to evolve towards “a more proactive approach”, with collateral becoming more of a centralised global function for market participants — Hasumi says that though the positives for successful technology adoptions are “obvious”, implementation is always a challenge. Greater efficiency and increased transparency are two benefits of successful technology.
In May 2022, J.P. Morgan announced the transfer of tokenised money market funds (MMFs) shares on blockchain as collateral — stating it was the first firm globally to do so. The firm confirmed that both collateral provider and collateral receiver must be present on the blockchain-based application, known as the Tokenised Collateral Network (TCN), enabling participants to transfer ownership of the collateral without the need to transfer the underlying asset.
“It was a big moment for the industry,” says Hasumi, “in demonstrating how the technology works and to further drive more transparency, diversity and efficient scalability.”
According to Squire, a common problem that the industry faces is getting the right securities in the right place at the right time — an issue that is becoming increasingly important given evolving regulation and the current environment. Squire predicts that this is costing the industry tens, if not hundreds of millions of dollars on an annual basis.
Liquid assets get “stuck” in the real world all of the time, Squire indicates. He uses as an example a European government bond that settles five minutes before market cut off. “Ideally, you have lined up some secured financing for that asset, with five minutes before the market closes, the likelihood of being able to mobilise that asset into the right place is very difficult. The result is that the asset is going to be trapped or unencumbered in that location and not being utilised.
“Imagine a world where that asset is on a DLT and those assets can move seamlessly 24/7, the efficiencies that could be created for our industry is very exciting. Today, global banks hold liquidity buffers in Asia-Pacific, EMEA or the US. Imagine that you could take a US asset as part of the inventory pool and mobilise that around the timezones.” Squire indicates that DLT gives market participants an opportunity to make assets easier to mobilise.
The next quantum leap
In Q3 2022, EquiLend launched a new DLT solution to combat reconciliation inefficiencies called 1Source. The programme, which is currently in the design phase, aims to use emerging technologies to develop a common record, or “single source of truth”, to support trade processing across the transaction lifecycle. EquiLend indicates that, in building this solution, it will deliver a centralised DLT-based platform that will act as a “single source of truth” for securities finance lifecycle events and a universal source of data for the industry.
Shortly after this announcement, BNY Mellon and Goldman Sachs International settled agency securities lending transactions using the HQLAX DLT platform. HQLAX created ISIN-level securities trackers called Digital Collateral Records (DCRs), from loaned securities it received from BNY Mellon, giving Goldman Sachs a digital copy of those trades. Those records enable holders and agents to transfer ownership of any security on the HQLAX distributed ledger, without the need for conventional settlement mechanisms.
Squire finds a “real value” for DLT in the inventory and collateral management space, noting that the technology can be used to reduce friction associated with the fragmented settlement environments, especially in Europe, where there are a number of different markets. However, there are concerns. Squire highlights: “I do worry a little bit that we are building to create an ecosystem of disparate DLTs and that we end up creating an even more fragmented ecosystem for DLTs and the traditional world.
“We are going to need to take very thoughtful approaches as an industry. We might need to change our approach in the way that we think about competition and the way that we work together to make these worlds really come together and create a collaborative ecosystem.”
Assessing the next move for the industry, Akeroyd believes that there will be an increase in asset tagging — when collateral eligibility details are embedded in smart contracts, similar to how lifecycle events may be embedded into smart contracts. Akeroyd says that this will allow firms to look at the availability of collateral in real time. “A key new functionality is the locking of collateral to secure a party in one location against a liability in another, without having to move the collateral around,” he notes.
“A real-time view of our collateral and our positions will allow us to optimise our collateral and manage risk in a more efficient way. Going forward we will see more asset tagging, embedding eligibility criteria into smart contracts, we are going to be able to do this with many more assets than we are currently doing. We are potentially going to open up the world of collateral to assets that were previously not eligible,” Akeroyd explains.
Many within the financial industry look positively toward the adoption of digital assets and for this to become a part of an industry standard operating model. However, market participants remain mindful of potential complications and have recommended further education and regulatory frameworks as tools to promote the safe development of a tokenised economy.
Hasumi suggests that a clear regulatory framework is of key importance — ideally, a global alignment of regulatory framework and complimentary standards — to help force all market participants and vendors to think carefully about the best possible outcome and impact on the economy by creating real value.
In terms of regulatory framework, Akeroyd states that the perimeters for digital assets have been drawn “fairly widely” and, therefore, these perimeters need to be narrowed. This comes as no surprise given the broad definition of a digital asset. As stated by the Internal Revenue Service (IRS): “Digital assets are broadly defined as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.” Akeroyd notes that there are “obvious” differences in the risks presented by different types of digital asset, for example cryptocurrency and a tokenised government bond. Scalability, interoperability, composability are important to consider in this journey.
He adds: “Education will remain a focus. Like all new technologies there will have to be a translation layer between the market participants who will fund initial application and network development and technology providers. Full benefits will be realised once fast followers join the network as cost and operational efficiencies become obvious.”
As the industry looks towards the mainstream adoption of digital assets, industry bodies such as the International Securities Lending Association (ISLA) and the Pan Asia Securities Lending Association (PASLA) are working towards specific objectives to facilitate this journey.
“Firstly, standardisation has been mentioned as something which is very important, we are looking to clearly define what a digital asset is and the risk profile of each of them,” explains J.P. Morgan's Haswani. She indicates that the Common Domain Model (CDM) will play an important role in delivering this standardisation, essentially representing a dictionary of common terms. She anticipates that this will produce a clearer understanding of what a digital asset is and how to fit digital assets into the lifecycle of the business.
Secondly, ISLA, PASLA and their members continue their efforts to digitalise the Global Master Securities Lending Agreement (GMSLA) onto the CDM, allowing the standard GMSLA to be used for standard product and digital transactions.
Exploring this further, Haswani says: “For example, in the future, we are going to be seeing clients with a hybrid pool of assets — with traditional assets and digital assets. This portion of digital assets is going to grow in the future. How should clients account for a hybrid pool of portfolios going forward?”
Technology is evolving on a day-to-day basis and new ways are emerging to issue and structure digital assets, says Haswani.
Hasumi adds: “We are not quite tokenised. Ultimate nirvana would be interconnectivity of value and data. There are two segments of DLT — one is DLT of data, which is 1Source, and DLT of value, which is tokenisation. I personally feel this is the next quantum leap for the industry.”
“One of the really interesting things with this space is that you don't know what is going to happen next week, let alone in three or five years' time,” Squire concludes, “the immediate focus is going to be on-ramp and off-ramp.” To clarify, an on-ramp is any platform that facilitates users to acquire crypto assets or enter their markets. An off-ramp is a platform that facilitates a user to dispose of crypto assets or exit their markets.
He continues: “At BNY Mellon, we serve an interesting space where we can issue service custody and help finance those assets. As we talked about the fragmentation in this space, we are going to start to see complete solutions and more collaborations. It is going to be really exciting.”
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