Tokenization: The Business Case for Adoption May be Improving

The business case for the adoption may be improving for the tokenization of assets – typically securities or real-world assets that may benefit from distributed ledger technology to remove intrinsic friction from current standards. This is according to a recent report produced by McKinsey entitled, Tokenization:
A digital-asset déjà vu.

While the prospects for tokenization may be getting better, progress has not lived up to the hype. At least so far. The report states that “stronger business fundamentals and structural changes” may foreshadow a promising future of tokenized assets.

While noting that some analysts predict that digital securities could top $4 trillion or even $5 trillion by 2030, the report adds that Fintech Broadridge is now enabling over $1 trillion of “tokenized repurchase agreements monthly on its Distributed Ledger Repo (DLR) platform.” So this is a real world use case that has traction. There are others.

The benefits probably start with cost. Smart contracts that automate operations in the life of a digital asset can simplify and accelerate processes that can become almost instantaneous.  The “cheaper and more nimble infrastructure” can drive savings for all stakeholders in a digital asset. This can include asset owners or managers, investors/purchasers, and intermediaries that enable the entire process. Issuance, custody, trading, servicing, and compliance can be automated.

So what is the hold-up if things are so rosy?

McKinsey points to “infrastructure, implementation costs, market maturity, regulation, and industry alignment.” This and the fact that relatively few assets have been tokenized to date.

Beyond operational hurdles and institutional inertia, regulatory parameters don’t exist everywhere. Securities markets have been running effectively for many decades. Blockchain tech is the new kid on the block. Change is hard.

The report explains:

“To date, the regulatory framework for tokenization has differed substantially by region or has simply been absent. US players are particularly challenged by undefined settlement finality, lack of legally binding status of smart contracts, and unclear requirements for qualified custodians. Further unknowns remain regarding the capital treatment of digital assets. For instance, the US Securities and Exchange Commission has implied through Staff Accounting Bulletin 121 that digital assets must be reflected on the balance sheet when providing custodial services—a stricter standard than for traditional assets. This requirement makes it cost prohibitive for banks to hold and potentially even distribute digital assets.”

The SEC may be missing an opportunity here as they appear to be pushing back instead of leaning in, in a world where everyone knows digital is the future.

The report believes that tokenization may be at an inflection point. While a long time in coming, this is good to hear for industry pioneers. The report says “tokenized cash” or stablecoins are gaining traction, and short-term business fundamentals are looking better.

While the US has been slow to embrace the need for tokenization rules, other jurisdictions, like the EU, may pull America along.

In closing the report summarizes:

“These shifts are always challenging, as it means running the old and new operating models in parallel for a while, which is hard to do when costs are in focus. Regulatory uncertainty only compounds the difficulty. However, given the potential benefits tokenization can bring to financial services, recent moves by leading incumbents suggest they may be up for the challenge, although it could take some time. Meanwhile, banks, asset managers, custodians, and others can take some no-regret moves today to prepare for this possibility of a tokenized world—the strategic optionality may be worth it after all.”

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