What's Asset Tokenisation and what impact for financial markets?
Unnoticed by many, innovations in financial services have shaped large parts of the world as we know it today.
Most notably, the invention of the joint stock company as well as the stock exchange had lasting geopolitical effects on a global scale. The ramifications of these novelties that led to a democratisation of capital markets can still be felt today. At present, we see ourselves confronted with new developments that are likely to be as revolutionary as was the introduction the joint stock company and the stock exchange: asset tokenisation. Going forward this new concept will unlock massive values globally and will help to create more efficient and fairer capital markets.
DISTRIBUTED LEDGER TECHNOLOGY AND TOKENISATION
It can be argued that, with the arrival of tokenised assets, we are at the dawn of a development similar to the introduction of the joint-stock company and the opening of the first stock exchange in 1602. Asset tokenisation converts rights to an asset into a digital token. While the process itself is similar to asset securitisation, tokenisation makes use of Distributed Ledger Technology (DLT), most notably the blockchain. This technology provides five major advantages over conventional technology employed by financial services firms. First, DLT provides greater transparency to all parties, as they share identical documentation that can only be updated via a clearly‑defined consensus process. Secondly, this innovative technology provides better means of traceability, as every transaction is recorded and stored simultaneously on a vast number of nodes, and is thus auditable. Along with the first two features goes the third advantage of DLT, namely enhanced security. DLT is more secure than traditional means of recordkeeping, as transactions must be agreed upon before they are recorded and are immutable ex post. These features also lead to the fourth advantage of DLT: it typically increases efficiency and speed, as it largely does away with paper-based processes and human error. Last but least, it regularly reduces costs, as it streamlines processes and reduces the number of parties involved.
APPLYING DISTRIBUTED LEDGER TECHNOLOGY TO FINANCIAL MARKETS
While the advantages of DLT may sound somewhat abstract at first, they become more tangible if we put them in the context of capital markets. Deploying DLT to the world of finance yields numerous benefits, among others these five: firstly, we will observe an increased degree of disintermediation, i.e. a reduction of middlemen. Theoretically, we no longer need a bank, a broker and an exchange, as buyer and seller can directly interact with each other. Secondly, we will experience higher execution speed, as DLT reduces the number of middlemen and shortens settlement times. Thirdly, any investment opportunity can obtain global market exposure. Virtually anyone with access to the Internet can participate, within the given statutory limits, in virtually any investment opportunity, independent of geographical presence. Fourthly, investment projects will enjoy larger crowds of investors, as new investor segments can be reached. Investment opportunities currently restricted to a few wealthy individuals, such as art or gemstones, can be made available to anyone. Fifthly, DLT has the potential to significantly reduce market manipulation, as every transaction is transparently recorded in real-time, shared, immutable, auditable, and at all times accessible to all stakeholders, including the regulators.
The hurdles for tokenising an asset in order to make it tradable on a DLT-powered financial market are extremely straightforward and inexpensive from a technical point of view.
At the same time, the benefits of making an asset tradable should not be underestimated. In his seminal paper “Marketability and Value: Measuring the Illiquidity Discount” (July 2005), Aswath Damodaran explicated that a publicly traded company displays a 20-30% liquidity premium over a non-publicly traded company. This liquidity premium is due to higher market efficiencies resulting from ceteris paribus more market participants, higher trading volumes, smaller spreads and a lesser price impact. Given this line of argument, the case for asset tokenisation becomes rather compelling: everything else remaining equal, an asset will increase in value if it is made tradeable.
Already today, various examples of tokenised assets exist, covering as diverse areas as real estate (e.g. Property Coin), commodities (e.g. Oil Coin), diamonds (D1 Coin), gold (digix coin), art (e.g. Maecenas), luxury goods (e.g. Tend) and national currencies (e.g. Tether). Another case in point is the blockchain-based platform Bitcar, which provides fractional ownership of a portfolio of exotic cars. Hence, instead of owning one single vintage or sports car yourself, you can buy into an entire portfolio of such cars. What may look like a rather eccentric investment at first glance has a serious economic background: collectable exotic cars the last decade. The tokenisation of such cars opens up an asset class to an investor segment that until now could not afford buying into it. But the investor is not the only one profiting from asset tokenisation, the seller of the assets also benefits from the new arrangement. Imagine the owner of a piece of art who needs liquidity at short notice: she could now sell half of her painting to a crowd of art enthusiasts. Or think of the owner of an SME who would like to retire gradually. Now, thanks to asset tokenisation, he could conduct a public offering that investment banks would have previously priced as prohibitively expensive. Via a so-called Security Token Offerings (STO), the art owner as well as the company owner could now tender their assets, or parts thereof, to any investor globally.
These new offerings in the world of security tokens are furthermore complemented by an entire range of service firms, providing asset tokenisation, emission, and trading as a service such as STOGlobalX. Moreover, an increasing number of incumbent players are now venturing into the field, providing those bits and pieces of the infrastructure which are necessary to create a lasting ecosystem for tokenised assets and security tokens: Fidelity Investments, for instance, announced to establish a subsidiary providing custody and execution for digital assets. Falcon bank now offers a digital wallet to store tokenised assets. The Swiss Stock Exchange proclaimed its objective of establishing a regulated trading platform for digital assets1. Lloyd’s of London has widened its product offering to insure custodians holding digital assets for their clients. This list of developments is not exhaustive.
The sum of total global wealth is currently around USD 317 trillion2. Discounting for exchange-traded financial products, and thus only assuming a liquidity premium of 10 %, more than USD 30 trillion in value could be unlocked by making assets more fungible. In the years to come, asset tokenisation will be the method of choice to do exactly that. Moreover, those countries that embrace this new concept and democratise capital markets will obtain a strategic advantage over other nations. Those countries fostering asset tokenisation may shape the future of the world as did those who first embraced the notion of the joint stock company and the stock exchange in the past.
|PATRICK SCHUEFFEL is adjunct professor at Fribourg’s School of Management in Switzerland and the school’s Liaison Officer in Singapore. He is an educator, researcher and business developer. After many years of experience in banking and financial services in Europe, he now also advises firms by connecting the dots between digital Europe and digital Asia.|
(1)https://www.six-group.com/en/site/digital-exchange.html, July 2018.
(2)According to Credit Suisse Global Wealth Report 2018.