Changing everything
The tokenisation of assets involves the digital representation of physical assets on distributed ledgers, or the issuance of traditional asset classes in tokenised forms. It means you can manage and exchange assets globally in real time, increasing operational efficiency.
Currently, trade settlement and cash payments involve verification by a central body, which can be a time consuming process. The decentralised nature of blockchain changes that, creating efficiencies in record keeping and the delivery of funds for asset managers and asset owners alike. We are also seeing the emergence of tokenised bonds, which improve accessibility and liquidity through potentially lower fees and quicker settlement times. It’s still early days, but the impetus is already there. Additionally, tokenisation enables fractional ownership, which can improve liquidity and open up access to private markets and illiquid investments. Fractional ownership is increasingly in demand as asset owners continue to look for alternative sources of return but want more liquidity, given the geopolitical and global economic backdrop.
Inside blockchain
Blockchain is an information technology protocol that facilitates the process of recording transactions and tracking assets. Every transaction is logged into a data block and validated.
These blocks are all linked to each other, and the validation mechanism makes it almost impossible to break the chain. The longer the chain, the stronger it is; this is why blockchain is considered tamper-proof. It represents a shared record of the truth, and no participant can change or tamper with the transaction.
Utilising blockchain and digital asset technologies to drive operational efficiencies is not new. For example, Carrefour, the European food supermarket group, has gradually integrated blockchain technology to store information about a product, its origin, where it was farmed, how it was produced and where the product was sold.
Today, this is giving consumers more transparency about some of the products they buy.
Tokenisation is the process of converting any underlying asset into a digital token – this means the ownership of the asset is digitalised. The different types of tokens are:
- Stable coins: Cryptocurrency with a fixed price, often pegged or tied to government-issued currency.
- Securities tokens: Digital-assets for financing or investment. They represent a digital form of financial instruments or cash certificates. These should bring operational efficiency to the market.
- Non-fungible tokens NFTs: This is a growing area of interest in wealth management. An NFT is a cryptographic token — a digital identifier that might be linked to ownership of a piece of art or music.
- Central bank digital currency (CBDC): A digital currency issued, controlled and regulated by a central bank. A CBDC has the same functions as traditional currency
A protocol called a consensus mechanism is used to validate the authenticity of transactions on the blockchain. This means that if you purchase a tokenised security and transfer it into your wallet, everyone must agree that you own that security. This forms the governance structure of the blockchain.
‘Proof of work’ and ‘proof of stake’ are the two major consensus mechanisms used to verify transactions in the blockchain. ‘Proof of stake’ is the younger of the two and uses much less computing power and energy consumption. This concept is more environmentally friendly than the ‘proof of work’ model.
The important role of custodians
In the digital asset space, asset security and the ease of transacting will reinforce the value of custodians.
Custodians play an important role in determining the adoption of digital assets. They help manage the use of digital assets by harnessing their existing expertise, building clearly defined controls and procedures for the safekeeping of assets — similar to how they approach traditional assets today.
In the digital space, a custodian’s role will evolve to the safekeeping of a private key that provides access to the underlying assets. This is an important distinction. Controlling access to private keys will be paramount for the security of the underlying assets, ensuring that they cannot be accessed by another party while providing the same level of security that applies to traditional assets.
Practical considerations also need to be embedded into the tokenisation of financial instruments, such as the ability to facilitate corporate actions. This is likely to be in the form of ‘smart contracts’ – programmes stored in the blockchain that run when predetermined conditions are met. It means custodians need to develop a strong network of partners that can replicate what is done in the traditional space, such as corporate actions and income, in the digital assets space.
In the longer term, the very nature of digital assets will reinforce the value of custodians as guardians of asset security.
Central bank digital currencies will change everything, along with regulation
The emergence of CBDCs is a really important step. The Bank of England, for example, is looking at the case for a CBDC, as are other central banks around the world. This will drive greater adoption of blockchain.
Today, there is still a difference between delivery of assets and payment, with cash still managed traditionally in the blockchain.
A CBDC will change this, as everything will be able to be managed on the blockchain.
Regulatory activity around digital assets is also intensifying, and will potentially become less fragmented. Not surprisingly, regulators are focused on consumer and investor protections, along with risk policies, procedures and controls.
A limiting factor is the secondary market, which is restricting the expansion of digital assets. However, in Europe, the European Union DLT Pilot Regime is being developed and will lead to a trading facility. Through the facility, tokenised fund shares will be bought and sold in the secondary market.
Building awareness and becoming prepared
There are many paths ahead, and the financial services industry will have to grapple with the introduction of blockchain technology over the coming years. It’s clear that the speed of digital assets development will largely be in the hands of regulators and the creators of CBDCs. Developments in this area are quick to progress.
We might also see behavioural changes with institutional investors, which will drive demand for digital assets.
How do we grapple as an industry with this innovative evolution?
Digital assets education is going to be key across core functional areas such as compliance and risk. It will also be fundamental for those who control other oversight functions, such as fund boards and pension scheme trustee boards.
CACEIS is a major player in the fast-evolving asset servicing sector, building a digital assets ecosystem to meet clients’ growing demand for digital assets.
