If you have not yet heard of tokenization, you likely will in the near future. It is a promising innovation and a potential solution to some of the systemic challenges embedded in traditional finance (TradFi). Tokenization refers to the process of converting traditional assets (such as real estate, stocks, and commodities) and non-traditional assets (works of art, rare collections, wine, etc.) into digital tokens stored on a blockchain, which is a type of distributed ledger technology (DLT). The main challenges embedded into the TradFi system are illiquidity, high costs, and inaccessibility by the masses.
Benefits of tokenization
Increased liquidity: Tokenizing assets can enhance liquidity, allowing for easier and faster trading and settlement of transactions compared with traditional markets. In theory, tokenized assets can be traded around the clock on decentralized platforms, which would unlock value and reduce illiquidity premiums.
Lower transaction costs: Tokenization eliminates the need for most intermediaries and streamlines the settlement process, leading to quicker settlement and lower costs for investors as it is algorithmically driven. Additionally, fractional ownership enables smaller investors to buy into high-value assets that were previously considered out of their reach.
Improved accessibility: The tokenization of assets has the potential to democratize access to investments by breaking down barriers to entry. Regular investors may have the opportunity to incrementally invest in a diverse range of assets – including real estate, fine art, and venture capital projects – without the need for large capital outlays, which have served as a de facto barrier to entry in the past.
Challenges and risks of tokenization
Regulatory uncertainty: The regulatory frameworks surrounding tokenization vary greatly across jurisdictions and are still evolving. There is no universally agreed-upon framework yet. The uncertainty surrounding legal and compliance issues may hinder the widespread adoption of tokenized assets and potentially lead to regulatory crackdowns in some cases as all of this is still being figured out.
Security concerns: The digital nature of tokenized assets introduces cybersecurity risks, including hacking, fraud, and outright theft. These issues could be proactively addressed by means of encryption and multi-factor authentication to better protect investors and build trust in tokenized platforms.
Market manipulation: As with any financial market, tokenized assets may be susceptible to manipulation and abuse. This will require transparency and robust market surveillance so that regulators can provide much-needed oversight to quickly detect and effectively deter illicit market activities.
How has Wall Street responded?
According to a SEC filing from March 19, 2024, BlackRock – the 800-pound gorilla of Wall Street – has created a new tokenized asset fund called the BlackRock USD Institutional DigitalLiquidity Fund. On-chain data reveals the fund has been seeded with initial capital of $100 million USDC (USD Coin, a digital stablecoin) on the Ethereum blockchain. With this new venture, BlackRock clearly hopes to pioneer and lead the transition from traditional investments to decentralized digital assets.
Conclusion
Is tokenization the wave of the future? It certainly has that potential, and based on the BlackRock announcement, the future may already be here. If approved and implemented, tokenization would go a long way toward democratizing access to premium assets that have so far been available only to the uber-wealthy, thus helping tear down the walls between the haves and the have-nots. The rapid and “always on” nature of trading tokenized real-world assets would certainly add to the convenience, but it may also increase an investor’s emotional anxiety as there would always be live market pricing on hard-to-value assets. All in all, asset tokenization has all the hallmarks of a disruptive technology with the potential to make life both easier and more complex. Regulators must proactively keep pace with innovations and provide investors with the protections they need and deserve. If executed properly, tokenization can become the rising tide that lifts all investor boats.
– JEFFREYJANSON, CFP®, AIFA®, CBDA
Senior Wealth Advisor
