For several years now, tokenization of financial assets, a process where an asset is replaced or replicated with a code-based digital “token” on a digital ledger such as a blockchain, has been viewed as a potential game-changer in the investment process, promising to significantly enhance efficiency and transparency.
This method offers gains in terms of settlement speed, accuracy of data transfers between security accounts, and transparency of information related to a given asset. However, developments in this space have so far been predominantly limited to experimental “proof of concept” tokenization use cases, rather than done at scale with real portfolio assets.
New research indicates a growing trend, with nearly half (40%) of buyside investment institutions now implementing a digital asset tokenization strategy, anticipating both revenue gains and operating cost savings.
The State Street 2024 Digital Assets Study was conducted earlier this year and surveyed 300 investment institutions, including asset managers, asset owners and insurance companies, on a variety of digital asset topics, including tokenization.
Of particular interest is the potential for tokenization to be applied to illiquid assets. A significant majority of respondents (64%) believe that private equity would be among the first asset classes to be routinely tokenized and traded via digital ledgers. Half of the respondents expressed the same sentiment for private debt, and 44% for real assets such as real estate and infrastructure.
Conversely, just a third (33%) said the same of publicly traded fixed income while only 28% expect tokenization to be applied to public equities.
Respondents also see significant benefits in terms of operating cost reductions and revenue increases that could accrue from tokenization.
Among the principal challenges to trading and settling tokenized assets is moving them on and off chain between digital ledgers such as blockchains and traditional ledgers. Such interoperability requires a network of providers and partners to offer a combination of traditional financial services such as custody and fund administration, as well as services involving new technologies that facilitate tokenized investment.
Interestingly, our Digital Assets Study finds that smart contract generation and the creation/issuance of tokenized assets is one of the top service areas investment institutions are interested in. They would like to see provisions in the marketplace to enable interoperability between traditional finance (TradFi) and decentralized finance (DeFi).
Tokenization is a top priority for a substantial minority (41%), along with blockchain creation and maintenance (45%) and cybersecurity (43%). These services will be particularly important to more than half (55%) of respondents who plan to issue tokenized assets.
Respondents are also divided on how long it would take before tokenization becomes a mainstream form of capital markets security. More than half (58%) expect it to take at least a decade to become mainstream, while nearly half (47%) have already traded assets between digital and traditional custody arrangements or are “extremely prepared” to do so.
It appears organizations may be underestimating their peers’ preparedness for tokenization, relative to their own. If so, their predictions for the time it will take to enter the mainstream across the industry could also be underrated, and we could be closer to a world of tokenized assets than the industry realizes.
Jeslyn Tan is head of product management, Asia-Pacific, at State Street.
