Security Token Exchange

The advent of blockchain technology has brought new opportunities to the markets, tokenization being one of them. 

While the concept of owning and trading fragments of highly illiquid assets such as jewelry, art, precious metals, intellectual property rights, bonds, equities, and real estate might have seemed far-fetched for many a few years back, today, it has been made possible by tokenization which allows for fractional ownership and investment.

Tokenization is the process of taking traditional assets and putting them on-chain. These assets are represented by digital tokens that can be traded in secondary markets. 

By converting illiquid assets into “tokens,” it allows issuers to secure higher liquidity, as instead of purchasing the entire asset, tokenization allows for fractional ownership — a portion of the assets. This opens up investment opportunities to a larger pool of potential investors and helps create a more liquid market.

However, it might not be the full picture as Tal Elyashiv, co-founder and managing partner at SPiCE VC, argues:

“The market’s expectation from blockchain to be the magic that will bring liquidity to private equity and private securities was not very realistic.”

According to Elyashiv, while blockchain and tokenization have the possibility of providing more access and smoothing the transactions, “this is not what creates the liquidity.” What these assets need to be is “more interesting,” accessible, and have growth to create liquidity.

“If there isn’t much change, it doesn’t necessarily indicate volatility. But if the value of an asset changes, again, you’re unlikely to see much liquidity. That’s because people tend to buy and hold, and then nothing happens,”

– Elyashiv at the inaugural TokenizeThis conference.

We need more assets that are naturally “changing hands at a higher velocity in order to see more liquidity,” he added. Moreover, the market is too fragmented, as per Elyashiv, who noted that the more the number of players, the more broken the liquidity of an asset, and that has to change. 

He further said, “I think that players will have to come together and figure out that in order to create liquidity in a market that is growing from the bottom, you have to share order books and allow different players to fulfill an order or to create liquidity together.” 

Navigating the Present: The Tokenization Trend

Tokenization has been in trend this year, with traditional finance embracing its potential. It has been only recently that these big players started realizing the promising value of this transformative technology. 

Initially, the tokenization of financial assets started with less interesting assets, which resulted in “almost no liquidity,” but over the last couple of years, we have started seeing these big players being interested in tokenization, which simplifies processes and solves a lot of problems in the securities arena. 

However, we are still in a place where a fair amount of processes are being done manually. So, what is happening is there is a parallelization of token technology getting better and better and real-world assets being made available in a form that’s consumable, noted Alan Qureshi, managing partner at Blue Water FinTech. With the average end investor not having access or scale to be able to get access to these traditional assets, tokenization creates a “natural segue.” 

Lately, tokenization is gaining increasing traction in the US treasuries market due to the soaring interest rates in the global traditional market while the yield in decentralized finance (DeFi) tanks. Tokenization of Treasuries is actually leading the effort to put real-world assets (RWAs) to blockchain rails as crypto investors seek higher returns. In 2023, tokenized versions of US Treasuries grew nearly seven-fold to $698 million, according to RWA.xyz.

This growth is led by the Ethereum (ETH) blockchain, which is followed by the Stellar (XLM) network, with Polygon (MATIC) and Solana (SOL) also starting to attract attention, indicating “a diversifying blockchain landscape for tokenized assets.”

At the TokenizeThis conference, Elyashiv pointed out that “almost every major player” in capital markets today is using blockchain one way or another, which is the “mega progress” seen over the last five years. This, he believes, “reinforces the expectation that 10, 15 years down the road, all financial assets will be written on blockchain one way or another.”

It doesn’t matter which blockchain or protocols will be used by these institutions because, according to Elyashiv, “these will change over the next many years. What is important is that blockchain is going to be a key infrastructure behind the securities industry, and that means over a hundred trillion dollars worth of assets over a blockchain one way or another.” 

However, Scott Smiley, co-founder of HiYield, argues that, for tokenization, markets that don’t have good existing infrastructure are a good place to target as opposed to securities. This is because tokenizing existing securities comes with a double ledger system that you need to comply with in addition to moving settlement and other types of transactions on the chain, so you “have to mirror both in both infrastructures.” Hence, the next pocket of demand can be in areas where you can simply come in and bring efficiencies to areas like transparency history and action settlement.

Long-Term Outlook: The Future Trajectory of Tokenization

While the tokenization industry is increasingly attracting mainstream attention, we are still in the early phase. The Markets & Markets projects the tokenization market to grow to $5.6 billion by 2025 from $2.3 billion in 2021. Meanwhile, investment firm 21.co forecasts the market for tokenized assets to grow to $10 trillion by the end of the decade. So, there is clearly astounding growth ahead of us. 

As for how this future will look, especially who’s going to bring tokenization to the next level, Elyashiv believes it is going to be a combination of old big players such as JPMorgan, BlackRock, HSBC, and Fidelity as well as new entrants. 

Over the last three years, we’ve seen many incumbents seriously getting into this, who are not only investing money into the space but also doing serious stuff with tokenization, starting from the really hard areas of settlement and then moving to making things more accessible to investors, noted Elyashiv. So, “the ones that will adopt the technology will win, and the ones that won’t will not be here,” he said.

What this means is the future of tokenization will be led by incumbents along with new players, and “it’s going to move both top-down and bottom-up and meet somewhere in the middle.” HiYield’s Smiley is of a similar opinion and believes that both fintech and large financial institutions will have their kind of place in their niche in the future of capital markets. 

But this won’t be happening anytime soon, like next year, Elyashiv pointed out that instead, “this is going to take 10, 15 years.” During this time, we’ll be seeing steps being taken to realize such a future. 

This timeframe makes sense given that regulations around crypto space are still not clear yet, something that traditional finance institutions need to make their move onto a nascent industry like blockchain and crypto. However, after the implosion of the crypto exchange FTX last year, regulators around the world have ramped up their efforts to establish crypto oversight. 

Besides FTX, in the recent past, we have seen the crypto market go through a brutal winter, the ripples in the banking system resulting in the collapse of crypto-friendly banks like SVB, and investors in the crypto space looking at alternative ways to get access to assets.

According to Qureshi, this “shakeout has been good for the industry,” as well as the resulting potential for regulation. “I think that having less hype and more focus on real-world assets” that provide real value and solve real capital and investment needs is overall good for the crypto and tokenization space, he said.

We are already seeing the establishment of the world’s first comprehensive framework for crypto regulation in Europe with MiCA. While in the US, there are no clear regulations regarding digital securities, lawmakers are working on several pieces of legislation. However, their intentions or positions have been pretty clear.

“The US has been very fortunate that the SEC moved very early in 2019 and said digital securities are securities, everything applies, go play,” noted Elyashiv, “that made things much easier in the digital security space than in any other blockchain-related space.” But of course, there is this “duality” with the SEC wanting to see everything settled the old way, even if it’s on the blockchain.

Despite this, Elyashiv is of the view that change is coming in the near future. The reason for this is the entry of “a lot of very big traditional” and main market players coming into the space. “We recognize that regulation can change and adapt to the blockchain as a standard and will allow the settlement to happen in a natural way, and you won’t have to have the duality anymore,” he added, when that happens, it’ll be a big step forward, and we’ll see much more happening with more players joining into this and more standardization. Smiley said:

“I’m looking forward to ending that duality, however long that takes. You’ve already seen it in Europe. You don’t need this duality of managing both systems. So, I’m looking forward to that day coming.”

To put it succinctly, the future of asset tokenization promises widespread adoption. After all, it holds immense potential in terms of improving tradability, enhancing accessibility, and ensuring security. So, as blockchain technology matures and regulatory clarity continues to improve, we will see tokenization become more integrated into the global financial system, reshaping the way we invest, trade, and manage assets.

“The nugget is, at the end of this 10, 15-year process, you see well over hundred trillion dollars of assets on the blockchain, so it’s very, very worthwhile staying for the duration,” Elyashiv said.