tokenisation done right
Platform design
What should the tokenisation roadmap look like? What are the key design criteria that we are building into our tokenisation journeys today and what are the considerations behind them?
10. Tokenise first, then go native
“You don’t need any regulations to manage tokenised assets today – you just need the blockchain participants to agree on the rules and treatments”
The significant majority of blockchain cases today are based on tokenised securities – rather than natively digital issuance.
Driven largely by regulatory limitations (around the treatment and recognition of digital assets by regulated institutions), the tokenisation of existing securities can seem frustratingly tactical for many firms – given the significant reduction in the benefits that can be derived.
Yet - as platforms such as Broadridge DLR, Paxos and Axoni have shown - there is plenty of efficiency (and learning) to be derived from this tactical step – free as it is of regulatory dependencies. Firms can reduce friction, fees and data corruption across ecosystems today using tokenisation – making up a powerful first step in the road to ‘the main event’.
11. Connecting to legacy: managing switching costs
"So much focus is on what’s on the blockchain – but that’s the easy part. How do you fit that into the platforms that we already have? That’s the real problem"
The single business challenge that market participants face in their tokenisation journeys is connecting their blockchain infrastructures to their legacy technology platforms. And as our tokenisation efforts grow each year, so does the importance – and cost - of this key step.
Even before tokenisation, our legacy platforms already had a huge prioritisation challenge – just to keep up with business-as-usual requirements (driven by clients, regulations, etc.). In that context, the need to connect a legacy treasury system to a new blockchain (for example) is just another item on an already long list – and a potentially significant switching cost.
"Do we treat tokens as traditional securities in our systems; or do we tokenise the traditional ones so that everything behaves as a token"
In the short term, this has forced many tokenisation platforms to stay disconnected from mainframe systems – either through separate entities or through separate risk and treasury management systems. Many bond issuances today have been done on platforms that have yet to connect to core banking systems and general ledgers – but we are only delaying the inevitable.
Yet those that have connected their token and legacy infrastructures (to support live, scale usage) have run into several core challenges.
First, how do you treat the assets? Do you treat your tokens as traditional securities in your core systems – or do you tokenise everything and run everything on a ledger? Consider the treatment of a utility settlement coin (a tokenised Euro for example) and the answer is less clear than it should be. Is a tokenised Euro the same as a traditional Euro (i.e. with the same currency code) or does it justify its own currency code (similar to the CNY / CNH designation for Chinese RMB)? The downstream implications of these minor questions are profound and need extremely detailed analysis.
Second, how do you avoid having to choose between CSDR and tokenisation, for example? By adding new requirements to already crowded system roadmaps (supported by limited resources), firms can inadvertently force themselves into very difficult choices.
But perhaps connectivity to legacy technology shouldn’t be the participant’s concern at all. High profile projects such as Clearstream’s D7 have been built on the principle that the underlying technology (blockchain or not) should be invisible to the user. If participants connect via an API to manage their securities today, why wouldn’t they continue to do that tomorrow (or until they are ready to become a node)?
By managing and taking accountability for the switching costs between old and new worlds, tokenisation platform operators can significantly simplify the path to platform adoption – accelerating usage and scale.
"The technology needs to be invisible to the market participants"
12. Public chains vs privacy: is it a choice?
In 2022, one of the key evolving themes in the tokenisation discussion has been around the use of public and private blockchains.
Against a backdrop of cyber-security and hacking concerns, it is no surprise that the significant majority of institutional blockchains today are run on a private basis. By keeping the entire blockchain separate, firms can maximise security and minimise their network risks. Only those distributing products to retail or wealth clients might opt for public blockchains.
"How can we create an environment that is as public as possible but as secure as possible? People want to go there."
Yet through this year, people have increasingly questioned this logic. ‘Why cant we have a public blockchain where everyone can participate – but where not everyone can see all the data?’
The business case to support this, nuanced solution are clear. If every firm were to build and manage their own private blockchain the costs to them (and their clients) would be vast – and most likely prohibitive for all but the largest players. By contrast, the use of shared infrastructure across multiple firms would increase accessibility, bring down entry costs and help to fuel innovation.
The only question is how to ensure privacy for every participant on the chain. Here the key point is in separating the chain from the application that runs on it.
“There’s no reason why the blockchain and privacy have to be one and the same. We’re moving to a model where the app defines the privacy properties for its own data – and then the blockchain enforces those.”
(Yuval Rooz, Co-Founder and CEO – Digital Asset)
13. What about the cash?
“The value of a means of payment is determined by its tradability in the market. No other alternative has the liquidity today”
“Stablecoins are still not cash. There are no technical constraints for us to use them – but plenty of legal ones”
Whilst huge advances are being made in tokenising the security-leg of transactions, the cash leg of these transactions continues to be managed off-chain in the majority of cases today.
This is driven by two factors.
In the spirit of assuming a manageable level of risk in each project, most firms have opted to use old world payment rails for the short term – simply because it removes complexity and risk from the project. It is easier to distinguish a tokenised security from a traditional one in a system than it is to distinguish two types of the same cash – and so firms prefer to leave that challenge for the future.
The second is a lack of alternatives. In today’s regulatory environment (and in the absence of any viable Central Bank Digital Currencies – or CBDCs), no stablecoin or payment token has yet emerged that can equal the value of cash (from a liquidity and balance sheet treatment perspective).
Change is no doubt coming, but tokenised cash is not part of many project plans today.
14. Interoperability: who should I be talking to today?
“We need to have just one token that all distributors will use”
As more blockchains enter live usage, the question of inter-chain connectivity is growing evermore important – in two different dimensions.
Much discussed is the question of how competing chains can connect to form the scale of ecosystems that will unlock significant industry value. With individual blockchain operators inevitably limited by the scale of their existing deployments (often with a small number of counterparties on each chain), there is an existential need for them to join in order to make sufficient volumes of liquidity available. Far from being a competitive misstep, connectivity to other blockchains (e.g. in bond issuance) is a core requirement if each provider is to reach the deal volumes needed to justify their investment. Blockchain operators need to be asking themselves which of their peers they should be connecting to – today.
The second dimension of interoperability is within the firm and across the asset lifecycle. We now have tokenised bonds, tokenised collateral and tokenised repo platforms – and so how can the three join together so that a tokenised bond issued and kept by HSBC can be available as collateral in HQLAx or used in a repo on Broadridge’s DLR?
