5 game-changing benefits that tokenization provides

Written by Pat LaVecchia, Founder and CEO of Oasis Pro Inc./Oasis Pro Markets.

Gone are the days when I spent most of my business development efforts explaining the potential application of blockchain and distributed ledger technology (DLT) in the financial markets. Today’s market players have become aware of, if not already dipping their toes into, this market.

Headlines like the ones below show more than toe-dipping and more like major institutions embracing this latest development in the capital markets:

JPMorgan executes its first DeFi trade using public blockchain

UBS AG launches digital bond settled on blockchain and traditional exchanges

Blackrock, BNY Mellon, State Street join blockchain consortium for alternative investments

BNP Paribas joins JP Morgan’s Onyx blockchain as it ups the ante on digital assets

My view is that most major market players now see digital assets as part of their future. Why? Countless articles have been written about the benefits of digital securities. We know that tokenizing a security (whether it’s a simple stock or bond or a more complex investment like a private offering) is the process of leveraging the blockchain to create a digital representation (or “token”) of the security or underlying asset . This tokenization process can enable institutions to streamline processes and potentially expand their investor base. What else can financial institutions, and the investors they serve, gain from tokenizing securities?

Here are five game-changing benefits that tokenization promises to deliver.

New opportunities

The private markets, historically notorious for being opaque and inefficient, present a strong use case for tokenization. They are massive and growing even bigger, and yet many investors remain underweight private equity due to factors such as high minimum investments, long lock-ups, relative illiquidity and cumbersome underwriting processes. With the digitization of private offerings (such as in private equity, real estate and infrastructure), some of these disadvantages and inefficiencies are reduced, allowing more investors to gain exposure to growth and income opportunities. Correspondingly, these improvements open up for issuing institutions a wider potential investor base and increased income opportunities.

Cost savings

Smart contracts are the “worker bees” of blockchain technology, automatically executing complex sets of transactions when certain conditions are met. It is the use of smart contracts that brings benefits such as cost savings. Savings are achieved by reducing steps compared to traditional processes, both upstream (when a token is issued) and downstream (service/maintaining a token). These savings can be shared between the issuer (lower costs of bringing an offering to market and maintaining it) and the investor (the potential for improved economics in the form of higher returns or higher potential returns).

How does this occur? Calculations on the blockchain can serve as the single source of truth, removing the need for multiple reconciliations. Any updates can be automatically fed via application programming interface (API) directly to the financial institutions’ systems to feed downstream processing. Finally, this highway that is the blockchain will give institutions additional flexibility in figuring out how to one day leave behind the many legacy systems whose technology can be expensive to support and whose language is dated.

Streamlined payment processes

When an investment provides periodic interest payments, the benefits of tokenization are further realized. Traditionally, investors receive coupons or dividend payments, for example, only after third-party providers and back-office services have double-checked information such as wire instructions, mailing address and primary owner on the cap table. This process takes time and money. With a tokenized security that makes regular payments, the only information needed to process those payments directly to the investor’s digital wallet can be built into the token. The result is that earnings can be paid out correctly and almost instantly, with both sides having an immutable record (the blockchain) that these funds were sent.

Take asset-backed securities, many of which can be complex and provide uncertain and/or variable income streams. The cash component involved in these investments is often paid out as often as monthly. Using blockchain technology to review wallet addresses and eliminate cumbersome steps to get cash distributed back to each owner is a big part of the service equation.

Improved settlement processes

Traditionally, without blockchain, the settlement of an investment transaction is a three-step process. First there is the trade (the buy and sell order amounts are matched). Then there is the clearing process (the two so-called clearing members agree to exchange cash, thereby creating claims on each other). Finally, after two days (the standard settlement period for most securities – although some settlements are much longer), the final step in the transaction – settlement – has occurred when cash is transferred in exchange for security transfer via DTC.

With blockchain, settlement is almost instantaneous. It is now a two-step process – match and settle. There are no clearing steps involved. The smart contract facilitates the exchange of cash versus securities directly into each party’s wallet; if it doesn’t, the transaction will reverse itself. This near-instant settlement allows both parties to return cash and investments to operate faster.

KYC and client qualification process improvements

With the use of digital wallets and smart contracts, specific information about a customer’s eligibility, security-specific transfers and other regulatory restrictions can be encoded. This allows for more streamlined transfers of funds and securities and more effective monitoring of compliance. This benefits financial institutions that perform know-your-customer (KYC) procedures, which are critical to preventing fraud, money laundering and other crimes. It also benefits investors as these often time-consuming forms and applications can be completed once (and updated appropriately) rather than with each new investment.

The tokenization process benefits both issuers and investors by increasing efficiency in creating, issuing and managing assets and creating more secure, transparent and accessible markets. As awareness of this technology grows, so will momentum and real-world use cases. In fact, by 2030, some experts predict that the tokenization of global illiquid assets alone could grow to over $16 trillion and account for roughly 10% of global GDP. Both institutions and investors should be ready for the start.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice regarding your specific situation.

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