Tokenization is the registration of asset ownership on the blockchain, improving settlement efficiency, programmability, accessibility and reducing costs. Ethereum is the protocol with the greatest potential to achieve a universal global platform. Stablecoins are the first application of tokenization technology, with a market value of $158 billion. Gold tokenized products have the ability to transfer risk, and the tokenization wave is also concentrated in the treasury and credit product markets. Tokenization has the potential to drive blockchain activity and fee income, and Ethereum is the best choice. Tokenized protocols such as Ondo Finance and Centrifuge provide governance rights and protocol income. Tokenization is expected to become an important trend in the global capital market, bringing value to public chain tokens.
Original title: Public Blockchains and the Tokenization Revolution
Original author: Zach Pandl
Original source: grayscale
Translated by: Kate, Mars Finance
•Tokenization refers to the registration of asset ownership on a blockchain infrastructure. In tokenized form, assets may benefit from the capabilities of the blockchain, including more efficient settlement and the ability to interact with smart contracts.
• In most cases, the modern financial system is already quite efficient, and tokenization itself may not immediately lead to efficiency gains. Instead, we believe the main benefits may come from integrating users, assets, and applications onto a common global platform.
•From a crypto market perspective, while various assets may benefit from the tokenization trend, the assets with the greatest potential may be protocols that can provide a universal global platform.
Currently, Grayscale Research believes that the Ethereum blockchain is most likely to achieve this goal in the future.
Public blockchains can be viewed as general-purpose technologies with many potential use cases, from payments to video games to digital identity systems. Part of the value of this technology comes from bringing a variety of applications to a platform that is permissionless and open-architecture.
When users, capital, and applications are concentrated in one place, everyone in the ecosystem benefits from network effects.
Tokenization is one of the many applications of public blockchain technology. In some cases, existing "back-office" processes are so cumbersome that moving asset management to blockchain infrastructure may immediately improve efficiency.
But for many types of assets (such as public equities), the current digital infrastructure works reasonably well, and it’s not obvious that public chains work.
In these cases, the potential gains from tokenization could come from network effects: by moving the world’s assets onto a common platform, we have the potential to create a more powerful, more accessible, and lower-cost financial system.
From a crypto market perspective, while a variety of assets may benefit from the tokenization trend, the ones with the greatest potential may be protocols that can serve as a unified platform for tokenized assets, investors, and related applications.
Currently, Grayscale Research believes that the Ethereum blockchain is most likely to achieve this goal in the future.
System Upgrade
At some point, when blockchain is more widely adopted, securities might be issued and tracked entirely on-chain.
But today, beneficial ownership of securities—as well as physical assets such as real estate, physical commodities, and collectibles—is recorded on traditional off-chain ledgers (usually electronic books). Tokenization is the process of registering asset ownership on blockchain infrastructure so that market participants can benefit from the blockchain's capabilities. By design, the price of a blockchain-based token should closely track the price of the underlying reference asset.
Some of the benefits of converting asset ownership into blockchain-based tokens may include:
1. Settlement efficiency: Blockchain transactions are settled almost instantly and can be structured so that the exchange of assets is conditional on payment, reducing the risk of settlement failure.
2. Programmability: Tokenized assets can be integrated into software applications to allow for added functionality. For example, this could include transfers conditional on off-chain information, such as compliance approval, or using tokens as collateral in decentralized lending platforms.
3. Accessibility: Like the internet itself, blockchain is not limited by national borders. Therefore, tokenized assets can allow investors in more countries to access the world's best capital markets. Blockchain can also open up access to new asset types through fragmentation.
4. Reduced costs: By increasing automation and reducing the role of intermediaries, tokenized assets can reduce costs for issuers by reducing underwriting fees and lowering interest rates.
Researchers at the Bank for International Settlements (BIS) have defined a tokenization “continuum” to consider how the process might affect specific markets. On one end are markets that still require a lot of manual workflows, such as real estate or syndicated loans.
These assets may be difficult to tokenize, but the process can create meaningful efficiency gains.
On the other hand, in many other markets, the current electronic book entry system works quite well, such as public equities, mutual funds and ETFs, and exchange-listed derivatives.
These assets may be easier to tokenize, but the process offers more limited efficiency gains.
The best candidate for tokenization is probably somewhere in the middle of the BIS continuum: markets that would benefit from moderately better electronic recordkeeping and smart contract capabilities.
This list could include many types of fixed-income securities, such as government bonds and structured products. However, as discussed further below, the greatest benefits may come from moving all assets onto a unified global platform.
Tokenization: Now and in the future
The first application of tokenization technology in finding product-market fit is stablecoins, which tokenize the simplest and most liquid asset: cash. The market capitalization of stablecoins now totals $158 billion, led by Tether (USDT) and USDC (Exhibit 1). Stablecoins come in different forms, but both USDT and USDC can be considered fiat-backed stablecoins.
They operate similarly to other tokenized assets: the traditional asset is held in custody off-chain, and the tokenized representation can be held in a blockchain wallet.
In tokenized form, this type of digital cash could be used for payments, benefiting from blockchain’s potential for near-instant settlement, reduced costs, and/or interaction with smart contracts.
Chart 1: Stablecoins have found product-market fit
After stablecoins, the next widely adopted tokenized asset is gold (Figure 2). The two largest projects, Tether Gold (XAUt) and PAX Gold (PAXG), have a combined market capitalization of approximately $1 billion. While there are many ways to invest in gold, these products all offer blockchain features, including the ability to transfer risk on weekends or outside of traditional market hours.
This characteristic played out during recent geopolitical tensions in the Middle East: during the week of April 13-14, when other markets were closed, both XAUt and PAXG saw notable volatility.
Figure 2: Timeline of selected tokenization projects
The latest wave of tokenization has focused on two distinct markets: U.S. Treasuries and closely related assets, and credit products.
Tokenized U.S. Treasury products are designed as cash equivalents and can be considered a yield-bearing alternative to stablecoins. According to data provider RWA.xyz, the weighted average maturity of all existing products currently offered is less than two years. In other words, these products are designed to provide yield and offer cash-like functionality. When cash rates are close to zero, the opportunity cost of holding stablecoins is relatively low.
But now that U.S. dollar interest rates are approaching 5%, investors have a greater incentive to seek out yielding alternatives, which may have boosted the growth of tokenized Treasury products.
There is currently over $1 billion outstanding in tokenized Treasury funds, led by the Franklin On-Chain U.S. Government Money Fund (FOBXX) and the BlackRock USD Institutional Digital Liquidity Fund (BUIDL) (Exhibit 3).
Many existing products have been launched on the Ethereum network and appear to be geared toward crypto-native institutions, such as crypto trading funds and DAOs (decentralized autonomous organizations).
However, the largest fund, FOBXX, took a different approach: it launched on the Stellar blockchain and is open to retail investors via a mobile app.
Overall, about 60% of tokenized treasury fund assets are managed on Ethereum, 30% on Stellar, and the rest on other blockchains.
Figure 3: About 60% of tokenized treasury products are on Ethereum
Many companies have also launched tokenized credit products. This is a diverse category that includes direct lending to individual counterparties, structured credit product pools (such as ABS, CLOs), and lending to intermediaries in specialized fields (such as real estate financing, emerging markets).
While these products can be risky and complex, and are currently designed only for institutional investors, their goal is simple: to move money from lenders to borrowers over blockchain infrastructure.
According to RWA.xyz, there are currently $612 million in active loans in this category, with an average yield of approximately 10% (Figure 4).
Figure 4: Tokenized credit products cover different borrower groups
There are many other potential applications for tokenization technology, but few have made it past the experimental stage. For example, tokenized real estate platform RealT provides non-US investors with a way to fractionalize property ownership; the protocol currently has $103 million in total value locked. There is also hope that the tokenization of private equity funds will provide the alternative investment industry with a way to attract a wider range of investors. It remains to be seen whether these new distribution channels will contribute meaningfully to the industry's AUM. Various fixed income securities have been issued directly on-chain, by public sector issuers (such as the European Investment Bank) and private sector issuers (such as Siemens). Although there have been previous attempts to tokenize equity securities, we suspect that these projects will require more regulatory clarity before they can move further.
If adoption continues, tokenization has the potential to drive significant blockchain activity and fee revenue because the addressable market is so large.
In the US alone, Treasury bonds represent a $26 trillion market, and total lending to the domestic non-financial sector is $36 trillion. The number of tokenized assets currently on-chain is a small fraction of these totals. However, in order for these products to outpace today’s crypto-native institutions, they need to connect more efficiently to existing pools of capital.
This may require establishing a connection to a brokerage or bank account, or providing investors with a sufficiently compelling reason to move their assets on-chain.
The revolution will not be personal
There is a common misconception that tokenization may not benefit crypto assets because such activity will occur on private permissioned blockchains rather than public permissionless blockchains like Ethereum.
While banks have indeed experimented with private blockchain infrastructure (such as JPMorgan Onyx, HSBC Orion, and Goldman Sachs DAP), this is at least partly a reflection of current regulation, which prevents depository institutions from interacting with public chains.
Asset managers that don’t have the same constraints have been building on public chains, or a hybrid of public and private chains.
In fact, this is true for almost all successful tokenized applications to date. Stablecoins, tokenized treasuries, and tokenized credit products have been launched on public blockchain infrastructure. The reason is simple: this is where the users are.
We anticipate that moving certain assets onto blockchain infrastructure will increase efficiency.
But the greater promise of tokenization comes from seamlessly connecting assets and investors (or borrowers and lenders) around the world, and building richer experiences through interoperable applications.
Public chains have many applications beyond tokenization, making them natural hubs for user assets and activity over time.
For this reason, they are also likely to continue to be a key destination for asset issuers and developers building open finance applications.
In our view, private permissioned blockchains operated by national government companies are unlikely to reliably provide the neutral global platform needed to custody the world’s tokenized assets.
Transactions, Fees and Accruals
Blockchain transactions typically generate fees, which can flow to token holders directly (such as dividends) or indirectly through a reduction in token supply (such as buybacks).
Therefore, if asset tokenization leads to transaction activity and fees, this can add value to blockchain-based tokens. However, the mechanism by which this occurs will vary depending on the type of protocol and token properties (Figure 5).
Figure 5: Crypto assets can benefit from tokenization
Certain components of our smart contract platform crypto sector should see the most immediate impact. Layer 1 blockchains in this segment (and perhaps eventually components of their layer 2 ecosystems) can serve as a global, universal platform for tokenized assets.
The native tokens of these protocols are often used to pay transaction fees (“gas”) and may earn staking rewards and/or benefit from token supply reductions.
There is meaningful competition in the smart contract platform crypto space, but the Ethereum ecosystem still dominates other chains in terms of users, assets (total value locked), and decentralized applications. In addition, in our view, Ethereum can be considered very decentralized and reliably neutral to network participants - likely a requirement for any global tokenized asset platform.
Therefore, we believe Ethereum is currently best positioned among smart contract blockchains to benefit from the tokenization trend.
Other smart contract platforms that could benefit from the tokenization trend include Avalanche (used in various proof-of-concept projects for financial institutions), Polygon, and Stellar, as well as layer 1 blockchains designed for tokenization such as Mantra and Polymesh.
The next group of beneficiaries include the tokenization protocols themselves — platforms that provide software applications that bring traditional assets on-chain (Figure 6).
Many of these providers do not have governance tokens (e.g., Securitize, Superstate), but some do. Examples include Ondo Finance, an issuer of tokenized treasury products, and Centrifuge, a tokenized credit product platform and component of the financial crypto sector. Before considering these tokens, investors should consider the nature of the governance rights they convey and the claims they provide on protocol revenues (if any).
Figure 6: Year-to-date returns of selected tokenized protocols
Finally, increased blockchain activity due to tokenization could support various other components of the crypto ecosystem.
For example, Chainlink hopes that its Cross-Chain Interoperability Protocol (CCIP) will provide the core infrastructure for passing data across blockchains, both private and public.
Likewise, the Biconomy Protocol provides certain technical processes that can help traditional financial institutions interact with blockchain technology (e.g., a “paymaster” service that allows users to pay for gas in tokens other than the blockchain’s native token).
Both Chainlink and Biconomy are components of our Utilities and Services Crypto division.
Tokenization Vision
Grayscale Research believes that many aspects of digital commerce are transitioning from closed platforms hosted by centralized intermediaries to open and decentralized platforms based on public chain infrastructure.
Tokenization is one of many blockchain adoption trends, but it could be a significant one given the size and scope of global capital markets.
If a public blockchain can bring together borrowers and lenders (or asset issuers and investors) and eliminate the intermediation role of existing financial technologies, then increased network activity should bring value to the public blockchain token.
Disclaimer: This article does not constitute investment advice. Users should consider whether any opinions, views or conclusions in this article are suitable for their specific circumstances and comply with the relevant laws and regulations of the country and region where they are located.
Keywords: Tokenization Ethereum
Reposted from MarsBit
