The Federal Reserve Board recently released a paper discussing the rapidly growing financial innovation in crypto asset markets known as tokenization. This paper provides an overview of tokenization and its potential implications for financial stability. The report was published by Francesca Carapella, Grace Chuan, Jacob Gerszten, Chelsea Hunter, and Nathan Swem
What is Tokenization?
Tokenization refers to the process of constructing digital representations, known as crypto tokens, for non-crypto assets, termed reference assets. This innovation creates interconnections between the digital asset ecosystem and the traditional financial system. If tokenized assets reach a significant scale, they could transmit volatility from crypto asset markets to the markets of the crypto token’s reference assets.
Design Features of Tokenization
Definition: Tokenization links reference assets to crypto tokens through design features that tie the token’s price to the value of its reference asset. Ideally, it would allow a crypto token holder to have a legally enforceable ownership claim over the token’s reference asset.
Development: Tokenization projects are often financed and developed by venture-capital backed crypto companies. Notably, financial firms like Santander, JP Morgan, and Franklin Templeton have announced crypto-related projects or pilot programs related to tokenization.
Components: A typical tokenization involves five design features:
- A blockchain
- A reference asset
- A mechanism to assess the value of the reference asset
- A means to store and/or provide custody for the reference asset
- A mechanism to facilitate redemptions of the token and/or the reference asset
Current Size of Tokenization Markets:
As of May 2023, the estimated market value of tokenized assets on permissionless blockchains stands at $2.15 billion. This includes tokens issued by decentralized protocols and traditional companies. The total value locked (TVL) in the entire DeFi ecosystem has remained consistent since June 2022. However, the TVL in categories related to real-world assets has seen growth since July 2021.
Examples of Tokenized Assets:
- Agricultural Commodities: Tokens like SOYA, CORA, and WHEA represent soybeans, corn, and wheat respectively. These were launched in Argentina by a joint venture between Santander and Agrotoken.
- Gold: Tokenized gold has a market capitalization of approximately $1 billion as of May 2023. Dominant coins in this market include Pax Gold (PAXG) and Tether Gold (XAUt).
- Real Estate: Real Token Inc. (RealT) tokenizes legal rights on residential properties. Each property is owned by a separate LLC, and the membership interests in these LLCs are tokenized.
- Financial Assets: Tokenized versions of stocks, bonds, and ETFs exist. For instance, tokenized stocks of companies like Amazon, Tesla, and Apple have been traded on crypto exchanges.
Potential Benefits of Tokenization:
- Accessibility: It can provide investors with access to markets that might be otherwise inaccessible or expensive to enter.
- Programmability: The ability to embed additional features into the tokenized asset can benefit markets for the underlying reference assets.
- Lending: Tokens can be used as collateral, facilitating lending where it might be more costly or impossible with the reference asset.
- Quick Settlement: Transactions in tokenized assets can settle faster than those in their real-world counterparts.
Tokenization is a promising financial innovation with the potential to reshape the landscape of asset ownership and trading. While it offers numerous benefits, it’s essential to be aware of the financial stability implications as the market for tokenized assets grows. Here at allincrypto.com we will keep you up to date with the revolutionary features DLT offer the financial markets in the form of tokenization!
Source: Finance and Economics Discussion Series 2023-060, Federal Reserve Board