(Kitco News) -
Tokenization has been a hot topic in recent years, with many experts predicting that the blockchain technologies that undergird cryptocurrencies will eventually be applied to traditional financial assets such as stocks, bonds, and real estate. With the news that BlackRock's iShares Core S&P 500 ETF (CSPX) has been converted into a token on the Ethereum network and can now be traded on the Uniswap decentralized exchange (DEX), that future appears to be upon us.
The significance of this move is difficult to overstate. BlackRock is the largest asset manager on the planet with $8.6 trillion in AUM as of year-end 2022, and with nearly $57 billion in the fund, CSPX is one of the most important ETFs in the marketplace.
And BlackRock is not alone. HSBC and the European Investment Bank (EIB) recently teamed up to launch the first-ever pound sterling-denominated digital bond using the HSBC Orion tokenization platform, and January saw Cité Gestion become the first private bank to tokenize its own shares under Swiss law in partnership with Taurus Technology.
But according to Jeff Vier, Head of Tokenization at Republic Crypto, the real innovation here is not technological, but legal, and while big-name firms and popular asset classes may grab the headlines, the biggest winners of tokenization will be the trading platforms themselves.
To have and to hold
Republic Crypto is a platform that curates private investing opportunities with high-growth potential across startups, gaming, real estate, and crypto. Vier has been plugged into the investment innovations of the crypto ecosystem “24 hours a day, seven days a week for about 10 years,” and he believes the BlackRock move is a harbinger of things to come.
“BlackRock issued a tokenized ETF, and they deployed it on a decentralized exchange,” Vier told Kitco Crypto. “That's actually very, very innovative. They allowed an asset that requires KYC [know-your-customer] to access to trade freely without the access component. It looks kind of vanilla, but it’s radically innovative […] imagine any amount more ETFs coming into decentralized finance, not being redeemed, but allowed to be traded and to participate in the lending, borrowing nature of finance in a decentralized way… it's like, the cat’s out of the bag.”
Vier said the global demand for securities is massive, but KYC prevents most people from buying them, breaking the world up according to geography, citizenship and regulatory environments, which limits the potential and the scale of the global market. “You want to give the world securities, because it's what people want to own,” he said. “But you can't because of KYC. And then when people do get there, they can't get liquidity because they're isolated into the platform that they've registered with.”
According to Vier, the magic happens when the custody and redemption components of securities are separated.
“When you take [securities] and you separate the custody piece, meaning being able to hold it, and keeping in mind it's not an asset that can be destroyed, you've separated the ability to hold it versus being able to redeem it,” he said. “So the trading value, or the decentralized finance [DeFi] value as collateral, has an unhinged or separated value from the redemption value, being able to actually go to the platform, conduct KYC with the asset that you purchased on Uniswap, and then actually redeeming it for its cash value.”
This means that because BlackRock still retains custody of their CSPX, but only issues tokens, these tokens can be freely traded anonymously across the globe, and KYC regulations do not apply. “It's actually very, very innovative,” he said. “It's not happening at the blockchain level, it's just happening at the legal level, and it's very smart.”
Have your KYC and eat it, too
Under this new tokenized regime, the asset gains the advantages of blockchain technology and DeFi without running afoul of regulators or sacrificing the security that traditional securities enjoy. Anyone who wishes can buy and trade the token, or post it as collateral, or stake it for yield on DeFi exchanges and protocols. Meanwhile, qualified token holders can still take custody of the underlying asset if they choose.
“Say I've decided I actually want to go and redeem for that asset,” Vier said. “I can go and conduct KYC, go through those processes and get that paper.”
“Now you may say, I don't want that. I actually want to remain in this private way, but I would like to leverage this asset. I would like to realize some of the value of it. So I'm going to post it as collateral for a USDC loan,” he said. “I'm going to take that USDC, I'm going to make an investment in something else, and then hopefully at the time of margin call, I'm going to return my premium, realize the upside to that loan, and get my tokenized ETF shares back.”
“That's what is really, really powerful here,” Vier emphasized. “You’re inextricably adding value to decentralized finance. I always say that the tokenized version is immediately more valuable than the paper version, because if it is as verifiable, as secure, or more secure than the paper version, but infinitely more flexible, then it could only be more valuable.”
While the tokenized asset creates profitable new opportunities for customers, the additional flexibility and traceability of the blockchain creates new opportunities for issuers as well.
“BlackRock may even decide that there are disclosures or information about that asset that does not require KYC,” he said. “They could stand up a Web3 webpage that anyone who's holding that token in a browser can go and access that information, and other people can't. So just because of the nature of being a token and being able to operate on that protocol layer of the internet makes it immediately more valuable. It's just a much more capable piece of technology.”
Gold, small nations will benefit from tokenization
Another key advantage of tokenization is efficient ‘hyperfractionalization,’ the ability of issuers to slice assets up into tiny pieces and create affordable entry points in all kinds of markets while keeping processing and management costs down.
“This hyper amount of fractionalization brings the access price, the cost to purchase way down,” Vier said. “And then the last leg of that journey is, because the price is way down, your distribution goes way further. So the more you can fractionalize an asset, which tokenization is the best at, the larger the investor base, and in this case retail investor base, you can reach.”
Vier said the biggest reason stories like the tokenized BlackRock ETF are getting attention is their ability to effectively create brand new markets for existing financial assets. “In some cases, depending on its instrument and its legal structuring, you can get it into decentralized marketplaces, and that further increases the liquidity and fungibility and trading of the asset, which is really exciting,” he said. “This can be a dollar-cost average strategy for anyone.”
And perhaps just as significantly, it can be offered by anyone, in any part of the world. This could be particularly advantageous when it comes to things like commodities, which are still limited by physical and regulatory barriers, trading hours, contract sizes, and licensing. “So if a small nation state wants to treasure a lot of gold, but they're not necessarily the size of a reserve currency like the U.S., they can actually afford all those transactions themselves.”
Tokenization will be won by platforms that make the market
Looking ahead, Vier sees a tokenized future dominated not by the big banks or the giant asset managers, but by one or more platforms that get in early and intelligently and leverage their direct access to both issuers and customers. “I don't think it's going be one asset class or one institution,” he said. “I think it's going be one platform, like a Republic or like a Robinhood, who's already interacting with investors on a day-to-day basis that’s just going to start conducting their issuances as tokens.”
Vier believes that when issuers come to a platform that recognizes the true potential of tokenization, the platform will take it upon themself to act as the tokenizer of the stock. “The platform is going to really be the conduit or the catalyst for ushering in tokenization to the masses,” he said. “It's the platforms that provide a two-sided marketplace. They work hand-in-hand with issuers to reach retail investors. That's who we think is going to win the tokenization watershed event.”
In Vier’s view, tokenization is inevitable for most financial assets, because it serves the interests of the biggest of BlackRocks, but also the smallest of retail investors, and it creates new opportunities for big profits, but no less important mechanisms for savings.
“I think they'll just become ubiquitous,” he said. “Everyone will see the cost savings, which is boring but a large part of why it's so valuable, and I think everyone will understand. It's a very big operational overhaul to make the change, but they'll do it, because it's the asset that retail investors will insist on holding, and the asset the platforms are insisting on issuing, and the one the issuers are insisting on. So it has all the advantages.”
