The launch of the first blockchain application bitcoin in 2009 invoked much hype but also scepticism. However, increasing market adoption and institutionalisation of the underlying blockchain technology warrant a closer look.
Blockchains are distributed databases managed by a network of multiple participants. Through their innovative technical setup, blockchains ensure both consistent and immutable data across multiple stakeholders. Blockchains can be either private or public. While private blockchain participation is restricted, public blockchains are open to everyone. Private blockchains consist of a network of participants that know each other and can build trust among themselves, while public blockchains mostly operate on a pseudonymous basis. Even in a trustless environment, the public blockchain technology ensures data consistency among the network participants.
Blockchain technology has large potential for financial markets. Assets can be ‘tokenised’--that is digitally represented on a blockchain as a token. While the scope of tokenisation is unlimited, we at DWS generally distinguish two categories: First, tokenised assets including all traditional and alternative asset classes, such as tokenised equities, bonds and real estate, and also tokenised funds. Second, tokenised money describes tokenised traditional fiat money and can either be issued by central banks (e.g., central bank digital currencies or CBDCs) or by private institutions (e.g., ‘stablecoins’).
By using tokenised assets... market participants directly communicate via the blockchain
Broad tokenisation adoption is expected to lead to considerable efficiency gains. Today, the asset management and broader financial markets value chain is fragmented across many centralised parties. They must constantly reconcile transaction and other data, leading to considerable friction loss. By using tokenised assets and tokenised money, the different market participants directly communicate via the blockchain. This would therefore increase market transparency, as well as enable faster settlement and heightened automation. Smart contracts, that is automatically executable code on a blockchain, could automate many processes such as corporate actions. Tokenisation could thus lead to cost efficiencies and may even shift market infrastructures with new players emerging and others losing power.
Use cases
Blockchain technology has been successfully tested for the last 15 years. Today, the largest tokenisation use case is stablecoins, which are blockchain-based tokens that are 1:1 pegged to an underlying currency, most often the USD. Stablecoins have a current market capitalisation of ~$140bn (as of 26 February 2024, according to coinmarketcap.com).
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Other tokenised assets are still in their beginnings, but there are landmark proofs of concept from large institutional players. Examples include the European Investment Bank, which in 2021 tokenised a bond on the public ethereum blockchain, and Siemens, which in 2023 tokenised a bond on the public polygon blockchain. Even if there are multiple hurdles to overcome for scaled adoption and new risks that need to be understood and managed, the large potential of blockchain technology warrants further work on this topic. Other past disruptive innovations such as the computer, the internet, but also passive investing have taken many years if not even decades for scaled adoption.
Barbara Schlyter spoke on a blockchain panel at the Association of the Luxembourg Fund Industry’s Global Asset Conference on 20 March 2024. This guest contribution first appeared in Delano’s print edition.