Introducing Tokenization and Web3 to Financial Institutions
Joseph LaMonte, John Avery
March 15, 2023
The total value of retail and institutional investments held by financial institutions reached US$112T at the end of 2021, according to Boston Consulting Group (BCG) – that’s 117% of the World Bank’s estimate of 2021 global GDP. How those trillions of dollars are invested greatly impacts how individuals build wealth and save for retirement. It affects how investors and the most prominent financial services organizations operate.
Additionally, equity funding to wealth tech startups hit a new record of $18.9B in 2021, nearly tripling that of 2020. That funding continues to flood into tech-driven artificial intelligence (AI) and blockchain technology. This year’s FIS® Global Innovation Report revealed that most executives are hiring and incorporating digital assets into their strategies for 2023. Specifically, 50% of financial services firms are hiring for Web3 expertise. The tokenization of real-world assets to use Web3 technology can unlock a world of opportunities for investors and fund managers. They just need to know where to start.
Demystifying the terms behind the technology
When people hear the terms blockchain and tokenization, their minds immediately turn to cryptocurrencies. In today’s world, volatility is another buzzword linked to the crypto asset market, and it’s no wonder people paused after the significant loss of value in some cryptocurrencies in the second half of 2022.
However, it’s important to know that the events that transpired in 2022 are concentrated in the market structure for crypto as an asset class and not the broader digital asset technology space. Investors and fund managers have a real opportunity to leverage similar technology in new, innovative ways. To expand, let’s start by demystifying the key terms blockchain, Web3 and tokenization.
The blockchain has three significant characteristics: it’s a type of distributed ledger, decentralized and immutable. On the blockchain, data can be simultaneously stored and accessed across multiple nodes, and that data isn’t controlled by a single administrator. Additionally, since it’s immutable, cryptographic algorithms that reinforce the blockchain make it so that once a block is added, it’s nearly impossible to alter. The blockchain serves as a single source of truth since all the information stored there is practically tamper-proof, resilient to attacks, fully accessible and isn’t controlled by a central authority. Because of this, blockchain technology is proving to be exceptionally valuable wherever there is a demand for high-data security and data sharing.
When we think of the web today, we’re in the era of Web2. It’s the social media revolution where anyone can consume and create content, but the ownership of that content belongs to the “big guys” like Facebook, Twitter and YouTube. Unlike Web2, where we have no control over our data, where it’s stored, who it’s shared with and how entities monetize it, Web3 is decentralized. Chris Dixon, a partner at a16z, describes Web3 best as “the internet owned by the builders and users, orchestrated with tokens.” This means the network runs on millions of computers worldwide and hosts decentralized apps (dapps) that run on blockchain technology. In Web3, every time users and builders participate, they accumulate tokens where you can either hold onto your earnings or exchange them against fiat currencies.
Tokenization is not a new concept, but its execution using blockchain opens a world of possibilities to create, record and transfer assets and value. Essentially anything that has value can be tokenized including securities, real estate, commodities, art, physical goods, collectibles and intellectual property. Tokenization unlocks liquidity for illiquid assets and enables the digital transfer and management of these real, “off-chain” assets in the digital world.
Benefits of asset tokenization
Digitization is known to increase speed, convenience and accessibility. Add those benefits to the use of blockchain technology, and you have operational efficiencies that include smart contracts and programmable actions to automate processes and reduce time and operational costs. Using blockchain to tokenize real-world assets means they can be recorded, stored and managed digitally in an unchangeable and distributed way. Because of the management efficiencies driven by smart contracts, operational costs are lowered such that minimum ticket sizes for investments can be reduced, democratizing access to otherwise, which creates new opportunities for investors and fund managers.
Tokenization opens new opportunities for investors and fund managers
For investors, asset tokenization can deliver easier access by reducing minimum investment amounts. This helps attract a wider range of investors and thus builds and taps into larger pools of capital to provide deeper liquidity, efficient price discovery and the potential to use investments as collateral. Additionally, tokenization allows investors to increase their investment breadth with a broader range of asset classes including private equity, private debt, real estate and more.
When blockchain technology and asset tokenization collide, fund managers can benefit from smart contract automation to unlock efficiencies such as streamlining back-office processes, faster transaction times and instant payments. Tokens can be traded 24/7, with records updating within minutes. They’ll also benefit from efficient and transparent asset processing and the resulting cost efficiencies that unlock a wider set of institutional and retail investors. The compliance process is also streamlined because, with blockchain, fund managers have controlled visibility to external parties and can code restrictions into the tokens themselves such as who can hold tokens and when they can be traded to reduce the burden on internal administrators.
What’s in store for the future of institutional adoption?
Looking forward, tokenizing real-world assets using Web3 technology will continue to grow and better connect disparate pools of issuer and investor capital. In addition, stablecoin use-cases will start to take shape in B2B payments and other value transfer use-cases that are inefficient and slow today such as cross-border flows between businesses. Finally, established administrators, custodians and brokers will continue building out the pipes connecting digital assets into their services for fund managers and wealth managers – not just for crypto, but for all digital assets.
Those who focus on future opportunities, adapt quickly and listen to market needs will thrive in the next wave of blockchain-driven innovation. By engaging with technology, institutions have the opportunity to be active participants in the innovations of tomorrow.