Blockchain technology is increasingly finding applications across a wide range of banking, and asset mobilization is the one area to benefit from the technology.
Blockchain combines elements of distributed databases, consensus algorithms, cryptography, and peer-to-peer networks to create an immutable distributed ledger that cannot be altered. It’s often known as distributed ledger technology (DLT) – which sets it apart from traditional financial ledgers which are centralized.
One particular use-case of DLT is in the tokenization of assets. This is where assets are digitized into a token that represents the real (physical) asset. This token is then stored on the blockchain. This results in all sorts of possibilities, from automation, disintermediation, transparency to improved liquidity potential, and fractional ownership of assets.
Today, tokenization is seen as the new way people will trade various types of assets through using technologies like blockchain and smart contracts. It opens up markets that were previously only accessible by large financial institutions and has the potential to disrupt the main players in the financial market.
The trends that are converging to change asset mobilization
There are a number of wider trends impacting the financial markets at the moment:
- The financial sector is striving for digital innovation – users are expecting technology to close the gaps of inefficiency they have suffered so far
- Users are ready to adopt new solutions if they prove easy to use, flexible, and good value– disruptive technologies such as DLT open up new business avenues
- Financial institutions and fintech vendors compete for innovation – DLT-based solutions represent a valid alternative to traditional instruments and are setting the new competitive scenario for financial institutions and fintech vendors
A common thread in today’s thinking is that current methods of asset exchange using centralized trust agents such as central banks, exchanges, financial institutions are inflexible and inefficient. Decentralized asset registers, using DLT technology with distributed consensus algorithms, represent a more efficient method to verify the integrity of transactions.
As Darwin said, “it is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.” This quote can be applied to the banks and financial institutions and their role in the token economy.
What are the benefits of asset tokenization using blockchain?
Currently, credit asset portfolios have very low liquidity or, if they do, it is very relative. In addition, it is very expensive to operate in markets for the purchase of NPLs, syndicated loan shares, PFs, or trade finance and this is only available to a limited number of investors. This market is tremendously limited, not very transparent, very manual, takes a long time to execute its transfer and has many intermediation costs, and even requires geographical mobilization to structure sales. Therefore, because of the aforementioned inefficiencies, the bid-ask gap of credit assets is increased. For example, traditional Trade Finance players, commercial banks mainly, moved into a model of originate to distribute (OTD) and currently, institutional investors are increasing their interest on the trade finance space as an alternative to low interest rates.
Asset digitization and by extension, tokenization is not a new concept but the use of blockchain to record trades of tokenized credit assets opens up a number of benefits in trade finance for corporates and investors:
- The public blockchain by default implies transparency: all trades taking place on the blockchain are available to all its participants. This is important for any user, as they can trace the entire history of all actions with a particular asset, verify its origin, and see how its ownership has been transferred.
- Security, compliance, and data protection in the tokenization of credit assets: transactions are public recorded, and the details cannot be removed from public evidence once written on the blockchain network, bringing highest standards of security to all players. Blockchain technology also adds confidentiality to all participants and works as an immutable and tamper-evident proof.
At the same time, different KYC and AML procedures are already implemented in the model and they can be easily exported to multiple jurisdictions.
- Efficiency: tokenized assets can be operated into a utility-based platform for trading and custody that provides easy, fast trading and settlement process without moving assets from the original SPV with all documents securely stored in private data rooms.
- Flexibility: Potentially, trading based on token-by-token basis, allows investors to improve investment strategies amplifying capabilities such as stock picking in terms of risk, return profile, geography... On the other hand, the increased number of participants, due to the multiple and fast token transactions among different investors, facilitates the portfolio bid-ask gap reduction.
- Increased liquidity and accessibility: Blockchain technology provides a decentralized system and allows anyone from anywhere around the world to tokenize assets and sell them at any time. Moreover, the list of assets can be extremely broad and include illiquid assets such as real estate or even antiques and artworks. Blockchain removes numerous barriers to investment and provides greater liquidity.
- Lower illiquidity premium: Illiquidity premium describes the compensation investors seek for the risk of loss relative to an investment’s fair value if an investment needs to be converted to cash quickly. Blockchain makes investments more liquid and therefore lowers the illiquidity premium.
- Real-time clearing/settlement and reduced costs: Blockchain technology allows the owner of the asset and its buyer to trade with each other directly without an intermediary and without the need for third party settlement and the costs associated.
Moreover, it usually takes hours or even days to transfer assets and conduct related transactions and legal paperwork, but thanks to the blockchain this process can now be completed in seconds.
In conclusion, asset tokenization using blockchain technology has the ability to transform traditional asset mobilization. It has the potential to enhance liquidity, increase transaction transparency, and reduce costs associated with clearing and settlement.
At NTT DATA, we are helping Corporate Banks in the transition to blockchain and tokenization and leading them towards new disruptive business cases based on the technology we offer. From now on, banks and corporates should work together to find the correct route for this new technology that will consequently add extra value across the chain.