Scaling tokenisation: key requirements and challenges

Who will win the race to tokenise real-world assets? Will it be the innovators in decentralised finance (DeFi) where most of the activity currently takes place or will banks and traditional firms eventually come to dominate the market?

Different parts of the digital asset market face distinct challenges when it comes to Real-World Asset (RWA) tokenisation. These distinctions are often missing from discussions about scaling tokenisation but it’s an area where both crypto-native players and regulated firms have something to learn from one another.

Traditional banks and regulated financial institution are required to take a very different approach in order to enter the tokenised asset market. Often, TradFi firms are less familiar with digital assets and find it costly and complex to navigate all the pieces needed to tokenise and custody assets in a compliant way. In DeFi, by contrast, there remains a lack of liquidity because the largest asset managers, investors and real-estate trusts are not active on decentralised exchanges and the absence of regulation means that institutional liquidity is still sitting on the sidelines.

Rene Michau, Global Head of Digital Assets at Standard Chartered says that, while not everything works perfectly in DeFi, there is a reason why tokenisation is mostly still happening in this space: “In the DeFi world, the players understand digital asset custody and how to map a RWA onto a cryptographically-secured smart contract. In contrast, the regulated financial markets need to grapple with all of their existing legacy infrastructure, regulation and compliance requirements. Bridging the gap between these two extremes is essential for tokenisation to scale”.

So how should financial institutions get started with RWA tokenisation?

Rene argues that: “many of the constraints that prevent us from having digital asset innovation in traditional financial services organisations are not regulatory; it is more of an infrastructure problem”. He says that four pieces of infrastructure really need to be in place for real-world tokenised assets to scale. The first two crucial steps are being able to deal in a transferable form of digital money, specifically stablecoins, as well as having the ability to custody assets across multiple networks.

The need for settlement assets on-chain

For financial institutions, the idea of open money on a blockchain currently only exists in the form of stablecoins. Indeed, a recent report from Standard Chartered and Zodia Markets notes that stablecoins are arguably blockchain’s first ‘killer app’. To deploy stablecoins, market participants either need to be customers of a particular bank and use that bank’s stablecoin or else require a Central Bank Digital Currency (CBDC) to settle the cash leg of the transaction. Since CBDCs currently don’t exist at scale, banks must use stablecoins, which predominantly exist on public blockchain networks.

Rene explains the dilemma: “For this to become a reality, we need a mechanism to custody these assets. We need the assets to move over a network to multiple new forms of distribution, whether that’s other banks or exchanges. They can even be traditional exchanges; it doesn’t have to be a crypto exchange. And we need the ability for money to move back the other way on a blockchain in the same way that the assets can move both ways.”

The paramount role of the digital asset custodian

Digital asset custody means that you can see that asset visibly on a public blockchain. Having the ability to custody assets across multiple blockchains is an important aspect for banks working with issuers. Rene explains: “Imagine what it takes to deal with the risk and regulatory component of that process within a regulated institution. First, if you work with asset issuers, it’s ideal if you have a custody capability. If you can allow the smart contract which represents the asset to be written to a wallet address, where you can manage that wallet address infrastructure and potentially write that smart contract to the issuer’s address, and then allow the issuer to distribute that to buyers”.

Finding a good third-party custodian is paramount. As we continue to see the rise of tokenised RWAs, tokenised money market funds and stablecoins, one of the most important capabilities for a regulated bank is being able to provide safekeeping. Only with secure custody, combined with risk management and the infrastructure for permissioned and public blockchain compatibility, can financial institutions begin scaling RWA tokenisation more effectively in future.

The challenge of distribution

Many regulated firms issuing tokenised assets today have solved the problem in the short-term by building their own self-managed platforms such as HSBC Orion, Onyx by J.P. Morgan or Goldman Sachs’s GS DAP. These platforms have all the characteristics of a blockchain but they are wrapped inside an organisation and operate more like centralised databases. This has its drawbacks, says Rene:“Instead of being able to take the asset and get it to a wider pool of investors or improve the efficiency of getting it to your existing investors, you have to bring investors to you. You need to do that and all of the blockchain implementation as well. The interim step duplicates the cost. You need the ability to get the asset to more venues giving access to more investors. Otherwise, fractionalising the asset becomes less interesting”.

In the digital asset world, most of those complexities are not there. Products are not built on a single database, which is managed by a discretely employed workforce and where money transfers to another organisation with another discretely employed workforce supporting another central database. Instead, a product is written on a distributed ledger that is visible, as is any construct you put on top of that, such as the fractionalisation of that asset.

The need for venues

Once the first three factors are in place, the other missing piece of the puzzle is the need for venues. Currently, cryptocurrency exchanges are not regulated for the types of assets that traditional firms want to tokenise, so are largely not suitable for serving TradFi players’ needs. They tend to lack the necessary KYC/AML requirements and other elements needed for regulatory compliance. On the flip side, traditional exchanges are not integrated enough with the digital assets ecosystem to be able to take on tokenised assets and list them. The arrival of more traditional venues would also bring a much-needed level of product marketing that is currently lacking from the more niche crypto exchange side.

Which use cases are ripe for RWA tokenisation?

Many real-world assets are ripe for tokenisation including high-value assets such as gemstones and precious metals, art, real-estate, equities and bonds. Tokenised money market funds have already achieved some interest and publicity, notably BlackRock’s BUIDL which launched last year. Currently, however, Rene believes the most straightforward use case for tokenisation is stablecoins, which offer a transferable claim similar to bearer instruments.

Tokenised bank deposits, while emerging as an alternative, are not yet at scale or delivering their full commercial benefits. Historically, bearer instruments provided value transfer flexibility, an attribute that account-based systems lack. Stablecoins resemble cash-flow assets like government bonds, which can be traded or used as collateral, improving utility.

He comments on this need for genuine utility in the market: “The problem we’ve got is that it is very easy to look at a bond or commodity like gold and tokenise it. That does not mean that it’s any more useful as a token. It depends what can you do with it, who else can you trade with and so on. It’s not just I can actually tokenise it but why have I tokenised it? And what is it good for?”

He adds: “Taking an asset and writing that as a token to a blockchain is trivial as an exercise. The key question is, where are unregulated institutions adopting the tokenised forms of monetary instruments? Corporates are using stablecoins for difficult-to-reach markets. From a payments perspective, crypto exchanges are starting to look to money market funds for forms of collateral to improve the way they operate credit on their venues. Many investors are now using an ETF structure over crypto to get exposure to more risk on assets. This is where the unregulated part of the market is finding utility and therefore adoption”.

In future, once the missing infrastructure is put in place to service traditional markets, there are likely to be lots of asset classes in different contexts that develop scale. The challenge for 2025 onwards is bringing all these pieces of the RWA tokenisation puzzle together so that this rising asset class can really achieve its full potential.

 

Disclaimer: This article is provided to you for your information and discussion only, and represents the views of others outside of Zodia Custody. It should not be regarded as a solicitation or an offer to buy or sell any products or services in any country to any person to whom it is unlawful to make such an offer or solicitation. Virtual Assets may lose their value in full or in part and are subject to extreme volatility, and the owner and/or investor in the Virtual Asset can lose all the money or other value they invest, and does not benefit from any form of financial protection. View full disclaimer here: zodia-custody.com/marketing-disclaimer.