The Tokenization of Institutional Funds

In 2021, prominent banks like JPMorgan Chase, BNP Paribas, and BNY Mellon introduced blockchain conversations to institutional audiences. In 2022, tokenization will feature prominently in financial discussions across the country.

What had been quietly brewing in the background came to light late last year as a number of banks identified blockchain technology as critical to scaling alternative investments.

From JPMorgan Chase opening up blockchain-based payments for big businesses to huge retail banks like BNP Paribas and corporate investment banks like BNY Mellon issuing digital asset and tokenization whitepapers, 2021 was a banner year for exploring modernization strategies.

These early explorations set the stage for a more efficient alternative investments ecosystem where many manual intermediaries are automated away by improving the underlying technology. The path to going fully digital is becoming readily apparent, and tokenization is leading the way.

Contractual Efficiency

Tokenization is the process of issuing and managing securities on a blockchain so that each share is represented as a unique digital asset security token. Also known as digital asset securitization, this process represents an opportunity for institutions to streamline investment operations from start to finish.

In practice, tokenization combines bespoke securitization methodologies with templatized smart contracts to manage both physical and digital assets on the blockchain. Predefined smart contracts serve as tokenization’s connective tissue, programmatically executing repeat labor that would normally be managed by hand using over-the-counter (OTC) contracts.

This intelligent automation generates long-lasting operational efficiencies that will continue to accrue as institutional tokenized funds grow in size, volume, and popularity.

Goodbye Reconciliation

Using blockchain platforms and smart contracts to manage the securities lifecycle makes reconciling transactions trivial.

Today, a single OTC trade can require more than a dozen post-trade operations. After settling the trade, accountants from their respective firms need to zero out balance sheets across all intermediaries involved, a massive act of consensus that occurs more than 100,000 times per day. Tokenization obviates the intermediaries needed to manage post-trade processing, reducing operational costs while improving efficiency.

Blockchains run on consensus, and some newer blockchains like Algorand and Avalanche make achieving trade consensus between disparate parties easy from the base layer on up. Using these blockchains to settle trades across different parties provides investors with a more secure, shared, and scalable balance sheet that minimizes the need for reconciliation.

Essentializing Services

When emerging technology becomes essential, legacy institutions decide whether to build or buy the services that those technologies provide. Historically, building in-house has provided control at the risk of taking more time to align the old with the new. Buying, on the other hand, can reduce time to deployment and deliver improvements more nimbly. The choice is non-trivial.¹

Building for the future requires making a square peg fit in a round hole without knowing the exact dimensions of the peg. Buying an adaptable round hole leaves room for future-fitting.

Modernizing capital markets so that they can expand and contract as needed will prove mission critical when it comes time to close the gap between future businesses (the square peg) and legacy capital markets (the round hole). Institutions exploring tokenization today will close the gap early.

Long-Tail Tokenomics

Digital asset securities are programmed to only execute prescribed functions. This ensures that securities management best practices operate exactly as instructed, a feature that is incredibly valuable in the highly regulated securities world. At the same time, the blockchains that digital asset securities run on can be upgraded, which is great for businesses of all sizes.

The technological efficiency generated by tokenization produces long-tail economic effects, which will lead to a paradigm shift in securities management.

This more compliant pathway to enhanced securities management will help firms more readily calculate investment risk and develop informed business outlooks. Efficiencies generated early-on will take time to permeate the largely antiquated securities industry. Gradually, then suddenly, the foundational work being done today will result in a transformation of private capital markets. This transformation will eventually permeate public capital markets worldwide.

Turnkey Tokenization

Tokenizing institutional funds as digital asset securities makes reaching a wider audience more cost-efficient than using legacy infrastructure alone. After initial capital investments, technological efficiencies reduce operational expenses. Eventually, legacy infrastructure becomes redundant.

In late 2021, Securitize launched the first-ever tokenized institutional funds tracking S&P’s indices,² marking a milestone in financial markets. Moving into 2022, we expect to see increased allocations to alternative investments as end-to-end access becomes more widespread.

Financial firms are no longer deciding whether to digitize, they’re deciding how. With tokenization now turnkey, financials can use this opportunity to grow their business funnels. In 2022, legacy institutions will decide whether to build or buy new applications to provide more tokenized offerings to investors. Beyond 2022, tokenization will continue to grow across the securities industry from the inside-out. Financials that tokenize early can get ahead of the curve.^{3, 4}