The token economy, which provides the foundation for assets and cash on the blockchain, can be seen as part of the internet’s evolution since the early 1990s.
Historically, Web 1.0 focused on the transmission of information, with the ‘read’ function of search engines gaining popularity at the time. Web 2.0 then ushered the next step in the internet’s journey – the platform economy. Companies like Amazon and Facebook, which recently crossed the one trillion dollar barrier, exemplify this period from the end of the 1990s and the beginning of this century.
From Web 1.0
Slow initial user adoption was characteristic of both Web 1.0 and Web 2.0. A similar trajectory awaits Web 3.0, the era of the token economy, where on top of writing and reading, the functionalities of ‘own’ and ‘execute’ will be implemented.
These modes are what makes this new era so attractive for the financial industry. If we are to see the token economy as the next step in the internet’s evolution, with the potential to reshape the financial sector, it then becomes a crucial catalyst for industrial change.
Many areas of the financial industry could be affected – such as post-trade processes, including settlement and clearing in combination with custody. Processes between the involved market players will also increasingly be mapped on the blockchain. As well as a much higher level of automation going forward, value will be created by the setup of new roles in the ecosystem. On the other hand, oligopolies in the existing world of finance might be questioned and some intermediaries might partially lose the importance they have today.
Another second area that could be affected is the product space. Tokenisation will be a more sophisticated electronic wrapper for investable products, for what is now known as securitisation in the form of physical global certificates. Combined with the fractionalisation of tokens, this will go hand-in-hand with further democratisation and individualisation of investing.
Payment mechanisms will also likely shift to blockchain as a platform. Take central bank digital currencies and stablecoins. Looking at opportunities in data management, the acceptance of blockchain as a single source of truth will lead to efficiency gains, greater transparency, easier accessibility and significantly lower costs.
Regulatory clarity in the token economy, a clearly defined governance structure and guardrails for the financial industry are key elements for further evolution. Financial stability and investor trust are main characteristics of the industry as we know it today. In this new era of the token economy, these elements must be maintained and preserved. European Securities and Markets Authority and its national regulatory bodies, along with the ministries of finance, have created a regulatory framework for crypto-assets, which also includes blockchain-based traditional securities. This offers market participants the opportunity to get involved in these products, keeping financial stability and trust in mind.
Figure 1. Pain points range from lack of data standardisation to siloed data structures
The life cycle of a traditional bond
Source: Union Investment, Axa Investment Managers
The life cycle of a traditional bond (Figure 1) from origination and primary, secondary markets, post-trade processes to life cycle events and maturity are shown in comparison with a blockchain-based, so-called tokenised bond. Pain points in the current environment are addressed. Possible solutions for these based on blockchain technology with not only assets on the blockchain, but also required cash on the blockchain, are provided. Central banks will play a major role in this context.
What benefits can the new ecosystem deliver?
For clarification, it is not about technology for the sake of technology. When combining assets and cash on the blockchain, innovation and competition will lead to higher speed, lower costs and reduced risk. A higher level of automation will simplify administrative processes and a real-time golden source for data will provide a higher level of transparency.
Settlement and clearing will benefit from higher speed; atomic settlement, meaning instantaneous settlement, will be a possibility going forward. Smart contracts as the brain behind blockchain technology will allow new features.
Overall, blockchain is the catalyst behind the token economy. The ability for tokenisation to make processes more efficient in terms of speed, costs, risks and enabling new business models, makes it a key force for change in the financial industry. Now, the focus in 2024 must include central banks’ implementation of digital currencies and the setup of distributed ledger technology-based secondary market trading platforms and regulatory initiatives like the go-live of the Markets in Crypto-Assets Regulation.
Christoph Hock is Head of Tokenisation and Digital Assets at Union Investment and Frank Scheidig is Global Head of Senior Executive Banking at DZ BANK.
This article featured in the Digital Monetary Institute Journal, summer 2024 edition.
