The future of tokenization? Permissioned blockchains

Many interpret BlackRock pouring $100 million into Ethereum as a sign that institutional tokenization will finally take off on public, permissionless networks.

It will — but BlackRock’s tokenized fund is only melting the tip of a Titanic-sized iceberg.

The crypto industry has cried wolf about institutions coming many times. By this point, we definitely know they’re interested in tokenization. The big players — BNP Paribas, JPMorgan, Goldman Sachs, the Hong Kong government, Franklin Templeton, Hamilton Lane and now BlackRock — have already been exploring blockchain technology for a while.

It’s certainly a watershed moment when the world’s largest asset manager opts for a public chain over a private platform like JPMorgan’s Onyx or Goldman Sach’s solution. BlackRock’s tokenized fund on Ethereum signals institutional trust in a public, permissionless network, bringing much-needed legitimacy to the nascent public ecosystem. The move will also encourage other traditional institutional players to transition to on-chain funds.

But while BlackRock’s tokenization on Ethereum was a bold move worthy of the headlines it made, the reality is tokenization is predominantly taking place on private, permissioned blockchains.

To date, the majority of institutional efforts have involved private networks. The Hong Kong government’s $100 million tokenized green bond used GS DAP, deployed on the privacy-enabled blockchain Canton.

Goldman Sachs, BNY Mellon, Cboe Global Markets and other firms recently wrapped up a series of pilots on the same network. HSBC has used its platform, the Orion digital assets platform, to tokenize gold for everyday investors in Hong Kong. And BlackRock has used the private Tokenized Collateral Network on JPMorgan’s Ethereum-based Onyx to tokenize shares in one of its money market funds.

Read more from our opinion section: Fintech has hit a wall. Blockchain will break through it.

Bitcoin proved that a multi-billion dollar market can essentially come out of thin air. The industry believed that everything could be tokenized and traded via blockchain and enjoy increased liquidity. However, the glittering promise of liquidity for real-world assets has (so far) proven a mirage.

The initial token boom of 2018 hyped trillions of dollars in tokenized assets on public networks. Almost seven years later, there are only a few billions of dollars in total assets under management on public networks — a tiny piece of what’s theoretically possible. Meanwhile, private networks are moving billions of dollars in daily transactions.

The crypto industry loves to float the $16 trillion in illiquid assets Boston Consulting Group projects to be tokenized by 2030. Even the more conservative estimate — McKinsey & Company’s $5 trillion in tokenized real-world assets — is huge.

If we look at the trends and what’s happening, though, it’s clear that a majority of these assets will first be tokenized on private networks.

Unlike crypto — which is an entirely new asset class existing within open ecosystems — real-world assets inherit the legacy of traditional finance. This legacy favors control over assets and customers, closed ecosystems and compatibility with traditional markets — a direct contrast with the ethos of public, permissionless networks.

This explains why financial institutions favor private networks. Private networks operate closer to the existing financial infrastructure and can facilitate easier compliance. These networks are more capable of meeting business needs, as they provide flexibility in governance and customization, like modifications to the blockchain’s consensus protocol, transaction validation rules and permissions. These networks can also handle higher transaction volumes, which is essential for scalability.

There’s also the issue of regulation. It’s only in the past couple of years that regulators have begun to pass and enact comprehensive frameworks guiding involvement in crypto assets. As a result, public blockchain technology has felt untouchable until recently to these institutions, for whom compliance is paramount.

For securities, there is at least some clarity. Tokenized securities are still securities and must operate within the existing regulatory framework. However, some assets — like real estate — which are not necessarily securities off chain will be considered securities once tokenized. The industry is still figuring out what it would take for these assets to meet existing requirements.

Today, nobody doubts the benefits of blockchain technology. The issue for traditional finance is mostly one of integration and technology costs, infrastructure compatibility and regulatory concerns. While public networks offer more transparency, immutability and decentralization, private networks are more practical and familiar for financial institutions.

There are also a few technology issues to sort out. Let’s use BlackRock’s chosen Ethereum as an example. While Ethereum has made progress with initiatives like layer-2 solutions and the Merge to Ethereum 2.0, the network faces challenges meeting the demand for speed, privacy and compliance necessary for transactions involving regulated institutions.

As the technology matures and regulatory frameworks evolve, we can expect to see more tokenization migrating to public blockchains and a new wave of innovation. However, at least for the near future, the majority of institutional tokenization will take place on closed, permissioned networks.

Graeme Moore is the Head of Tokenization at the Polymesh Association, a not-for-profit dedicated to the growth of the Polymesh blockchain ecosystem. He is also the author of B is for Bitcoin, the first ever ABC book about Bitcoin. Prior to Polymesh, Graeme was the first employee at Polymath; the creative director at Spartan Race; and an associate at Canada’s largest independent investment advisory firm.


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