The Treasury’s 2024 Budget Review reported that the Intergovernmental Fintech Working Group (IFWG) is currently examining the potential effects of tokenization on the financial markets. A paper on the overview of tokenization is expected to be published by June 2024. Then by December 2024 a discussion paper on the policy and regulatory implications of tokenization and blockchain-based financial market infrastructure is expected to be published.
What is tokenization?
It is generally accepted that definitions or meanings are derived from authoritative sources. For English word meanings, the Oxford Dictionary is usually taken as an authoritative source, but it is no longer the sole source, especially for technical words. There are other competing sources that have emerged over the years. When it comes to technical financial terms, we have the IMF, BIS and others that are considered as credible sources for definitions. The BIS defines tokenization as “the process of recording claims on real or financial assets that exist on a traditional ledger onto a programmable platform” that typically relies on distributed ledger technology; while the McKinsey Institute defines it as “the process of creating a digital representation of a real thing.” In simple terms, tokenization is the digital representation of asset ownership on a blockchain. Real assets such as real estate, stocks, commodities, etc are represented as digital tokens on a blockchain. Blockchain technology, in particular Ethereum and its smart contract functionality is the root of tokenization.
Tokenization offers a range of advantages, including immediate global reach and streamlined cross-border remittances. It also allows for fractional ownership, enhances liquidity, and speeds up the transferability of assets, making previously illiquid assets tradable and accessible to a broader spectrum of investors. The widespread adoption of tokenization can deliver substantial economic benefits by increasing economic efficiency via lower transaction costs, simplifying asset management, and boosting market liquidity. Moreover, the expansion of the tokenization sector could generate job opportunities across various industries, including technology, finance, agriculture, and legal services. In the long run, by democratizing access to investment opportunities, tokenization can promote greater financial inclusion and fairer wealth distribution, thereby encouraging economic growth and stability in developing countries.
Global trends of tokenization
The tokenization technology is now maturing, and regulatory frameworks are being developed to govern tokenized assets, with a view to balance innovation with investor protection and market stability. Furthermore, tokenization has brought about an expansion of asset classes beyond traditional assets (such as real estate, commodities, and securities) to include art, collectibles, intellectual property, etc. The emergence of non-fungible tokens (NFTs) like art, music, and virtual real estate has shown the potential for tokenization beyond financial instruments. The concept of decentralized finance (DeFi) leverages tokenization to create decentralized alternatives to traditional financial services.
There are global efforts to improve interoperability between different blockchain networks to facilitate the seamless transfer of tokenized assets across platforms. Financial institutions are exploring tokenization to improve efficiency in processes such as securities trading, settlement, and cross-border payments. Examples of financial institutions embracing tokenization include the following. Over the years JPMorgan has been exploring blockchain and tokenization through its Quorum blockchain platform and has the JPM Coin initiative for cross-border payments. Deutsche Bank is similarly exploring blockchain technology and tokenization for various financial assets. Société Générale is involved in blockchain initiatives and tokenization projects in areas of trade finance and derivatives. Goldman Sachs is participating in blockchain, and tokenization projects related to digital assets and is exploring potential applications in trading and settlement. Furthermore, the concept of tokenization is intersecting with other technologies such as the Internet of Things (IoT) and Artificial Intelligence (AI) to create new use cases and business models.
The above trends reflect a growing acceptance of tokenization and its growing potential to reshape the global economy. Several leading companies and platforms are engaged in tokenization. Ethereum is considered a key player in tokenization and pioneer of smart contracts and decentralized applications. Because of its low transaction costs and compatibility with Ethereum, on the other hand, Binance Smart Chain has become the popular platform for token issuance and DeFi systems because of its compatibility with Ethereum as well as its low transaction costs. For tokenization projects seeking scalability and interoperability, the Polkadot blockchain protocol has been an attractive solution, whereas Tezos, a decentralized ledger hosting the digital token Tez (XTZ) offers a blockchain platform that supports tokenization and smart contracts. Cardano, a public blockchain platform that is open-source and decentralized, has a goal to provide a secure and scalable platform for the deployment of smart contracts and tokenized assets. Its emphasis on peer-reviewed rigorous research methods is attractive to projects that are looking for a robust foundation for tokenization.
The above platforms and others are pioneering tokenization, each of them offering unique features and capabilities to support the issuance, management, and transfer of digital assets across various industries and applications.
Africa stands to benefit significantly from advancements in tokenization and blockchain technology. A report by PwC predicts the tokenization market in Africa could reach $100 billion by 2025[1]. In alignment with this potential, the African Development Bank has established a $10 million fund to encourage blockchain and tokenization initiatives across the continent[2]. Moreover, several African countries are exploring the tokenization of land ownership records.
South African use cases
In 2018 DoshEx, a Bryanston-based exchange and South Africa’s first developer of tokenised ecosystems, formally launched the trading of tokenized assets on its exchange. While tokenization is still a novel concept in South Africa, it has great potential as a tool for leveraging corporate growth for businesses with international aspirations.
To some varying degrees, several financial institutions in South Africa are embracing tokenization. The South African Reserve Bank (SARB) is exploring the potential of tokenization, in particular the viability of central bank digital currencies (CBDCs). The largest bank in South Africa, Standard Bank, is involved in blockchain and tokenization initiatives whereby it is exploring applications such as cross-border payments and trade finance. Similarly, ABSA and FirstRand Bank are exploring the use of blockchain and tokenization in various areas of their operations.
Notwithstanding the high demand for tokenized solutions in South Africa, the major constraints are scarce local skills and absence of blockchain and cryptography training. The tertiary education sector is still figuring out an appropriate curriculum for the innovation.
The financial system of the future
In a recent paper, a staffer of the Bank for International Settlements (BIS) and an Indian entrepreneur sketched the elements of the future digital financial system. They termed it the “Finternet” which they define as “multiple financial ecosystems interconnected with each other, much like the internet, designed to empower individuals and businesses by placing them at the centre of their financial lives”. Tokenization is one of the innovations that the Finternet leverages alongside other technologies such as the internet, blockchain technology, distributed ledger technology and unified ledgers. The Finternet is touted as a user-centric approach capable of lowering barriers to access to financial services and thus fostering financial inclusion. However, since its realization will depend on proactive collaboration between public authorities and private sector institutions, the jury is out there.
[1] https://www.businesslive.co.za/bd/opinion/2023-08-15-tokenisation-could-be-the-secret-to-unlocking-africas-economic-potential/
[2] ibid
