02 Jul Australia readies to ride $32trn tokenisation wave – AFR
Source: Australian Financial Review
Blockchain is becoming mainstream infrastructure and ideas that were merely theoretical just a few years ago are becoming a reality.
There’s a mind-boggling number in the prospectus for the Digital Finance Co-operative Research Centre (CRC) that explains why the federal government, Reserve Bank of Australia, leading companies and universities set up the new body this week: the projected volume for “tokenised assets” is expected to grow from near zero today, to $US24 trillion ($32 trillion) by 2027. That’s with a T.
“Tokenisation” refers to creating a digital representation of a physical asset, or existing asset class, on distributed ledger technology. By injecting liquidity into previously illiquid markets, the process allows a wider range of real assets to be traded and creates whole new categories of tradeable assets.
Blockchain is becoming mainstream infrastructure and ideas that were merely theoretical just a few years ago are becoming a reality. By seeding the new Digital Finance CRC with $181 million this week, Australia policymakers and regulators showed they realise they need to prepare to ride the tokenisation wave set to wash over financial markets.
Much of the intense focus on digital assets this year has been on cryptocurrencies like bitcoin, and other “tokens” created by private players to fund new projects on ethereum or other public blockchains. There’s also been plenty of hype about non-fungible tokens (NFTs) which are creating newly tradeable assets like digital works of art. (Traditional auction house Christie’s sold a digital artwork by US artist Beeple as an NFT for $US69.3 million in March.)
In contrast, the main focus of the new CRC, whose partners include the RBA, Macquarie Bank, National Australia Bank, National Stock Exchange and Digital Asset, in which ASX has a stake, is digitising real world and hard assets. Think commodities and real estate. It will also examine central bank digital currencies (CBDCs) which will ultimately be needed to ensure riskless settlement on distributed ledgers, via a digital representation of cash.
The ability to instantly transfer assets without intermediaries creates plenty of issues for regulators and intermediaries in the current system, like banks and markets. Traditionally, transactions have been batched overnight by banks and delayed settlement processes have allowed markets to take days to settle trades. This has been necessary to provide time for financial world systems to update. But in the blockchain world, information can update faster (almost instantly) while access and transparency can be improved.
Many financial assets are, of course, already digital. Most money is represented digitally in commercial bank accounts. The ASX’s CHESS system did away with paper certificates to prove stock ownership 20 years ago. But digital asset tokenisation goes beyond representing a financial asset digitally in an account: it’s more about new ways for assets to be created and represented digitally, so they resemble physical assets.
Blockchain and other technologies are set to become a fixture in financial markets, and may eventually lead to structural changes to market processes or even the market itself.
— Greg Medcraft, former ASIC chairman
Blockchain technology is useful because it means a digital version of the asset cannot be duplicated. This is the core innovation of bitcoin: the ledger, secured cryptographically, prevents double-spending.
The participation in the CRC of the University of Western Australia and Curtin University points to the research project accelerating digitisation of the mining industry. Digital asset technology will allow liquid trading markets to be created for minerals still in the ground.
As PWC explained to its clients in a report four years ago, an underground ore body could be divided up by a particular size and recorded as a token on a blockchain. The token would allow the ore to be sold and traded in a marketplace, making liquidity and allowing the ore deposits to be traded before they are mined. New markets for hedging commodity prices and future improvements in extraction techniques could be opened up.
Asset tokenisation will also create premiums for hard assets already out of the ground. For example, a tokenised bar of gold from a sustainable mine may trade at a premium on global markets given the focus on ESG. So blockchain can help a physical bar of gold, electronically tagged, to be tracked from mine to market. Diamonds can be imprinted with tiny QR codes to verify they are an ethical purchase.
One of the members of the advisory group for the new CRC, announced by Minister for Industry, Science and Technology Christian Porter this week, is Jon Deane, CEO of Trovio (formerly InfiniGold), which has developed and issued the world’s first token backed by government guaranteed gold.
But the potential use cases go further. There’s plenty of thought going in to the tokenising of real estate. This could also allow ownership to be “fractionalised”, so big high-cost items like commercial buildings could be held by a wider range of investors.
Global investment banks have been thinking about asset tokenisation for years; the topic was a key focus at the Sibos conference in Sydney in 2018. The formation of the new CRC, which is backed by seven universities, shows preparations are stepping up for a wide-ranging changes to financial supply chain systems, structures and the regulatory environment, as digital assets become more mainstream.
Andreas Furche, CEO-elect of the new CRC, says the decade-long research program will inform regulators and market participants about the impact of real-time infrastructure that will make market registry functions core to every transaction.
He explains that in a traditional market for, say, shares, an order to the market is really a commitment to buy the stock. The market matches it, brokers arrange credit, and at the end of the day, it gets settled then registries adjust ownership rights. But in markets for tokenised assets, what you put on the market is the actual tokenised asset. When it trades, it’s swapped in real-time for another token. Goodbye batching.
RBA explosres digital currency
That’s where the central bank digital currency (CDBD) comes into the picture. Tokenised assets on blockchain will force market participants to want transactions to be final when the exchange happens. Furche says a core focus for the CRC will be the legal impacts of dynamic registers. It will ultimately explore how digital tokens representing a virtual form of the fiat Australian dollar could allow tokenised assets to settle while reducing risk and providing transaction finality.
For the past 18 months, the RBA has explored the impact of a digital form of central bank money in the wholesale market, alongside NAB and Commonwealth Bank. A report on the project, which piloted the issuance of a tokenised CBDC for the funding, settlement and repayment of a tokenised syndicated loan, is due in July. The RBA has been exploring reducing settlement risk and allowing for “atomic settlement” (meaning digital cash and asset tokens are exchanged instantaneously and the transfer of one token occurs if, and only if, the other transfers).
The Reserve Bank said this week that its participation in the Digital Finance CRC will provide an opportunity “to collaborate with industry and academic partners on tailored longer-term research related to innovations in digital finance, including asset tokenisation, central bank digital currency and regulatory technology”.
The bank said the research centre would help “develop and exploit the opportunities arising from the digitisation of assets so they can be traded and exchanged directly and in real-time between any individual or organisation”.
As the CDC’s prospectus points out, Australia was at the forefront of the first wave of digital finance innovation, with Computershare building the first automated share registry and Australia developing the SEATS and SMARTS trading systems. Furche was CEO of SMARTS before it was sold to Nasdaq in 2010.
While ASX is updating its clearing and settlement system with a private blockchain, the CRC’s prospectus points out this new world of tokenised assets will ultimately challenge centralised exchanges. The future will see producers and manufacturers digitise more assets and “look to sell them not only through established stock exchanges, but automatically through any electronic distribution channel available to them,” it says.
”Exchanges remain a meeting of trusted intermediaries, with arranged lines of credit, who in real-time facilitate the exchange of purpose-registered assets, for their later actual exchange (settlement) at the end of the ‘trading day’, or some days later,” the CRC says. “This anachronistic and inefficient paradigm compels a new revolution – the universal digitisation of all tradeable assets to enable them to be traded, paid for, and exchanged directly and instantly between any individual or organisation.”
Greg Medcraft has been working deeply in blockchain policy for several years as the head of the OECD’s Directorate for Financial and Enterprise Affairs. In the introduction to this year’s OECD paper Regulatory Approaches to the Tokenisation of Assets, the former ASIC chairman wrote that “blockchain and other [distributed ledger technologies] are set to become a fixture in financial markets in the years ahead, and may eventually lead to structural changes to market processes or even the market itself”.
Regulators around the world are grappling with asset tokenisation in different ways, the paper notes. Some are introducing new, tailored frameworks for tokenised assets and blockchain-powered markets; others are defining new roles for new actors participating in such markets; others still are updating existing regulation, to address specific characteristics and risks unique to decentralised networks and systems.
Asset tokenisation is at an early stage but as the CRC forecasts makes clear, it’s about to take off. The movement promises to democratise financial markets. Smaller investors will be able to access private markets in the same way they have been able to access public markets. Asset classes like city buildings will be made available to SMSFs, helping asset diversification. Transaction costs will be cut and the speed will reduce many risks.
But just like any new technology, new risks will also be created. Some of the products are likely to be volatile and they don’t currently fit neatly inside existing laws and legal concepts. As the OECD advised, operating in a non-compliant manner exacerbates risks for market participants.
Read full article at Australian Financial Review.