The Evolution of Finance–Regulated Tokenized Assets

It seems that there is a growing appetite and sentiment for regulated tokenized assets solutions. In mid-September, Citi (C) launched a token service using blockchain technology to offer digital asset solutions for its regulated institutional clients. The new service, called Citi Token Services, will convert clients’ deposits into digital tokens that can be used for instant cross-border payments, liquidity, and automated trade finance solutions around the clock.

“Digital asset technologies have the potential to upgrade the regulated financial system by applying new technologies to existing legal instruments and well-established regulatory frameworks,” Shahmir Khaliq, Citi’s global head of services said in a statement. “The development of Citi Token Services is part of our journey to deliver real-time, always-on, next-generation transaction banking services to our institutional clients.”

Citi is not the only bank (or the first bank) to introduce blockchain technology for its clients. JPMorgan Chase (JPM) is most likely the first traditional financial institution to operate a blockchain network, Onyx, and a private stablecoin, JPM Coin, and has been experimenting with blockchain technology since 2015. The U.S. Patent and Trademark Office last year approved a trademark for “J.P. Morgan Wallet” – aiming to provide electronic transfer of virtual currencies for members, cryptocurrency payment processing, virtual checking accounts and payment settlement between parties. Like Citi, JPMorgan is also exploring a blockchain-based digital deposit token to expedite cross-border payments.

In the past few weeks, other traditional financial institutions have announced tokenized assets services and products, such as Swift, UBS and LSEG. The question is what this means for the future of financial markets and services, and for institutional investors. Before we answer that, let’s briefly explain what tokenization is, its benefits, and describe some of the tokenized assets’ projects currently in the works.

What is tokenization?

In the financial context, tokenization of assets refers to the process of issuing a digital token that runs on a blockchain. This token is a digital representation of an asset – tangible or intangible – and its value is based on the value of the asset it represents, like the process of traditional securitization, but digitized. The main benefits of tokenization are:

• Liquidity
• Reduced costs
• Transaction speed
• Transparency

For more information on tokenization and its benefits, see this article.

It should be noted that there is a misconception that tokenized securities are used to bypass regulations. Tokenization, in fact, can help regulation work better by increasing transparency, automating compliance, and keeping track of transactions. We will explore these benefits in-depth in a future article, but for now, it suffices to say that tokenization can simplify regulatory processes and create a safer and more effective system for everyone involved.

Examples of regulated tokenized assets products currently in the works:

Citi Group

In mid-September Citi Treasury and Trade Solutions (TTS) announced the creation and piloting of Citi Token Services for cash management and trade finance. The service uses blockchain technology and smart contracts to deliver digital asset solutions for institutional clients.

Citi tested the service with the shipping giant Maersk and a canal authority. The digital process used in the pilot service provided instant payment capabilities to the buyers and sellers via smart contracts to reduce transactions costs. The tokenized solution is designed to work similarly to bank guarantees and letters of credit in the trade finance ecosystem.

Citi Token Services was also tested on a global cash management pilot to enable Citi’s clients to transfer liquidity between Citi branches on a 24/7 basis.

Federal Reserve (Fed)

In July, the Federal Reserve Bank of New York’s Innovation Center (NYIC) completed a 12-week project of a regulated liability network (RLN) proof-of-concept. NYIC worked on this project with nine large financial institutions and the Swift network. The financial institutions that participated in this project are: Bank of New York Mellon, Citi, HSBC, Mastercard, PNC Bank, TD Bank, Truist, U.S. Bank and Wells Fargo.

The project created a theoretical infrastructure to exchange and settle commercial bank deposit tokens and central bank liabilities using distributed ledger technology and a simulated central bank digital currency in the U.S.; the simulated RLN functioned around the clock with instant multi-asset settlement and programmability, and preserved full U.S. Anti-Money Laundering and Know Your Customer protections in international settlements. The project did not identify any legal issues that would prevent the creation of the RLN system under current rules and regulations.

RLN is in line with the Fed's support of tokenization. In a recent speech by Fed Governor Christopher J. Waller on “Innovations and the Future of Finance,” he explicitly talked about the advantages that blockchain technology offers relative to traditional approaches to conducting transactions.

JPMorgan

JPMorgan is looking into the use of a blockchain-based digital deposit token to make cross-border payments and settlement faster. The bank has already built most of the infrastructure needed for the project and awaits the go-ahead from U.S. regulators for final completion.

JPMorgan has been using JPM Coin for several years, enabling corporate clients to move funds in dollars and euros from their different accounts within the bank. However, the new offerings could be used to send money to clients of other banks and to settle trades in tokenized securities.

A recent report by JPMorgan on “Deposit Tokens” states that "while we estimate that a multi-currency CBDC could cut costs by 80%…deposit tokens could unlock similar benefits by reducing fees, settlement times, and counterparty risks, and by enabling more direct funds transfers."

In a statement to Bloomberg, a spokesperson said, "Deposit tokens bring plenty of potential benefits, but we also appreciate that regulators would want to be thoughtful and diligent before any new product gets developed and used. Should that appetite develop, our blockchain infrastructure would be able to support the launch of deposit tokens relatively quickly.”

Swift

In late August, Swift successfully completed a project that placed its financial infrastructure as a central point for the transfer of tokenized assets by banks across multiple blockchains. Participants in the project included Australia and New Zealand Banking Group Limited (ANZ), BNP Paribas, BNY Mellon, Citi, Clearstream, Euroclear, Lloyds Banking Group, SIX Digital Exchange (SDX) and The Depository Trust & Clearing Corporation.

Web3 services platform Chainlink was used as an enterprise abstraction layer to securely connect the Swift network to the Ethereum Sepolia network, while Chainlink’s Cross-Chain Interoperability Protocol enabled interoperability between the source and destination blockchains.

Tom Zschach, chief innovation officer at Swift said, “the findings have the potential to remove significant friction slowing the growth of tokenized asset markets and enable them to scale globally as they mature.”

UBS

In early October, UBS Asset Management initiated a "live pilot" of an Ethereum-based tokenized money market fund, marking a significant step in the exploration of blockchain technology in financial markets. The pilot is being conducted through UBS Tokenize, the firm's dedicated platform for digital assets, as part of Project Guardian, led by the Monetary Authority of Singapore.

UBS Asset Management's exploration of blockchain technology also includes the issuance of a digital bond and a $50 million tokenized note in late 2022, and the issuance of 200 million yuan in fully digital structured notes in late June. These explorations further illustrate UBS’s commitment to Web3 transformation and implementation.

LSEG

The London Stock Exchange Group (LSEG) is drawing up plans for a new digital marketplace that would be built on blockchain technology as a separate entity and is now engaged in conversations with the UK government and regulators on the idea.

"The idea is to use digital technology to make a process that is slicker, smoother, cheaper and more transparent...and to have it regulated," said Murray Roos, head of capital markets at the LSEG.

It should be noted that LSEG is not the first exchange to consider such a solution. In 2018, Nasdaq, the second largest stock exchange in the world, was experimenting with the development of a platform for the issuance and trading of tokenized assets. Nasdaq has already been working on digital assets custody solutions but decided to pause its plans due to regulatory uncertainty.

What are the implications for regulated institutional investors?

The examples above signify a growing interest among major financial institutions in exploring and adopting blockchain technology and digital assets in a regulated setting. As blockchain continues to make strides in the financial sector, such initiatives are expected to play a pivotal role in shaping the future of global finance.

These are tenured traditional financial institutions that understand the importance of fully regulated tokenized assets, especially for their institutional clients – they understand the importance of compliance and in most cases, have a long history of working with regulators.

These recent developments might signify that there is a positive sentiment among legislators, too. The latest support for the launch of PayPal stablecoin by the Chairman of the House Financial Services Committee is one of those indicators. If, for example, JPMorgan receives the green light from regulators, it will open the door for more products like it.

Stepping in the evolution of finance by applying new technologies to existing legal instruments and a well-established regulatory framework would significantly upgrade current financial systems and open boundless possibilities and opportunities, not just for institutional investors but for every investor.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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