The cryptocurrency ecosystem experienced severe price corrections in 2022, after reaching record highs in market capitalization in 2021. Reminiscent of the 2018 “cryptowinter,” the collapse has eroded more than US $1 trillion ($1.4 trillion) in value and led to a drop in investor value. Layoffs, hiring freezes and subdued growth aspirations have been seen at native companies, while the number of shares in application is rising.
The Terra Luna crash, the Celsius debacle and the FTX collapse have all played a role in these developments. However, developer activity has remained robust and there is now an opportunity to channel capital and talent into viable blockchain applications. In a recent report published by BCG and ADDX, we highlighted a USD 16 trillion commercial opportunity in blockchain asset tokenization by 2030, which would represent 10% of global GDP. Blockchain technology has the potential to dramatically unlock liquidity, access and choice for multiple investment instruments at scale, especially for traditionally illiquid assets such as real estate, high-value art, public infrastructure and private equity.
To fully appreciate what these opportunities mean for regulators, financial institutions and investors, it is worth examining how the sector is expanding, as well as the potential benefits and pitfalls to watch out for. The benefits and risks of on-chain asset tokenization, whether fungible (exchangeable and divisible) or non-fungible (unique and non-exchangeable), presents an opportunity to overcome the barriers of asset illiquidity and improve on what has been achieved so far through traditional public tokenization.
This shift from traditional fractionation to blockchain tokenization expands investor access to more asset classes and this has significant regulatory implications, so it is necessary to understand the benefits and risks involved. Fractionalization of assets on blockchain-based platforms makes alternative asset classes, such as hedge funds, more affordable for investors by offering these investments in fractional sizes. Fractionation can also facilitate borderless accessibility of illiquid assets such as natural resources, land or ancient paintings.
It can unlock liquidity and improve flexibility by allowing these assets to be traded prior to maturity, allowing, for example, future profits from agricultural land to be unlocked. Another advantage is immutable transparency and accountability through a shared ledger across distributed network nodes. This innovation streamlines transaction efficiency through faster settlement times and asset servicing enablement during the lifecycle of an asset, without the need for third parties.
Tokenization can also ensure better price discovery of illiquid assets, thereby reducing “rent-seeking” by intermediaries such as auction houses. However, there are certain risks to be aware of as asset tokenization grows. Increased regulatory scrutiny and geographic variation in governance standards could lengthen the runway for scaling tokenization across borders.
The unevenness in regulations from jurisdiction to jurisdiction on issues such as money laundering, terrorist financing, illegal trading and cyber attacks could require companies to make significant adjustments to their operating models as they expand, slow or even delay the broader adoption of tokenization. .
Blockchain technology is still on its way to maturity, and regulators, financial institutions, service providers and asset owners are deciphering the key pieces of the puzzle. More also needs to be done to improve investor awareness and education. However, there are strong indicators that suggest the growing importance of blockchain asset tokenization.
The global trading volume of digital assets has increased significantly in recent years, surpassing US$2.3 billion in 2021 and is forecast to reach US$5.6 billion by 2026. Stakeholder sentiment is strengthening, following successful tokenization pilots in numerous markets.
Many monetary authorities have also recognized blockchain tokenization. Amid these positive signs, we also see more asset classes being tokenized, including unconventional illiquid assets such as crops and vintage wines. These developments are also supported by a growing talent pool. In 2020 alone, the decentralized finance (DeFi) space saw 67% and 45% growth in monthly active developers and frequent contributors, respectively.
In Asia, the potential for on-chain asset tokenization is worth close to US$3 trillion when estimated in terms of total private asset market capitalization. Robust adoption among individual investors is expected in several countries, including Japan, Thailand and especially Singapore, where asset tokenization is regulated. The Monetary Authority of Singapore (MAS) was one of the first regulators globally to say in 2017 that tokenized securities would be regulated in the same way as traditional securities, giving the nascent space much-needed certainty for investments and innovations to move forward.
In 2020, ADDX became the first tokenized securities exchange to be licensed by MAS. It also recently launched Project Guardian, to explore the economic potential and feasibility of applications in asset tokenization and DeFi, while managing risks to financial stability and integrity From tokenizers to issuers, developers and policy leaders, much can be done to harness the full potential of blockchain asset tokenization in Asia.
Traditional asset stakeholders can test, implement and scale blockchain tokenization as an upgrade to existing business models, while leveraging their large capital and customer bases, as well as their deep institutional knowledge of customer preferences and financial markets. They should partner with emerging fintech companies and DeFi projects to accelerate commercialization plans.
Tokenization service providers should invest in compliance capabilities while working to improve financial literacy and trust among individual investors. Developers can design standard architectures to ensure the underlying blockchain is built for scale, performance and functionality, while establishing standard protocols to improve adoption.
They can create talent incubation programs and ensure coding quality by validating smart contracts through third-party certified service providers. In the regulatory space, based on the encouraging progress made so far, there is scope to establish clear rules for all stakeholders.
Regulators can also deepen their thinking on how tokenization could affect anti-money laundering and terrorist financing, investor and consumer protection, financial system stability and market integrity. Regulators can also drive innovation in controlled environments such as regulatory constrained environments.
MAS’ FinTech Regulatory Sandbox provides Singapore-based fintech companies with a well-defined living environment in which they can innovate freely during the sandbox period, with a limited license and mandate. Through the sandbox, companies can safely test the viability of new fintech products using real money and real customers.
Looking ahead, while the funding outlook for blockchain-based projects is expected to remain tight, there is significant potential for growth. Adopting the right tools and measures to encourage blockchain asset tokenization can lead to transformative change in the midst of a covert “cryptowinter.”