Will 2024 be a big year for Tokenization?

This blog was inspired by three inputs – the first was a recent article I read in Medium from a fintech VC that suggested 2024 could be a big year for new investment in market infrastructure; the second was from glancing through the Tokenizer’s who’s who’s guide for 2023 and looking at some of the advances that service providers like Stokr and Stobox and finally a presentation given by the CEO of Bitbond that I came across on Youtube (https://www.youtube.com/watch?v=GjE2NluFOPE)

One of the common themes that emerges from evaluating these inputs is that, from an issuance and administration perspective in particular, the case for tokenization is strong. ?Not only is there enough variation in the Ethereum token permissioning options to satisfy the necessary compliance requirements for KYC/AML etc now present, not to mention other lower cost, faster alternatives, but with what one can achieve in terms of payment and settlement both on and cross chain, utilizing the combination of the blockchain and smart contract model, there is a compelling initial and ongoing administrative story to back the tokenization approach.

Furthermore, supported by the right legal framework, collateral management framework, and issuance vehicle construct, the opportunities for tokenization are vast, with a number of sources suggesting it is well over $10tr. Given that to date across various financial and physical assets, the estimated volume of tokenization is reckoned to be less than $300bl, the total addressable market looks additionally compelling to support an ecosystem of exchanges, technology service providers, and custodians. ?

Alongside this, the more comprehensive solution design that service providers are developing first time issuers who have never minted before and will find the process totally new is another positive indicator. When I first started exploring tokenization beyond NFTs 3yrs ago, service providers seemed to only be interested in providing an alternative issuance approach for established issuers and other capital market participants, but now with many able to offer something akin to an end to end platform model, supported by professional service and legal support alongside significant connectivity to other key infrastructure providers such as digital wallets, custodians and exchanges within their platform design, there is more reason to believe that a larger universe of illiquid asset holders as well as alternative asset managers can be reached.

Finally, when, as a higher net worth individual with the right qualifications, one considers the benefits of asset class diversification, the availability to invest in secure, exchange traded or marketplace accessible options that create exposure to collectibles, NFTs of different creative assets, Artwork, and Real estate alongside traditional fund vehicles that invest in private market products seems compelling since fractional ownership has rarely been available in these types of assets before.

All of the above clearly makes a strong case for further advancement, even though none of it particularly represents a new trend, so what could derail a more dramatic liftoff this year.

First, there are still legal challenges that remain in terms of token issuance, both in relation to the actual definition of the tokens relative to securities, and the legal framework that underpins their value as surrogates for collateralized assets held within a blind trust structure. ?As long as these issues not only persist, but also are addressed through differences depending on where one sits from a tax jurisdictional perspective, the size of the buying community will be restricted, and most properly be confined to certain types of Ethereum wallet holders.

Second, it is not clear to me at least whether or not the distribution model that will need to exist to introduce real liquidity into token marketplaces will be successful or in fact cheaper.? ?While it would appear that the administration of a token issuance will be able to take advantage of a certain level of automation and real-time authentication that isn’t always possible for OTC traded products in traditional capital markets today, there will be other types of costs related to collateral management and identity and wallet administration, including private key management that will need to be paid for.? Whether these costs are actually higher than those for traditional capital market solution designs isn’t clear to me.

Third, I still believe when it comes to addressing valuation, risk management, and liquidity management risks that the token solution design doesn’t presently itself as a “better option” for fractional vs. outright buyers. ?I am drawn to this conclusion mostly because:

1.??????? I am unsure how some of the derived income benefits that accrue to outright asset owners, such as through rental and leasing income are accounted for in the smart contract, if at all. ?This could therefore mean certain secured rights are not inherent to a token purchaser.

2.??????? It is not clear exactly if there are effective hedging mechanisms available to token holders, apart from liquidation if there is a decline in the value of the underlying collateral that sits in the SPV vehicle and which may have to be marked to market for a variety of tax and regulatory purposes by the owner behind the issuing entity.

3.??????? It is hard to know if a largely internal market actually can generate sufficient liquidity to support the set valuation of the assets that have been tokenized. Since one notes that in the digital currency landscape there is a huge dearth of actual continuous liquidity and market making capacity in altcoins, one has to be concerned about whether the actual bid/ask for tokens that sit aligned to “rarely priced” or “placed” assets will actually perform in any valuation stress situation.

Based on this, I think there are still a number of areas in what I would call the “buyers beware” category, so while there has been significant improvements to address the friction among sellers to actually entertain engaging in the tokenized process, I don’t think we have not quite arrived at a lift off scenario to yet allow the existing ecosystem (which is now much larger, particularly in North America and APAC (much less in Europe btw, outside of the DACH and EE region) to thrive. I think the level of experimentation will increase and the number of issues will continue to grow too, perhaps expanding beyond a reliance on Ethereum and Polygon in the process, but the balance of risk/reward suggests patience and progress, rather than “take-off” in 2024.

?