Tokenisation and how it can influence global finance

“The biggest question from central banks is, what is the role of tokenisation and digitisation? How quickly should they think about digitising their own currency? If every currency digitises, what’s that meant for bank payments, what does that mean for the payment companies like Visa &Mastercard – all these’re being questioned right now.”

This is what Larry Fink, CEO, Blackrock said this week in a panel discussion on the sidelines of Future Investment Momentum in Saudi Arabia.

And when the head of the world’s largest asset management company says this, we must pay attention to. Let's break down what tokenisation is, how it could influence global finance, and the challenges it presents.

In simple terms, tokenisation is the process of converting a real-world asset (like a stock, a bond, a piece of real estate, or even a currency) into a digital "token" on a blockchain or distributed ledger.

For instance, in Traditional Finance, if you own a share of a company, which is represented by an entry in a database managed by a depository (like CDSL), it’ll be validated through a chain of intermediaries (broker, the exchange, etc.).

But in a Tokenised world, you own a digital token on a blockchain that represents that same share of the company. The token is the proof of ownership, and the blockchain is the source of truth.

A Blockchain is a secure, decentralised digital ledger that records transactions in a way that makes them transparent and difficult to change. Simply put, it’s like a digital notebook where everyone in a group has their own copy, and any new entry must be agreed upon by the group before it’s added.

Instead of a single central authority, many computers (called nodes) on a network validate and store copies of the ledger. Transactions are grouped into "blocks," which are then linked together in a "chain" using cryptography, creating a tamper-proof, chronological record of all activity.

So, how could tokenisation influence global finance? Illiquid assets that are traditionally hard to buy and sell in small pieces - like real estate, fine art, or private company shares - can be fractionalised. A $10 million building can be split into 10 million $1 tokens, allowing small investors to own a piece of it and trade it 24/7 on a digital market.

This creates an entirely new asset class to a global pool of capital, increasing investment opportunities and potentially driving economic growth, leading to a dramatic increase in liquidity and accessibility.

Currently, financial transactions involve multiple intermediaries (brokers, custodians, clearinghouses, etc.), each adding time, cost, and complexity. Tokenisation on a blockchain can automate many of these processes with "smart contracts."

For example: A "smart" bond could automatically pay interest to token holders on a specific date, eliminating the need for manual processing. This brings up radical efficiency and lowering costs.

Every transaction involving a tokenised asset is recorded on a shared, tamper-resistant ledger. This creates a complete and transparent audit trail, reducing fraud and simplifying compliance. As Fink alludes to with the "digital wallet," assets can have rules embedded directly into them. This could automate complex compliance (e.g., a token can only be held by accredited investors) or enable new financial products.

If central banks issue digital currencies (CBDCs) and assets are tokenised, you could theoretically pay for a tokenised car with a tokenised digital dollar directly from your digital wallet to the seller's wallet.

This direct peer-to-peer transaction bypasses the entire card network and associated fees (the 2-3 per cent cut that Visa/Mastercard and banks take), revolutionising the payments. Tokenised payments could happen across borders nearly instantly and at a fraction of the current cost, challenging the SWIFT system and remittance companies.

However, the biggest challenges could arise from:

Regulatory uncertainty and fragmentation: What legal rights does a token holder actually have? Is a tokenised stock legally the same as a traditional one? Current securities laws were not written for this technology. Creating clear, consistent, and globally coordinated regulations is the single biggest hurdle. Another legal tangle is the jurisdictional arbitrage. If one country has lax rules, it could become a hub for risky tokenised products, creating global financial stability risks.

Technological and operational hurdles: Interoperability across the globe requires not just mere coordination but different blockchains (and traditional systems) need to be able to talk to each other seamlessly. Another aspect is the scalability. Can the underlying blockchain technology handle the volume and speed of the entire global financial system? This is still a moot and particularly with the current geopolitical conditions, it seems a stretch.

Arguably, the most crucial factor could be the cybersecurity. While blockchains are secure, the endpoints (digital wallets, exchanges, and smart contracts) are vulnerable to hacks, coding errors, and exploits. A single flaw in a smart contract governing a billion-dollar tokenised asset could turn catastrophic.

Systemic risks and financial stability: The vision of a decentralised system might lead to new, concentrated points of failure (e.g., a few dominant digital wallet providers or blockchain platforms). Also, the increased interconnectivity, round the clock trading could create financial shocks morphing into a contagion risk, much quicker than they do today. While a tokenised illiquid asset might appear liquid, during a market crash, liquidity vanishes almost instantly, leading to a ‘digital run’ on assets.

Societal and economic drawbacks: A fully tokenised system could exclude populations without reliable internet access ordigital literacy, exacerbating inequality. Also, as the govts issue these tokens, it could raise privacy concerns as they create a permanent, public record of every financial transaction of an individual. CBDCs could give govts unprecedented visibility and control into citizens’ transactions, while displacing entirely the existing ecosystem and infrastructure.

While Tokenisation promises a more efficient, inclusive, and liquid financial system, it requires us to navigating a minefield of regulatory, technological, and societal challenges.The transition won't be a simple switch, but a complex co-existence of old and new systems. The countries and institutions that successfully manage this transition- by building robust regulation, secure technology, and inclusive frameworks - will likely define the next era of global finance. Are you aligned?

(The author is a partner at “Wealocity Analytics”, a SEBI registered Research Analyst firm and could be reached at [email protected])