Chapter 4 in a series "How to Think About Blockchains".
This is the fourth chapter in an ongoing series. The first was about how we think about change, the second about Bitcoin, and the third about tokenised money. Still to come are essays on identity, and more on the future implications of this stuff. This article is about tokenising other things beyond money: everything, everywhere, all at once.
Let's start with this: the tokenisation of money is inevitable. At the time of writing (March 2024), the value of all Bitcoin in issue is $1.4 trillion, and that of Tether is just over $100 billion. That's still a way off the global money supply, but it is getting easier to see ahead to a scenario where tokenised money is being used for most transactions. By tokenised money, I specifically mean tokenised forms of the things that we already think of as money. Central Bank Digital Currency (CBDC) is a tokenised form of central bank liability, deposit tokens represent commercial bank liability, and stablecoins represent a claim on a high quality liquid asset. Because these represent some existing, known, form of money, what we are dealing with is a new technology layer that sits on top of the existing national and global legal system. We are not changing everything - this isn't bitcoin. This is about building a better system that relies on the existing legal and regulatory structures that we already have. If you project this principle and apply it more broadly, then this could end in everything, everywhere being represented as a token.
The dematerialisation of the stock market, like London's Big Bang in the 1980s, is a good analogy for this tokenisation process. The simplified version of this change is that you go from a system of settling with physical stock certificates, to one where the certificate is locked in a vault (or never printed in the first place), and ownership is recorded in the database of the Central Securities Depository. The 'C' in CSD is notable - it's a centralised system with all that implies: trust in the intermediary, relative speed and efficiency, and a single point of failure.
The equities and other financial instruments that were dematerialised in the Big Bang are the next logical candidate for tokenisation. We will move from database entries to distributed ledger records, or tokens - the next technology upgrade. This will happen because doing so provides a raft of benefits, and enables new business models. The UK Investment Association cites the absence of reconciliation, quicker settlement, automated processes, and easier collateralisation as some of the main reasons for tokenising funds.
So that will give us, eventually, a full set of liquid financial instruments that exist as tokens on blockchains. If it all works out, then these blockchains will be public, but the node operators will be licensed; they in turn will provide wallets to fully identified (KYC'd) customers. Thus we retain regulatory control and oversight while gaining the benefits of blockchains. There are lots of challenges along the way, including regulatory clarity, the blockchains to be used and their interoperability, the roles of the various participants, and so on. The path that we will take to get to this point is also up for debate. It will depend on who drives the process: perhaps a consortium of financial services businesses, or a group of global banks, or innovators providing new models. All of these are possible.
Current financial market infrastructure consists of payment systems, CSDs, securities settlement systems, central counterparties and trade repositories. In theory, all of these functions can be collapsed onto a blockchain. In practice, this will happen gradually, starting with the simpler use cases, but it will make processes far more efficient, as noted by the Investment Association. Global networks of tokenised money will solve the problem of cross border payments too. The interesting question is where we go from there.
The obvious route is to tokenise less liquid financial instruments such as alternatives. Property and private equity are the usual examples. A study by JP Morgan and Bain estimates a $400 billion opportunity for the asset management industry in doing this. This study is based just on making alternative investments more available to high net worth individuals: financial inclusion for rich folks. The same broad principles of access apply for the rest of us too, both at a retail level, in that transacting can become cheaper and simpler for all of us, and also at a corporate level. From a corporate perspective, tokenisation can make the process of listing much cheaper, thus bringing the liquidity and funding benefits of stock markets to a wider group of businesses. This is why stock exchanges around the world are beginning to experiment with blockchains.
On top of all this inclusion, a tokenised market will enable new business models. You could easily use your shares as collateral, in an automated process, to access a cheap loan. You could choose to use non-money assets in payment, converted cheaply on the fly to the asset that the vendor wants to receive - like paying with bitcoin, or even shares, at the supermarket. You could programme a portfolio to rebalance automatically based on parameters that you edit as your needs change. And so on.
A pre-requisite for the above scenarios is that each wallet is attached to an identity; this is more complex than just name and address, and is the subject of my next essay. But what all these cases - money and other financial assets - have in common is that the token represents ownership of something. The "something" may be a human invention like "money" or "shares", or it could be something physical. The token proves ownership. The first experiments in this space were with luxury goods; de Beers and Breitling have issued tokens showing provenance of diamonds and watches respectively. In the coming years, we will see this model extended to all manner of goods: property, cars, gold, potentially any physical asset. The token can enable a rich history of the asset, and will become the key component in an ecosystem of owners, manufacturers, service providers, regulators, and so on. The ability of a manufacturer to engage with the owner of a specific item beyond its initial creation or sale will enable new business models. Innovative producers of goods will find ways of engaging with the second-hand purchasers of their products, perhaps offering repairs, support, loyalty or community membership. Companies can collaborate on customer engagement or loyalty. New roles can emerge as experts are incentivised to verify condition of physical goods, and the life of something post purchase becomes the basis of a new economic model. Mattereum's work in this space is fascinating.
By changing our relationships with our stuff, blockchains can change the way we live. "Show me the incentives and I will show you the behaviour" as Charlie Munger said. In blockchain based systems - both money and stuff - we will create new ways of incentivising people. The potential to solve problems at a global level is enormously exciting, noting that blockchain's default accessibility is global. This is perhaps a subject for another day. We are just getting started.
Photo by Igor Mashkov: https://www.pexels.com/@igor-mashkov-14869791/
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