How can RWA tokenization democratize traditional bond markets?

What is asset tokenization?

Since the introduction of blockchain and smart contracts, traditional finance (TradFi) and decentralized finance (DeFi) ecosystems have worked hard to innovate and come up with the next big thing. Asset tokenization directly results from the efforts to bridge the DeFi world with the TradFi market. In simple terms, tokenization is the process of using blockchains to create a digital twin of a traditional asset — complete with ownership or usage rights. Along with creating a copy, tokenization also fractionalizes assets that were traditionally not divisible into shares. Asset ownership becomes represented by blockchain-based tokens, negating the requirement for tangible ownership evidence as everything is securely recorded in the digital ledger. Each token can correspond to the primary asset stake or partition. Blockchain technology allows almost any asset to be tokenized and split up into shares. In essence, asset tokenization is the process of representing an already existing asset from the traditional financial space on the blockchain in the form of a tradable token or tokens.

What are the main benefits of tokenization?

Thanks to blockchain technology’s decentralized, immutable and transparent nature, tokenization boosts the security and efficiency of storing and trading the linked asset.

• Access to illiquid assets: Tokenization can fractionalize the ownership of an illiquid asset, such as real estate or art. End users can easily tap into a market that was previously only accessible to institutional investors by owning a fraction of those assets with the ability to trade them.
• Globally accessible: Unlike traditional markets, which are limited to regulatory jurisdictions, blockchain is globally available. A global pool of investors can enter and trade on various markets, dramatically increasing financial inclusivity.
• Lower costs and faster transactions: By removing traditional intermediaries such as banks and clearing houses, blockchain-based transactions are executed faster at a lower cost —especially when complex assets that are held by multiple parties are involved. Tokenization enables the automation of several steps on smart contracts, making transactions faster and simpler.
• Transparency and security: Tokenizing an asset on blockchain makes each step publicly traceable and visible, eliminating fraud and technical error risks.

By 2030, the market for tokenizing illiquid assets is expected to grow to $16 trillion. According to Boston Consulting Group’s report, tokenizing global illiquid assets is expected to be a $16 trillion business by the decade’s end. Furthermore, a survey by BNY Mellon shows that tokenized assets have already attracted the interest of 91% of institutional investors. Last but not least, tokenized bonds attract investors with high liquidity and fractional ownership. Thanks to tokenization, the securities market can open to a much broader audience.

What types of tokenized assets are available?

Blockchain-based tokenization can represent a wide range of traditional assets. Called real-world assets, or RWAs in blockchain lingo, traditional assets that are ready to become digitally tradeable range from real estate and bonds to fine arts. The most common characteristic of tokenized assets is that there is a hungry market to trade them. For fine art, real estate, collector cars, precious metals and other high-level assets, tokenization enables a much broader profile of investors to flock in and start trading. But the tokenization surely doesn’t stop there. Blockchain technology can also enable the tokenization of financial contracts, including loans, guarantees, invoices and royalties.

As the market looks for more assets to trade with crypto tokens, it’s no surprise that tokenization efforts are going for the most prized assets of traditional finance: stocks, commodities, and even government bonds.

What are the advantages of tokenizing bonds?

Tokenizing bonds has already become one of the most prominent blockchain use cases. Insomuch that even financial behemoths like JPMorgan use tokenized bonds to test institutional-friendly DeFi. According to Dune, a public blockchain data aggregator, the market cap of tokenized securities reached $368 million as of November 2023. Blockchain-based bonds can enhance liquidity by democratizing access. A wider audience can reach investment opportunities with secondary market trading. Asset tokenization allows investors to transfer the bond issuance and management processes to smart contracts. Unlike traditional markets, blockchain has no trading hours, enabling a 24/7 open market for trading. On the technical side, atomic swaps simplify the process by allowing interoperability between different networks. With the absence of intermediaries, administrative costs and settlement durations drop dramatically. Thanks to decentralized ledger technology, all transactions can become transparent, immutable and globally accessible. Tokenized bonds also create new capital-raising opportunities for small and medium-sized enterprises (SMEs).

Which tools are available for asset tokenization?

RWA tokenization can be done using blockchain-based tools or sidechains. One such platform is Mintlayer, a future-proof blockchain that improves direct token interoperability. As a layer-2 sidechain on the Bitcoin network, Mintlayer expands Bitcoin’s functionality beyond peer-to-peer transactions via atomic swaps and introduces DeFi functionality on the Bitcoin blockchain.https://www.youtube.com/embed/d4z4fH4BvOo Developers can use Mintlayer to tokenize real-world assets as well as enable smart contracts, decentralized finance (DeFi), nonfungible tokens (NFTs) and decentralized apps (DApps) built on top of the Bitcoin network. With Mintlayer, Bitcoin becomes a significant contributor to the DeFi space. “The tokenization of real-world assets adds a layer of stability to DeFi, anchoring this innovative technology to tangible, established asset classes,” said Zaid Ismail, chief operations officer at Mintlayer. “Our approach at Mintlayer is to bridge the gap between traditional finance and DeFi, ensuring that tokenization is not just a concept but a practical tool for democratizing real-world assets for everyone.”

How can asset tokenization be more efficient?

Tokens can be created to represent any asset. However, due to current government procedures, issuing tokenized bonds can be burdensome and expensive. Mintlayer offers several features, including the MLS-01 token and access control lists, that will aid companies in the technical aspects of bringing assets to the blockchain. Tokenized derivatives are financial instruments representing a contract or a claim on an underlying asset, such as a stock or a commodity. Users can purchase and sell these tokens on digital asset exchanges like traditional derivatives. Tokenized derivatives allow users to add features to them that are not available in standard derivatives, such as smart contract-based automation and decentralized governance. Mintlayer’s unique approach to tokenized bonds removes the need for intermediaries and complex mechanisms such as peg-in, wrapped tokens or federated tokens, eliminating counterparty risk and reducing friction. According to Zaid Ismail, this approach “to bond tokenization is about cutting through the complexity, offering a more direct and cost-effective pathway for bond issuance and trading.”

What is the future of tokenized assets?

As RWA tokenization becomes widely adopted, both liquidity and accessibility will increase. Blockchain infrastructures will become more robust and safe as more people participate. Blockchain ecosystems can establish cooperation or integration to prevent increased usage from becoming a bottleneck. There will be more use cases when the users transfer tokenized assets between platforms. Wallet integrations can reduce transaction fees. It is reasonable to anticipate more layer-2 integrations as well. Integrating tokenized real-world assets into DeFi systems will create new financial tools and services. Once legal compliance is established, tokenized bonds and securities will function legally, accelerating innovation as a result.