Andreas Park PRO
Professor of Finance at UofT
Tokenization of Traditional Assets
and their trading
Katya Malinova and Andreas Park
- Relevant features of blockchains
- Possible features of tokenized stocks
- How would you issue/tokenize stocks?
- What challenges arise for tokens vis-a-vis traditional stocks?
- Trading of stocks
- Use in other blockchain applications
- The public offering landscape
- Impact on the financial sector's IO
Background and Overview of this Policy Paper
Idea: Think through the process and implications of tokenizing common shares on the Ethereum (or similar) public blockchain
My perspective: an economist, not a lawyer!
Source: "Relevance of on-chain asset tokenization in ‘crypto winter’"
By Sumit Kumar, Rajaram Suresh, Darius Liu, Bernhard Kronfellner and Aaditya Kaul, Sept 2022
(South-East Asian countries)
Key Institutional Differences
Key Institutional Features of Equities
- listed equities are
- securities by definition
- restrictions on who can hold them
- exchange and trading rules
- knowledge of ownership
- reporting requirements
- well-established custody and ownership transfer with regulated roles
- difficult for beneficiary owner to "use" asset other than transfer
- securities by definition
- If held on a blockchain, what challenges arise and what would need to change?
Institutional Differences: Crypto Asset Ownership, Accounts, Wallets, and Self Custody
Smart contract accounts
- controlled by code
- decentralized applications
- tokens
Externally owned accounts
controlled by private keys
private
key
public
key
(seed phrase)
public
address
wallet = software to keep and use private keys
Blockchain Ownership Attribution
- for the blockchain, an asset is always owned by
- externally owned account
- smart contract
- externally owned accounts can be "reached" by, e.g., blockscan
- smart contract ownership is trickier
Institutional Differences: Asset Creation
- token = smart contract (piece of code) registered on the blockchain
- can be created by anyone (incl me):
- can pretty much be used by anyone
- Use smart contract (incl tokens)?
- must pay blockchain validators in native crypto-currency
- \(\Rightarrow\) you always need to hold the cryptocurrency
Institutional Differences: The Investment Process
issuers
investors
- funding
- record-keeping
- instruments
- custody
- advice
- trading
services
needed & provided
- takes care of custody and allows self-custody
- allows instrument creation
- enables record-keeping
- allows circumvention of existing institutions
A general purpose value management infrastructure:
intermediaries
separate institutions
- asset custodians
- broker-dealers
- trading platforms
The blockchain reality:
new institutions
will emerge
Institutional Differences: Trading and Asset Registries
payments network
Broker
Broker
Stock Exchange
Clearing House
custodian
custodian
seller
buyer
beneficiary ownership record
Institutional Differences: Trading and Asset Registries
seller
buyer
Application: decentralized trading with automated market makers
- deposit = asset ownership transfers to a smart contract
- depositor gets a receipt token
Application: Decentralized Borrowing & Lending
borrow
provide collateral
- deposit = asset ownership transfers to a smart contract
- different models for interest accounting (usually based on receipt tokens)
UniSwap Lab supports development
a website app accesses the code
token holders control contact features
don't own the code
operation = decentral
control = decentral
anyone can use the baseline code
core code runs on the blockchain
tokens used as rewards
Institutional Differences: Blockchain Project Operation
Asset Tokenization or
"The Creation of Asset-Linked Tokens"
Tokenization of stocks is nothing new: American Depository Receipts
foreign investor/
issuer
domestic bank with foreign representation
ADR issuing bank handles
- shareholder communications
- dividend payments
- other recording-keeping
Is this a workable model for blockchain- tokenization of existing assets?
foreign representation of domestic bank/ its custodian
domestic depository bank
S.E.C.
registration with form F-4
domestic broker
issues and cancels ADRs
domestic investor
lets investors own and trade ADRs
domestic
market
deposits shares
foreign investor/
issuer
domestic bank with foreign representation
foreign representation of domestic bank/ its custodian
domestic depository bank
S.E.C.
registration with form F-4
domestic broker
issues and cancels ADRs
domestic investor
lets investors own and trade ADRs
domestic
market
deposits shares
Blockchain Tokenization has many options
existing investor/
issuer
token issuance platform
investor
wallet
instruct to create tokens
deposits shares
custodian bank
deposits shares
creates tokens and sells to investors
centralized or decentralized
market
S.E.C.
registration
existing investor/
issuer
investor
wallet
centralized or decentralized
market
S.E.C.
existing investor/
issuer
token issuance platform
investor
wallet
instruct to create tokens
deposits shares
custodian bank
deposits shares
creates tokens and sells to investors
centralized or decentralized
market
S.E.C.
registration
Token Standards
- ERC-20 = fungible token with minimal features such as
- balanceOf: how much does an address own?
- totalSupply: how many is there?
- approve: (contract owner allows token withdrawal)
- transfer: allows a holder to send a token).
- ERC-721 = non-fungible (has meta-data to describe the token; e.g. website URL or data hash)
- ERC-1155 = limited units of non-fungible
- there are other standards that allow e.g.:
- ERC-1726 dividends
- ERC-4626 interest payments
- ERC-1400/1404
- ERC-3643/ERC-621: restricts initial distributions
Some basic facts
Fact 1: Ownership of tokenized asset can be
- a person/legal entity
- a smart contract
Fact 2: By default issuers do not know who owns their tokens
Fact 3: Investors who hold tokens in DeFi smart contracts have fluctuating holdings.
Fact 4: General ownership restrictions are almost impossible to enforce, and transfer restriction would negate advantages of tokenization
Problems that require solving
ADR issuing bank handles
- shareholder communications
- dividend payments
- other recording-keeping
How are these functions performed with crypto-assets?
Fact 2: By default issuers do not know who owns their tokens
- It is possible to determine block-by-block EOA holders
- \(\to\) can send dividends directly
- but not very economical
- One can reach holders via EOA chat functions and disseminate information (e.g., chat.blockscan.com)
- \(\to\) opt-in for communcation
- good practice from DAOs is to lock tokens in contract and then do voting and dividend payments
- can also administer splits/reverse splits
Some remedies for communication and dividends
All this needs a legal framework that adapts to a decentralized, digital world
Problems that require solving
ADR issuing bank handles
- shareholder communications
- dividend payments
- other recording-keeping
Remaining FIs handle
- trading and transfer rule enforcement of ADRs
Fact 4: General ownership restrictions are almost impossible to enforce, and transfer restriction would negate advantages of tokenization
Legal and regulatory frameworks currently rely on intermediaries and are not prepared for self-custody
Banned addresses (usually by OFAC order)
criminals don't use USDC - why are we so worried?
Broader Implications for the Financial Industry and the Financial System
Asset tokenization would likely create a massive expansion in demand for stablecoins
max TVL:
top 20
max lending:
top 50
current lending:
top 100
Asset tokenization would likely create a massive expansion in demand for stablecoins
Stablecoins and Deposits
- DeFi applications for "real" finance
- DeFi Lending?
- Lending club on blockchain? (incl. personal loans etc)
- pools would be mostly stablecoin-based
- DEX & CEX trading?
- tokenized stocks require cash and stock deposits
- on chain FX require stablecoins in multiple currencies
- DeFi Lending?
\}
huge demand for continuously available "high quality" money
Broad Blockchain Risks to Financial Stability
Lending capacity & Monetary transmission
Deposit mobility
AML/CFT/Sanction evasion
Dollarization
Failures/runs
New cyber-risks
Broad Blockchain Risks to Financial Stability
Stablecoins require deposits that are invested only in HQLAs
- \(\to\) restricts balance sheet lending
- \(\to\) reduced monetary transmission
stablecoin deposits \(\not=\) sticky
Crypto-assets facilitate sanction evasion, money laundering, ransonware attacks, terrorist financing
USD stablecoins
- cause currency substitution in smaller countries
- Increase dollarization and threaten monetary sovereignty
Stablecoin failure/runs could lead to
- firesales of HQLA that disrupt markets
- social unrest
a host of unknown, highly scalable attack vectors
Lending capacity & Monetary transmission
Deposit mobility
AML/CFT/Sanction evasion
Dollarization
Failures/runs
New cyber-risks
Business risk for existing FI: super-easy entry
idea: create new mutual fund like asset
Business Risk to FIs: Customers choose what's best for them
"yield aggregator:" push capital where rate of return is highest
Yield Aggregators are very mobile liquidity
Source: "Phantom Liquidity in DeFi Lending", Park and Stinner (2023) working paper
- FIs would lose the role of providing access to the financial infrastructure
- less sticky capital
- new asset managers
- Investors continue to need advice
- breakup of bundled services is tricky
Effects on the IO of Financial Services
- paying for advice is tricky
- losing income sources will affect equity valuations and room to maneuver for FIs in liquidity provision
Last Words
Summary
- From a conceptual and efficiency standpoint, the advantages of tokenization are a no-brainer
- The current legal and regulatory environment needs to adapt
- There are still many tech problems to be solved
- There will be impacts on the movement of money \(\to\) financial stability
@financeUTM
andreas.park@rotman.utoronto.ca
slides.com/ap248
sites.google.com/site/parkandreas/
youtube.com/user/andreaspark2812/
tokenization-policy-paper-2023
By Andreas Park
