CDBCs Towards a Tokenized Future (2024)

CFA Institute

The Bank of International Settlement (BIS) has called tokenization a paradigm shift that can create new financial instruments, new business models and drive innovation.

Although tokenization is still largely in pilot stages, the opportunities it represents could increase demand for digital currencies in general and CBDCs in particular.

This article addresses tokenization as a use case for CBDCs and explores what the future of finance could look like if tokenization finds wide adoption.

Simply put, tokenization is the conversion of any asset into a digital representation – a token. Distributed ledger technology and blockchains are used to protect integrity and verify transactions, as with a cryptocurrency. (See our Research & Policy Center article, Down the Rabbit Hole: A Cryptocurrency Primer for more detail).

Tokenization can be applied to any tangible or intangible assets, such as real estate or commodities, stocks and bonds, or a work of art. The recent enthusiasm around non-fungible tokens (NFTs) is just one illustration of the technology’s appeal.

In the financial system, tokenization could allow trading of traditional stocks, bonds, warrants or mortgage deeds to run on public or private blockchains, reducing the need for intermediaries to preform basic trade functions such as settlement. As with a blockchain-based currency, the transaction is the receipt : settlement with digital tokens confers ownership at the time of trade.

But the paradigm shift that BIS highlighted comes further down the road as settlement and compliance processes become automated or even eliminated and large assets are fractionalized to promote greater access, liquidity and potentially also financial inclusion.

“Nothing we own or owe has to sit exclusively on paper anymore,” said Olivier Fines, Head of Advocacy and Capital Markets Policy Research for EMEA at CFA Institute. “The technology to digitize assets is here. The questions we still face are around how to use it.”

By 2030, tokenization in private markets could reach nearly USD4 trillion in value, an 80x growth rate, according to a Citi forecast. Another report from asset manager Alliance Bernstein estimates that up to 2% of the global money supply could be tokenized over the next five years. And HSBC predicts a potential tokenized value of USD24 trillion by 2027.

The efficiency gains on offer from tokenization depend on the development of a digital ecosystem – or vice versa. At present, conversions between digital assets and traditional fiat currencies can be cumbersome and expensive. The volatility of Bitcoin and other cryptocurrencies also make them poor stores of value. That is where CBDCs could play a role.

Stablecoins, which are typically pegged to a fiat currency, currently serve as a bridge between the traditional financial system and the world of digital assets. Instead of continually transferring between digital and fiat currencies, investors can settle trades in stablecoins like USDt from Tether and USDC from Circle, which are designed to maintain their value against the US dollar.

Stablecoins, however, have a somewhat dubious track record. Tether in 2021 paid a USD41 million fine after the U.S. Commodity Futures Trading Commission concluded the company misrepresented its reserves. Circle’s stablecoin lost its dollar peg briefly in 2023 after the failure of Silicon Valley Bank, which held USD3.3 billion of its reserves.

“Until they fix problems with safekeeping and the transparency of reserves, the financial industry is unlikely to widely embrace stablecoins,” said Fines.

Commercial banks have stepped in to bridge this gap. JP Morgan, reportedly already processes over USD1 billion daily in tokenized assets, typically using the firm’s own digital “coin”.

CBDCs, however, could displace these private initiatives by providing a trusted, liquid and easily convertible store of value for digital asset transactions.

Some CBDC pilots have hinted at this potential. In what is billed as the first of its kind, the European Investment Bank (EIB) issued a EUR100m digital bond using a public blockchain in 2021. The transfer of funds from the underwriting banks to the EIB was done in CBDC, as part of a pilot project with the Banque de France.

As the level of tokenization increases, demand for a standardized and trusted digital currency to complete transactions can also be expected to rise.

As we detail in our Future State of the Investment Industry report, tokenization could give investors better access to alternative assets or previously illiquid investments in real estate, art, private markets, or other niche areas, including insurance contracts. However, this prospect also raises potential policy questions related to investor protection that should not be dismissed – i.e. the risks involved with granting retail investors greater access to alternative assets should be scrutinized.

Tokenization also allows fractionalization, which could better distribute risk across multiple institutions, create liquidity for private markets, or simply make more assets accessible, and affordable, for retail investors.

Within the domain of financial services itself, tokenization proponents urge that wide adoption would also cut costs for services like equity indexing, portfolio management, or the creation of highly personalized investment products, making financial services more attractive, accessible and secure – by virtue of automating greater portions of the value chain of asset management operations.

And, as with open banking or embedded finance, tokenization could widen the door for more kinds of companies to enter the financial arena and offer asset services, boosting financial competition.

As discussed previously, CBDCs come with privacy challengesthat may make them less attractive for consumer use. But that same level of transparency could make them ideal for settlement between financial institutions. And if the projections for adoption prove correct, a wholesale CBDC could serve as the rails for a future financial system where trillions of dollars of tokenized assets flow seamlessly and securely between market participants each day.

Discover more insights. Explore the other articles in this series:

• The Fourth Kind of Money: Where CBDCs Fit in the Global Monetary System
• Code is Law: Why Design Matters in the Introduction of CBDCs
• CBDCs and the Concept of Trust