Digital Assets Mean Disruptive Change. Fact.

Speaking at the Swiss National Bank’s “Towards the future of the monetary system” event in April, Bank of England Deputy Governor Sarah Breeden predicted two distinct waves of benefits arriving because of tokenisation. First, she expects to see efficiencies that “broadly preserve the current structure of payment and settlement” but in the longer term, she sees it as more disruptive with post-trade processes collapsing, with layers of intermediaries being flattened.

Central Bank Innovation

Ms. Breeden’s perspective is important because while the Bank of England, in common with many other central banks, is experimenting with wholesale central bank digital currency (CBDC) of one form and another, the Old Lady of Threadneedle Street adopted a particularly innovative approach by creating a new category of central bank account (the “omnibus” account) for institutions. As I wrote recently, the introduction of the omnibus account led directly to the creation of Fnality, a private institutional form of tokenised money supported by a great many institutions. Institutions transfer Sterling from their accounts to the omnibus account and in return obtain Sterling Tokens that can be used in on-chain transactions.

The importance of this innovation should not be understated. Andrew Griffith (Economic Secretary of the UK Treasury) said last year that a wholesale private sector stablecoin (such as Fnality, for example) would precede a wholesale CBDC (which he sees as happening before a retail CBDC), while the Governor of the Bank England Andrew Bailey has said that he doesn’t see the need for a wholesale CBDC at all because the real time gross settlement system (RTGS) used for interbank payments already settles in central bank money (and, frankly, is always going to be faster than any form of shared ledger).

He has a point, as you might expect, because the benefit of a wholesale CBDC is that it gives the the ability to settle trades in tokenised assets on the ledger itself, enhancing liquidity in capital market: if that wholesale CBDC is backed by central bank money, then there is no need for a central bank to issue the wholesale CBDC itself. Having the entirely separate infrastructure also means that trading can continue on various ledgers even if the RTGS goes down, as does happen now and then (last August, RTGS went down for six hours.)

However some kind of tokenised central bank money comes to circulate between institutions, private or public, the Deputy Governor’s point is key to understanding the pressure for change here. The desire for decentralised finance, exchanging fungible and non-fungible tokens via persistent scripts (they are not “smart” and they are “not” contracts) is not because of ideology but because of money. These transactions will be cheaper, because the money tokens will be exchanged directly for the asset tokens with no need for “traditional” clearing and settlement. The money, as Marshall McLuhan might have said, is the message.

There is some interesting experimentation going on here and it’s not only the Bank of England exploring the potential benefits. The central bank “club”, the Bank for International Settlements (BIS), has just announced its Project Agora which will bring central banks together and private sector players to explore how tokenisation can enhance the functioning of the monetary system. The Bank of France (representing the Eurosystem), Bank of Japan, Bank of Korea, Bank of Mexico, Swiss National Bank, Bank of England and the Federal Reserve Bank of New York will seek to work in partnership with financial sector companies convened by the Institute of International Finance (IIF) to investigate how tokenised commercial bank deposits can be seamlessly integrated with tokenised wholesale central bank money in a public-private infrastructure using smart contracts and programmability, while maintaining its two-tier structure.

Tokenised central bank money will be used between institutions for payment vs. payment (PvP) and delivery vs. payment (DvP) to exchange money and tokenised assets. What kind of assets will be tokenised? Well, all of them in the long run, but right now funds are a particular focus. Taking an investor’s share or unit in a collective investment scheme (i.e., a ‘fund’) and turning it into a token that can be traded in a programmable, composable, automatic and cryptographically secure database shared between parties looks to be a practical way to improve markets. Apart from anything else, range of information can in theory be coded into the token, such as details of its ownership and the value of the token’s reference assets.

Infrastructure Disruption

I rather agree with Aisha Williams in her piece for NASDAQ NDAQ in which she writes that the fully digital infrastructure of real-world asset tokenisation and decentralised finance protocols will reshape financial markets by creating accessible and tradable asset. This will consolidate distribution, trading, clearing and settlement in a single layer, meaning more streamlined (i.e., less expensive) financial intermediation. This infrastructure is already under construction. Frankly, the move towards the tokenisation of real-world assets (or “stuff”, as I call it) and the trading of stuff for money in 24/7 decentralised markets is more of a vision of future global financial market infrastructure (FMI) than the co-ordinated manipulation of the meme stocks or the mempool front-running of cryptocurrency trades is. This is why it is so important to the get a solid legal framework in place, and soon.

Here in the UK, the Financial Conduct Authority (FCA) is working with the industry to explore potential uses of fund tokenisation which could make collective investment schemes more efficient, transparent, and accessible to a wider range of consumers. Meanwhile, in the US, BlackRock BLK has already announced the launch of its first tokenised fund issued on an Ethereum ETH blockchain, the BlackRock USD Institutional Digital Liquidity Fund.

Whether cryptocurrency becomes mainstream or not, and whatever you might think about Bitcoin BTC or the blockchain, digital assets mean that there will be real disruption in financial market infrastructure in the not-too-distant future.