Tokenization – Hype or Gamechanger? The view of McKinsey, CITI, BNY and EY 2023

Tokenization is one of the biggest use cases of blockchain technology. What is tokenization? In a nutshell, the goal of tokenization is to digitize all types of assets and make them digitally available in the form of tokens. If this happens, it would mean a fundamental change in the existing financial system. But is this just hype or is a change actually taking place? With all the sometimes contradictory information surrounding the topic of blockchain, crypto, etc., it is not so easy to keep track of what is really happening.

It is therefore helpful to take a look at what leading companies and experts think about tokenization and assess the current development. Numerous leading companies have conducted detailed analyses and studies on the subject in recent months and come up with interesting results.

The reports of four companies (McKinsey, Citibank, BNY Mellon, EY) are briefly presented below and a link to the detailed studies is included.

McKinsey

McKinsey is a leading global management consulting firm that helps companies with a variety of issues including strategy, operations, technology, and organizational development. McKinsey published an in-depth article in August 2023 on tokenization “Tokenization: a digital-asset déjà vu” published.

In this article, McKinsey examines the current state of tokenization and explains why the topic is currently at a turning point. Below are some brief excerpts from the article.

In the article, McKinsey authors first elaborated on the benefits of tokenization for asset owners, service providers and investors.

Subsequently, the challenges that existed in the past are presented and described. These challenges were and are:

• Technology and existing infrastructure are not (yet) prepared
• Limited short-term business benefits and high implementation costs
• Immaturity of the market
• Regulatory uncertainty
• Lack of standards and coordination

Despite the challenges outlined, however, McKinsey sees tokenization at an important inflection point:

Despite the challenges, tokenization may have reached an inflection point for certain use cases and asset classes. Trends in recent months point to a possible acceleration.

The authors see the reasons for this as:

• Progress in cash tokenization
• Improving the short-term fundamentals of the business model
• Emerging regulatory framework outside the United States.
• Increasing the market maturity and the maturity of the infrastructure

The authors conclude that while tokenization has not yet reached the scale needed to deliver on all its promises, the ecosystem is maturing, the underlying challenges are becoming clearer, and the business case for adoption may be improving. Early evidence, particularly in use cases that benefit from increased capital efficiency in a higher interest rate environment (as opposed to the traditional argument of improved liquidity for illiquid assets), points to additional use cases where the technology could gain traction and create significant value for global markets over the next two to five years.

Whether or not tokenization is at an inflection point, the natural question is how financial services firms should respond at this time.

The exact timeline and ultimate adoption of tokenization is unknown, but initial institutional experiments in specific asset classes and use cases (e.g., money market funds, repos, private funds, corporate bonds) have shown the potential to grow over the next two to five years. Those looking to secure a leadership position in this ecosystem might consider the following steps:

• Review of the underlying business cases
• Expansion of technology and risk competencies
• Building ecosystem relationships, especially for distribution of assets
• Participation in the definition of standards

In conclusion, the authors make the following recommendation: This is not the first time an industry has tried to switch to a more modern infrastructure. These conversions are always challenging because they mean running the old and new operating models in parallel for a period of time, which is difficult to do when cost is the focus. Regulatory uncertainty adds to the difficulties.

However, given the potential benefits tokenization can bring to financial services, recent moves by leading incumbents suggest they are up to the challenge, even if it may take some time. In the meantime, banks, asset managers, custodians and other firms can take some steps to prepare for the possibility of a tokenized world without remorse — the strategic optionality may be worth it, after all.

CitiBank

Citibank is one of the largest financial services providers and is part of Citigroup. Citibank is a global bank that offers various financial services such as retail banking, investment banking, and wealth management. Writers at Citibank created an in-depth article on tokenization in March 2023, “MONEY, TOKENS, AND GAMES — Blockchain’s Next Billion Users and Trillions in Value.”

The authors begin their introduction by noting that the value and benefits of blockchain are not as easy to grasp as with other technologies: “The potential of tokenization via blockchain has been described as transformative for several years, but we are not quite at the point of mass adoption yet. Unlike cars or more recent innovations like ChatGPT or the Metaverse, blockchain is a back-end infrastructure technology without a prominent consumer interface, which makes it harder to imagine how it could innovate.” But are coming to that assessment:

But we believe we are approaching a tipping point where the promised potential of blockchain will be realized and measured in billions of users and trillions of dollars. Adoption will be successful when blockchain has more than a billion users who don’t even know they are using the technology.

They see digital central bank currencies (CBDC), tokenized assets and social media payments as key drivers of mass market adoption.

As a prerequisite and support for further growth, from a technology perspective, progress on some key issues, such as digital identity and the existence of a legal framework are key issues.

In their assessment of the potential of the technology and the size of the market, the authors show very large dimensions.

Disruptive technologies are changing the way we live, work, spend money, invest, interact, and more. Blockchain — and the related Web3 concept — are disruptive technologies. They are creating controversy and debate, but also dreams and disappointment.

However, as a disruptive technology, blockchain is different from many others. Because it involves the transfer of financial assets, it enters the realm of money — a highly regulated area in most countries.

Those who have been promised the benefits of blockchain for many years may roll their eyes. But this time could be different. However, blockchain is not on the verge of a ChatGPT moment. Blockchain is a backend infrastructure technology more akin to cloud computing than artificial intelligence (AI) or the metaverse, which have the more distinct consumer interface.

So why do we think blockchain growth will be measured in billions of users and trillions of dollars by 2030?

Billions of users: The number of blockchain users will skyrocket through daily activities — money, gaming, social and more. Blockchain will not be successful until it has more than a billion end users who don’t even know they are using the technology.

• Money: countries with a total population of around 2 billion people are likely to experiment with central bank digital currencies (CBDCs) linked to distributed ledger technology (DLT).
• Games: The next generation of games will include tokenized assets, initially driven by games developed in Asia that are attractive to power users.
• Social: non-fungible tokens (NFTs) for art and collectibles, micropayments (including in metaverse games), decentralized social media, and large consumer brands will help drive Web3 adoption

Trillions of dollars: We estimate that up to $5 trillion could be converted to newer digital money formats such as CBDCs and stablecoins by 2030, about half of which could be DLT- or blockchain-linked. Regulatory reforms and greater interoperability could lead to up to $1 trillion in tokenization in global trade finance by 2030. Securities and funds are critical for tokenization in the private sector. We estimate that up to $5 trillion of non-financial corporate and quasi-sovereign debt, repo, securities finance, and collateral markets, as well as alternative assets such as real estate, private equity (PE), and venture capital (VC) could be tokenized by 2030. Industry estimates for the total volume of tokenization are even higher.

In their final assessment, the authors conclude, “Although we believe mass adoption may still be six to eight years away, the momentum of adoption has changed positively as governments, large institutions, and corporations have moved from exploring the benefits of tokenization to actual trials and proof-of-concepts.

BNY Mellon

The Bank of New York Mellon Corporation (BNY Mellon) is a global financial services provider. BNY Mellon provides investment management services to primarily institutional clients, such as pension funds, as well as investment services, such as custody banking, payment processing and numerous other services to other financial institutions.

BNY conducted a study in October 2022 in which 271 institutional investors were surveyed regarding their attitude towards investing in diegital assets.

The study revealed a very high level of interest in digital assets.

97% of the companies surveyed agree that tokenization will revolutionize asset management. 91% of respondents have expressed an interest in investing in tokenized products. These are impressive numbers for institutional investors that were unimaginable a few years ago.

For many years, the biggest question in the crypto investing world was: When will institutional investors enter the market? That question has been answered: it has begun.

The authors write: Our study provides a data-driven response that shows that a substantial number of people have invested, reaching a potential inflection point in adaptation, but that important conditions still need to be met for adaptation to increase.

Early crypto enthusiasts have always held the belief that one day all capital market infratructures would be mapped to blockchains. This study shows that the minimum of institutional investors has also changed and they can now imagine investing a third of their portfolio in digital assets. For financial services providers, this will require the ability to support hybrid portfolios in the future, a combination of digital and traditional assets.

In summary, the results of the study clearly show that currently a majority of the companies surveyed are actively engaged with a wide range of digital assets with a particular focus on tokenization, staking and access to DeFi (decentralized finance).

EY (Ernest & Young)

EY is one of the largest professional services firms in the world. EY offers a wide range of services, including audit, advisory, tax and financial advisory.

EY published a study in April 2023 titled: Staying the course: institutional investor sentiment toward blockchain and digital assets. EY conducted and published a survey of more than 250 institutions on their sentiment, usage and plans regarding blockchain and digital assets.

In the executive summary, the authors come to the following conclusion:

In an industry known for volatility, 2022 was a banner year for digital assets — with numerous headlines, television stories, and podcasts covering developments. On the one hand, we saw a complete change in the landscape of players, including the collapse of some of the best-known companies, as well as a historic drop in value and an increase in regulatory enforcement actions. On the other hand, we saw and continue to see the first meaningful institutional implementations of blockchain technology by large traditional financial organizations (TradFi), including the introduction of custody of digital assets, the introduction and use of tokenized deposits and settlement coins, numerous pilot projects for central bank digital currencies (CBDC).

These include the introduction of digital asset custody, the introduction and use of tokenized deposits and settlement coins, numerous digital central bank currency (CBDC) pilots, digital bond settlement on public ledgers, tokenization of private funds, intraday repo transactions on the blockchain, and the expansion of numerous use cases for payments and money movement.

Our results suggest that they are staying the course and not turning away from cryptocurrencies/digital assets. Institutions overwhelmingly believe in the long-term benefits of cryptocurrencies/digital assets, and their high level of caution stems primarily from concerns about regulatory uncertainty, identifying trusted institutions as partners, and the need to ensure the safety and secure custody of this new asset class.

Institutions see value in the ability to diversify assets as well as the potential for asymmetric returns when investing in crypto/digital assets. 35% of respondents said they allocate 1–5% of their portfolio to digital assets and/or related…

In conclusion, the authors make the following observation: Institutions see tokenization as very promising and are looking to invest more quickly in tokenized assets over the next two years, as well as tokenize their own assets. Hedge funds, in particular, are very optimistic about the timeline for starting their investments.

Summary Tokenization View

The evaluation of the four articles and studies clearly shows that something is happening in the field of tokenization. The institutional investors are there! They have the topic on their radar and are starting to build up capacities to position themselves in the topic of tokenization.

Certainly, there are still a few technical challenges to be solved and, above all, a clearer legal framework is needed in the USA, but these are not insurmountable hurdles. The benefits of tokenization are so great that these hurdles will be overcome in a timely manner.

Blockchain technology and the tokenization that builds on it has outgrown its infancy and gained maturity. It is no longer just pioneers, tech nerds, gamblers and alternative proponents of a new financial system who have recognized the value, but the big players see a future here for a trillion dollar market. This is more than evident in the articles and studies presented.