Download This PaperTestimony of Hilary J. Allen, House Financial Services Committee Hearing on "Next Generation Infrastructure: How Tokenization of Real-World Assets Will Facilitate Efficient Markets."
18 Pages Posted: 17 Jun 2024
Date Written: June 05, 2024
Abstract
The goal of today’s hearing is to learn about real-world asset tokenization. It is important to clear up the confusion between tokenization and crypto at the outset. Tokenization does not actually require the involvement of the crypto industry or any crypto-specific technologies. As this testimony will explore, tokenization does not require the use of stablecoins, and the tokenization of real-world assets is intended to differ in important respects from faddish NFTs. Tokenization does entail the use of smart contracts (a type of computer program that is often used by the crypto industry), but smart contract technology predates the use of the public permissionless blockchain technology that the crypto industry is built on. Such public permissionless blockchains can be used to record the ownership of tokenized assets, and there has been experimentation to that end. However, tokenization does not actually require the use of public permissionless blockchains technology; token ownership can be recorded on other types of ledgers (private, permissioned, and centralized). This is important, because public permissionless blockchains suffer from insuperable inefficiencies and operational fragilities that render them unsuitable supporting infrastructure for real-world financial markets.
Tokenization of real-world assets can and should be kept separate from crypto. Freed from the
limitations of permissionless public blockchain technology, tokenization may be able to promote significant efficiencies in some markets. There is particular interest in tokenizing deposits to improve the speed of interbank payments (particularly cross-border payments), which would require banks to adopt shared ledgers or at least make their ledgers interoperable. Tokenizing deposits would also allow some functions (like making monthly interest payments) to be automated with smart contracts. Tokenized deposits can also serve as the settlement asset in “composed” financial products that involve multiple other tokenized assets. In terms of other tokenized assets, there is significant interest in tokenizing securities as well as physical property like real estate and art. There is also significant interest in creating tokens that allow people to purchase fractional interests in these assets. Transactions in tokenized assets that are hosted on the same ledger can be settled instantaneously: while there are scenarios in which such “atomic settlement” is undesirable, there are also likely to be markets that would benefit from it.
It should be noted that two bills recently passed by the House of Representatives, if they were to
become law, could be detrimental to the tokenization of real-world assets. One, the CBDC Anti-Surveillance State Act, would prevent the Federal Reserve from issuing anything like a wholesale CBDC. However, the development of something like a wholesale CBDC is likely to be critical to facilitating the wide-scale adoption of tokenized deposits. The second bill, FIT21, creates an exemption from the securities laws for many tokenized securities. Without the SEC’s investor protections, investors may not have the confidence to invest in tokenized securities.
A lack of investor protections would also undermine any financial inclusion benefits associated with tokenization – but realistically, the benefits of tokenization will sound more in efficiency gains than in financial inclusion improvements. When roughly half of all Americans (some surveys say more) are living paycheck-to-paycheck, the problem is not a lack of investment opportunities but a lack of money to invest in the first place. Asset tokenization and fractionalization will therefore have limited financial inclusion benefits. If tokenized deposits allow for faster payment processing, that may help underbanked communities avoid expensive check cashing services, but tokenized deposits will not bank the unbanked. Improved efficiencies from tokenization will still be desirable in some contexts, however. We should remain mindful, though, that when systems become more efficient, they also tend to become more fragile. The increased financialization, speed, and automation envisaged by proponents of tokenization all have precedents in the lead-up to the 2008 financial crisis, and there may be circumstances in which tokenization’s increased efficiencies ultimately aren’t worth the attendant risks.
Keywords: financial regulation, tokenization, digital assets, blockchain, financial stability, investor protection, financial inclusion
Suggested Citation: Suggested Citation
Hilary J. Allen (Contact Author)
American University - Washington College of Law ( email )
4300 Nebraska Ave NW, Washington, DC
4300 Nebraska Ave NW, Washington, DC
Washington, DC 20016
United States