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Inside magazine issue 19 |

 Part 02 - From a core transformation/technology perspective

The tokenization of
assets is disrupting
the financial industry.
Are you ready?
Patrick Laurent Thibault Chollet Michael Burke Tobias Seers
Partner Director Consultant Analyst
Technology & Enterprise Technology & Enterprise EMEA Blockchain Lab Strategy Regulatory
Application Application Deloitte & Corporate Finance
Deloitte Deloitte Deloitte

From art to buildings, the way we invest in assets could


be about to fundamentally change with the arrival of
tokenization. The act of tokenizing assets threatens
to disrupt many industries, in particular the financial
industry, and those who are not prepared risk being
left behind.
Inside magazine issue 19 |
 Part 02 - From a core transformation/technology perspective

What is tokenization?
The tokenization of assets refers to the
•• Faster and cheaper transactions
Because the transaction of tokens We foresee that
process of issuing a blockchain token
(specifically, a security token) that digitally
is completed with smart contracts
(software algorithms integrated into a tokenization could
represents a real tradable asset—in many
ways similar to the traditional process of
blockchain with trigger actions based on
pre-defined parameters), certain parts make the financial
securitization, with a modern twist. These
security tokens are created through a type
of the exchange process are automated.
This automation can reduce the industry more
of initial coin offering (ICO) sometimes
referred to as a security token offering
administrative burden involved in buying
and selling, with fewer intermediaries accessible, cheaper,
(STO) to distinguish it from other types of
ICOs, which can produce different tokens
needed, leading to not only faster deal
execution, but also lower transaction faster and easier,
such as equity, utility, or payment tokens.
An STO can be used to create a digital
fees.
thereby possibly
•• More transparency
representation—a security token—of an
asset, meaning that a security token could
A security token is capable of having unlocking trillions of
the token-holder’s rights and legal
represent a share in a company, ownership
of a piece of real estate, or participation in
responsibilities embedded directly euros in currently
onto the token, along with an
an investment fund. These security tokens
can then be traded on a secondary market.
immutable record of ownership. illiquid assets, and
These characteristics promise to add

Benefits
transparency to transactions, allowing vastly increasing the
you to know with whom you are dealing,
A new “token economy” offers the potential
for a more efficient and fair financial world
what your and their rights are, and who volumes of trades.
has previously owned this token.
by greatly reducing the friction involved
in the creation, buying, and selling of •• More accessible
securities. We see four key advantages that Importantly, tokenization could open up
tokenization provides for both investors investment in assets to a much wider
and sellers: audience thanks to reduced minimum
investment amounts and periods. Tokens
•• Greater liquidity
are highly divisible, meaning investors can
By tokenizing assets—especially private
purchase tokens that represent incredibly
securities or typically illiquid assets such
small percentages of the underlying
as fine art—these tokens can be then
assets. If each order is cheaper and
be traded on a secondary market of the
easier to process, it will open the way
issuer’s choice. This access to a broader
for a significant reduction of minimum
base of traders increases the liquidity,
investment amounts. Moreover, the
benefiting investors who consequently
higher liquidity of security tokens could
have more freedom and sellers because
also reduce minimum investment periods
the tokens benefit from the “liquidity
since investors can exchange their tokens
premium,” thereby capturing greater
on the secondary markets, which are
value from the underlying asset.
theoretically global and 24/7 (subject to
regulatory limits).
Inside magazine issue 19 |
 Part 02 - From a core transformation/technology perspective

These advantages most clearly apply to Challenges the trade occurs. If it is compliant, the
asset classes that are typically considered Some obstacles need to be overcome, trade can happen on any token exchange.
illiquid and can benefit from improved however, if tokenization and the broader More development in this area to facilitate
transparency, efficiencies, and lower token economy are to take off. A big the easier creation and sale of tokens is
minimum investments. Two areas are problem revolves around regulatory needed to move forward.
particularly interesting when considering alignment, especially considering the fact
the possibilities of tokenization: real estate that blockchain-based platforms are de Additionally, regulations specific to tokens
and fine art. Rather than requiring very facto decentralized. Security regulations or, at the minimum, clear guidance from
large investments, or tying up your money are typically technology agnostic, meaning regulators would be welcome, since there
for extended periods with your investment that security tokens, depending on their is often uncertainty as to how a security
split across a number of other assets in exact features, can fall under the full scope token should be considered within the
the fund, tokenization could permit you of relevant security regulations, which law. While it may seem counterintuitive
to invest €50 in the piece of art or specific can vary significantly from jurisdiction to to encourage regulation of a technology
building in which you are interested, and jurisdiction. This is true not just for the with decentralization and independence
then easily sell the token at your discretion. creation and initial sale of the tokens, as some of its core characteristics, it is
This ability to freely choose where you but also for trading them on secondary important to consider the risks of not
invest will open up a new era of much markets. Consequently, many of the providing a legal and safe framework in
greater personalization and customization advantages of tokenization are undermined which the technology can thrive. A lack of
in investment—an area that is increasingly if regulations prevent the free and scrutiny can allow scams and open the
relevant as investors now look beyond just international exchange of security tokens. door to hacking—something particularly
returns and pay much closer attention to What is needed are compliant methods relevant for a relatively nascent technology.
where their investments are made. of creating and exchanging tokens in a Scams and hacks not only harm investors
There are already a number of companies domestic and, ideally, international scope. and the broader economy, but enough
helping to build the infrastructure to International regulatory alignment is an of them could discourage investors and
support the growth of the token economy. unlikely milestone in the near future, cripple the token economy completely.
Companies like Tokeny, a platform to but adding clarity to the regulatory
issue and manage security tokens, as well environment for security tokens and There has been a considerably uneven
as digital marketplaces like tZERO and facilitating compliant involvement in the approach so far to regulating and accepting
privatemarket.io, are just a few of many token economy is a possible and necessary tokenization, but there are signs that
that are driving the concept of tokenization. path forward if the opportunities are to be the traditional market infrastructure
realized. is adapting to the token economy. For
We foresee that tokenization could make example, both the US SEC and EU’s ESMA
the financial industry more accessible, Some companies are already helping to have made comments, albeit generic,
cheaper, faster and easier, thereby possibly solve the compliance issue. Harbor, for in this area. Meanwhile, Malta and
unlocking trillions of euros in currently example, aims at embedding compliance Switzerland have made more progressive
illiquid assets, and vastly increasing the at the token level, thereby checking if a plans to accommodate new marketplaces
volumes of trades. trade is compliant, taking into account for tokenized securities1. Having a clear
who the buyer and seller are, and where regulatory framework is of vital importance
Inside magazine issue 19 |
 Part 02 - From a core transformation/technology perspective

for the safe development of the token


economy. In the meantime, a set of "As a technical enabler for
common good practices and rules would
be a good foundation.
STOs we see a rapidly growing
Beyond regulations, as with any new
technology or solution, some questions demand from investment funds
need addressing. How tokens will remain
linked to the real asset that they represent
is a point of concern. For example, imagine
and established companies
if you own tokens representing a small
fraction of 100 gold bars at a bank, and to tokenize their shares and
five bars are stolen. What happens to
your token and to the other token owners
is crucially important, since the value
increase liquidity for their
of tokens becomes greatly undermined
if they cannot be proven to be linked investors."
to real-world assets. Another point of Luc Falempin, CEO, Tokeny
consideration is the issue of governance. If
ownership of an asset, such as a building,
is split among thousands of people, there
is little incentive for owners to bear the
costs associated with that asset, such as
maintenance and ensuring rent is collected.
There are also concerns related to risks of
hacking that any digital or online products
have, as well as stability concerns with a
hyper-liquid market. These are problems
that will likely be overcome or minimized,
but they require thought and possibly
intermediaries of some sort.

Once those critical issues about the


functioning of the token economy can
be answered, and there is progress on
1 C
 rypto-Securities Regulation: ICOs, Token Sales and Cryptocurrencies under
the regulatory front, tokenization might EU Financial Law—link”, pp. 5-6; https://techcrunch.com/2018/07/19/malta-
become increasingly present across the paves-the-way-for-a-decentralized-stock-exchange/; https://www.six-group.
financial industry. com/en/home/media/releases/2018/20180706-six-digitalexchange.html.
Inside magazine issue 19 |
 Part 02 - From a core transformation/technology perspective

This movement will involve actors from all •• Business model platforms they will work or collaborate
levels (governments, central banks, private Financial institutions will have to choose with. This will depend on the regulation
companies, and even local communities), where to play in the value chain. For they have to follow, the type of products
and will depend on their communal effort example, they might choose to advise or services they will offer to their clients,
to move tokenization forward. If the issuers on how to structure their token, and other factors more related to the
abovementioned issues are addressed, as or could act as safe keeper of the platform itself, such as its product
adoption increases and overhype—which tokenized asset (art, real estate property, strategy, and its potential as regards the
undermines the true value of the token luxury vintage car, etc.). They could also type and size of the user community.
economy—dies down, the token economy leverage their expertise as custodian
might take off rapidly, with ripple effects banks or paying agents to create life cycle Institutions need to consider an
throughout the financial services industry event transactions on the distributed infrastructure that will provide both
and broader economy. ledger or, in a more advanced model, technical and economic solutions to
implement life cycle processing in smart their business model while also taking
What financial institutions will need contracts and deploy them on a public into account the effect it will have on
to consider in order to take part in the blockchain platform. At the other end downstream systems. Added to this, if
token economy of the value chain, they could offer the new platform cannot integrate with
The token economy represents a services to maintain customer accounts legacy systems, institutions may face a
remarkable power shift from large, in cryptocurrencies and tokens or prefer partial re-platforming of their information
centralized trust agents to the individual. to act as central distributors facilitating system.
Cryptology replaces third-party access for their clients to transact on
•• Cybersecurity
intermediaries as the keeper of trust, with diverse tokenization platforms or token
With digital payments reaching US$721
blockchain participants running complex exchanges.
billion in 2017, and the growing popularity
algorithms to certify the integrity of the
•• Platform integration of bitcoin and other cryptocurrencies,
ledger of transactions. Financial institutions
Depending on the business model they tokens are increasingly becoming
must determine how they are going to
choose to embrace, they will implement targeted by cybercriminals. While
adapt to the token economy. We see
different operating models. One of the distributed ledgers themselves
major areas that financial institutions must
the main components of those new implement a high degree of cybersecurity
consider if they wish to remain relevant in
operating models being the blockchain measures at their core thanks to
the token economy:
platform, they will have to choose which cryptology and consensus among
Inside magazine issue 19 |
 Part 02 - From a core transformation/technology perspective

multiple nodes, the whole ecosystem consent from the customer, financial or give access to is not compliant. This is
does have some possible weak points institutions will transfer the reference to especially true for institutions that have a
at its edges that need to be properly this identity down the value chain so that global scale.
secured. One of them lies in the other institutions know with whom they
management of the wallets and private are dealing, such as a crypto-exchange We expect that with the spread of
keys that control them; it could also be transferring the identity to a bank. This tokenization there will be new actors, new
man-in-the-middle attack or advanced will speed up the on-boarding process, roles, and new services. A decentralized
social engineering to steal private keys. reduce the overall cost of KYC compliance financial system does not guarantee one
Not only shall the financial institutions and, at the same time, enable more without financial institutions, and prepared
consider implementing proper security direct and rapid interactions that are and forward-thinking institutions will be
measures to secure the whole value fundamental to the token economy. those that are most able to embrace the
chain when they run or interact with token economy. Traditional players will have
blockchain platforms, but they might also Another area that will be affected is the opportunity to meet the new demands
consider proposing a new kind of service taxation. Financial institutions that are of a token economy, be it a provision of
to their customers, for instance, to responsible for processing some tax platforms for storing tokens, or acting
securely store their wallets and keys. With will have to adapt their information as trusted intermediaries for when the
this in mind, institutions need to carefully systems and processes to compute and blockchain alone is not enough. Those that
plan for cybersecurity at different levels deduct certain tax schemes, such as do not rise to the challenge will struggle
from network and infrastructure, through withholding tax. Part of that processing in the face of fierce competition for an
systems, to applications, and consider might be encoded in a smart contract exciting new, tokenized world.
the opportunity of differentiation through and automated, and as long as the tax
advanced cybersecurity prevention. authorities do not accept payment of tax
in cryptocurrencies, financial institutions
•• Compliance
will remain in the taxation ecosystems.
MiFID, Anti-money laundering (AML), Conclusion
know your customer (KYC), and other
Industry Practicality Current industry
regulations are at the center of any
capability and viability implications are
financial institution’s obligations when •• Tokenization allows the creation
a key hurdle in the adoption process.
it comes to client service. In the token of a new financial system—one
For example, within asset servicing, if a
economy in which business interactions that is more democratic, more
fund is tokenized, will all the underlying
are more direct, expeditious and efficient, and more vast than
assets need to be tokenized and a
irreversible, operational measures to anything we have seen.
smart contract created for the daily NAV
comply with regulations will have to be
production so as to have a near-live token •• Tokenization is already a reality.
adapted, potentially becoming more
price for the fund unit? The emerging New players are rapidly building
upstream, factorized, and standardized.
landscape of this regulatory thinking is their own infrastructure,
Institutions should not reinvent the
developing at a faster pace in emerging while the traditional market
wheel, but collaborate with new actors
markets, like Singapore, rather than infrastructures are also showing
such as tech startups, KYC utilities, or
traditional Western economies. signs of paving the way for
blockchain analytics software vendors
mainstream adoption.
to implement new operational measures •• Jurisdiction
and demonstrate to the regulators that With legislative and regulatory •• Obstacles stand in the way of
they remain compliant while operating in frameworks differing from jurisdiction widespread adoption, principally
the digital space. to jurisdiction, financial institutions in the form of regulation. But
We can imagine that, in the near future, must ensure tokens remain compliant these obstacles can be overcome
KYC processes would likely be realized both in the issuer’s as well as in the with the support of actors from
once by a specialized KYC utility, encoded investor’s multiple jurisdictions (e.g., a all levels.
in a self-sovereign digital identity, and Canadian seller and Japanese buyer).
•• Only institutions that engage
used by customers each time they enter They should implement measures to
with the technology, plan for the
into a relationship with a new financial prevent investment by customers from
future, and adapt to the realities
institution. Provided that they have jurisdictions with which a token they offer
will thrive

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