Matt Higginson of McKinsey discusses why the future of digital asset tokenization holds greater promise than its tumultuous recent history might indicate.
Six years ago, the first digital asset tokenization took place, and it was quickly hailed as the Next Big Thing. Stalled by fraud, bankruptcies, and an unsettled regulatory environment, however, the technology didn’t scale and while a wise person does not go on the record predicting the future, I will venture to say this: even though the digital assets sector has had a rough ride of late, tokenization is poised to become a force.
‘Tokenization’ refers to the process of issuing a digital representation of a traditional asset on a blockchain; the token represents ownership, in whole or in part, of the underlying asset. The asset can be either tangible (such as art, commodities, or real estate) or intangible (intellectual property, carbon credits, even a cooking class) and is stored on a digital ledger.
How does an asset become a token? First, the asset is identified, and if it is tangible, stored in a controlled location. Then a digital representation of the asset is created on a blockchain and equipped with a specific standard that determines what functions apply. With the digital asset created and secured, it is ready to be traded; investors need to set up an account to do so. For institutional investors, a traded asset requires additional services, such as tax and accounting, and calculating its net asset value (NAV).
In short, it’s complicated. Still, given the breadth of possibilities, the potential is huge; as much as USD 5 trillion in tokenized digital securities could be issued by 2030. That is a guess, of course. What is more certain is that interest is growing, and the business fundamentals are strengthening. One benefit of tokenization is that it offers access to the advantages of blockchain technology, such as 24/7 operations, instant settlement, and higher degrees of automation. If it does indeed scale up, the benefits could include greater capital efficiency and transparency, cheaper compliance, and ultimately the democratisation of investment, with people able to access investment opportunities around the globe, at low cost and in small increments.
To get to take off, though, the industry needs to solve four problems.
Technology and infrastructure limitations. Blockchain technology historically has had limited utility and has been expensive, with interoperability challenges across financial institutions. This introduces new risks and makes it difficult to harmonise data, which is necessary to meet reporting requirements.
Lack of scale. It’s a catch-22. Tokenization reaches its full potential only when it is deployed at a large scale, but the business case to make the sizeable investments required, such as redesigning the back office, is still uncertain.
Market immaturity. Cross-bank capabilities are limited; tokenized deposits currently operate mostly within a single network. Therefore, the benefits of tokenization, such as instantaneous settlement, cannot be realised easily. In addition, there is a lack of distribution channels, with many assets only available on provider-created platforms. This constrains both distribution and liquidity.
Regulatory uncertainty. Or perhaps ‘global inconsistency’ might be the better phrase. Regulations can differ both within and between markets; they can also be fragmented and confusing. In the United States, the Securities and Exchange Commission has imposed stricter standards for digital assets than traditional ones.
No question: these are not trivial issues. Moreover, the public will take some persuading. Levels of digital trust in general are not what they could be, with a significant minority (30 percent) uncertain that the companies they do business with are serious about protecting their data. Despite its reliance on distributed, decentralised technology, tokenization has to overcome this scepticism.
But what can be said is that progress is being made, and the momentum is real. For example, there is about USD 120 billion in tokenized cash in circulation, and banks, supported by higher interest rates, are investing in tokenized asset capabilities. Many important markets, such as the European Union, Japan, and Hong Kong, are making progress in forging a clear legal framework to support the use of digital assets. And financial services companies are not running away. Rather, they are hiring digital-asset talent and investing in related capabilities. Certain asset classes and use cases, such as money market funds, repos, and corporate bonds, could scale up substantially in the next few years.
Disruptive technologies always carry an element of risk. A smooth ride cannot be expected, much less assumed. The challenge, and the opportunity, is to prove their worth in the market. That is beginning to happen, and younger consumers appear particularly intrigued. A 2022 McKinsey survey of 35,000 active online users in digital-asset markets in India, Singapore, and the United Kingdom found that 20 percent of those under the age of 45 already owned digital assets, and the majority of this cohort had either made payments using digital assets or traded non-fungible tokens.
The bottom line: the future of digital asset tokenization appears much more promising than its tempestuous recent past might suggest.
Matt Higginson is part of McKinsey’s leadership team for the Financial Services and Risk practices. His experience covers financial service clients in North America, Central America, the Caribbean, Europe, and Asia. He specializes in advising clients on end-to-end collections transformations, retail-banking operations, and strategy and the strategic implications of distributed-ledger technology (DLT), or blockchain.
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