In our latest instalment of Leaders in Action, Zoniqx had the opportunity to interview Dr. Ian Hunt. Dr. Hunt is a recognized expert on buy-side business processes and technology, renowned for driving innovation in investment strategies, risk management, and derivatives. He is widely regarded as an authority on Investment Book of Record and Blockchain technologies, with experience as an expert witness in several investment fraud cases and is currently an Advisor to Schroders on Digital Assets and Token Standards. He spoke to us in a personal capacity, as a well-recognized industry consultant and author. Here are some excerpts from his interview with Zoniqx.
Q1: In your view, what are the key factors driving the adoption of RWA tokenization across industries, and how does your project align with these trends?
Tokenization is useful. It allows us to deliver a self-maintaining register. It facilitates atomic settlement, and so reduces settlement risk (so long as cash is tokenized too). It gives us access to the real-time data alignment that distributed ledgers deliver to their participants, eliminating troublesome asynchronous messaging and reconciliations. It delivers the complete and immutable history of data in a blockchain, enhancing trust and disincentivising fraud. I was the designer of FundAdminChain’s ledger, on which the first tokenized fund was launched in the UK, with Fidelity, a couple of years ago. So I believe in these benefits and have worked to deliver them.
However, we should all recognize that tokenizing a conventional asset (or fund) doesn’t create a digital asset. It just creates a digital way of owning a conventional asset: a token instead of a share, or a unit, or a title deed, or an indenture, or an ISDA agreement. Or instead of one of the many other attestations of ownership that we have created for our conventional asset types. There is a benefit in owning assets through tokens – they are a consistent way of owning diverse asset types. But the diverse operating models, regulations, property laws and technology that swirl around the assets stay the same, irrespective of tokenization.
It currently takes around 16 regulated entities to deliver a simple equity ISA in the UK market: the most basic of tax-efficient investments for the private individual. Owning the ISA through a token, rather than through a share, makes little difference to that byzantine picture. The problem is the over-complex nature of the underlying product, and its governing law, regs, tech and entities. If we are serious about deploying digitization to transform the financial ecosystem, and really want to deliver better value and better solutions to our clients, then we need to confront the issues around the underlying assets and products, not just their tokens of ownership.
Tokens have the real advantage of being programmable, so they can be smart and active…which is a distinct improvement on an indenture. However, this genuine benefit is often presented as the opportunity to build into the tokens all of the laws, operations and regulations that stifle the existing conventional assets. Doing so just gets us straight back to where we started from, and perpetuates the issues that we should be addressing with digitization. We should be aiming for simplicity and commonality, not concretizing the way the world works now.
Q2: How do you foresee the growth of RWA tokenization impacting traditional financial markets and asset management practices in the next few years?
In the UK, the recent TreasuryTask Force, comprising the government, the regulator, the industry association and senior representatives from the industry, delivered a baseline definition of a tokenized fund that would be acceptable from a legal and regulatory point of view in the UK jurisdiction. It was a very positive development that these parties collaborated in this way. The baseline mandated that all current regulated roles should be the same in the delivery of a tokenized fund as for the delivery of a conventionally-issued fund. It prohibited on-ledger cash, and so prevented atomic settlement. It excluded investment in underlying digital, or tokenized assets. The result has been that very little actual fund tokenisation activity has followed. People are disincentivised from launching funds following the baseline, because it is so difficult to frame a credible business case for doing so: the achievable benefits are just not powerful enough.
There are some products for which tokenization is progressing. Money market funds are one, and carbon credits are another. We will talk about money market funds a bit later.
Q3: How is RWA tokenization influencing the strategies and operations of traditional financial institutions?
There are two kinds of thing that we currently call “assets”: there are genuinely real assets, that are inherently physical or organizational, like buildings or companies; and there are financial assets, that include loans, bonds, swaps, mortgages etc. We use “RWA” as a label for all of them. But in truth, there is nothing ‘real-world’ about a bond: it is just a fistful of promises. So is a swap, a mortgage, an option – and the rest. Financial assets are just collections of value-flow commitments, packaged by property laws and given a name, as if they were a coherent, atomic entity. They are not. We talk about the value and risk of a bond, but in reality, each promised flow has a different value and a different risk. The flows are primary – the ’asset’ is just a wrapper around them.
The boundaries between financial asset classes may have been helpful historically, but they are artificial and unnecessary. We create different ways of owning each asset class, and then solidify these with property and trading laws. Each asset class then acquires its own operating models, regulations and technology platforms, and becomes a walled-off silo. If we start from tokens that represent flow commitments (promises, contractual liabilities, IOUs etc. as you wish!) then we can construct any financial asset class that we choose, whether these are currently recognized assets or wholly new constructions. And we can have a single operating model across all of them, with one set of property laws, common regulations and a technology platform that supports all of them even-handedly. Assets and products become composable: this is the key to transforming our over-complex financial ecosystem. We can actively roll back that complexity, not meekly accept its inevitable growth.
Financial products are all about reengineering: the exchange of current value for future flows of value. Investors give up current value in exchange for future flows, and borrowers commit future flows to get access to current value. It is as simple as that. Once we have tokens of entitlement (representing commitments to future flows of value) as well as tokens of title (representing ownership of current value) then we have the right building blocks for a truly digital financial ecosystem. If we make those future flow tokens self-executing, then we can eliminate much of the friction in the delivery of financial services. Asset servicing, settlement management, securitizations and collateral management are fully automated, and become part of the same self-executing operating model, supported by the same platform, and operating under the same regulations. It is full composability: that’s real progress.
Q4: What are the challenges in the RWA tokenization space which can be a barrier or a hindrance, and what do you think can be a solution?
The most important obstruction to progress with a token-based ecosystem is the apparent inability of digital innovators to see beyond tokenization of RWA. At conference after conference, you hear speakers lauding tokenization as the universal cure to our every current ill. It isn’t - it is a useful component of a much bigger picture.
Of course, there is also stiction and resistance, driven from the vested interests of the current market players. In a fully digital ecosystem, there would be fewer, and more client-focused roles, so this is understandable. However, the real reason for the disengagement of current market players (other than the sexy, competing attraction of AI!) is that it is so hard to present a compelling business case for change, based just on tokenization of conventional assets.
There is always a noise about ‘regulatory uncertainty’. Our regulators are blamed for lack of progress, because we don’t know whether the path forward is legal and compliant, or not. However, it is our fault as innovators that we accept that current regulations (and their apparently inevitable growth) will be with us into the indefinite, digital future. There is a similarly meek acceptance that we have to fit in with current laws, and that we have to accept the existence, and underwrite the permanence of our existing asset classes. All of these are beyond questionable – they are wrong.
A fully digital ecosystem is a very different construct from our current financial world: it is a much simpler, much safer, much cheaper and much more flexible world. It presents us with the opportunity radically to simplify law, regulation and infrastructure; we will miss that opportunity if we just keep old regs, laws and tech in the new future. We have adopted a ‘don’t poke the bear’ mentality, and it is holding us back from delivering real value. Without a full vision of a digital future, and the transformational benefits that that can bring, it’s not worth the cost and effort of change for many industry participants.
Q5: BlackRock's BUIDL Fund Token shows promise for using tokenized real-world assets as collateral in crypto margin trading. Do you think this could be a major driver for wider adoption of tokenized RWAs in general? Why or why not?
Tokenizing an asset doesn’t, of itself, make it more eligible as collateral. If the asset is eligible, then it should be eligible in token-form or otherwise. What tokenization does is to make it easier to transfer the collateral: if it is in token form, and can be transferred on-ledger, rather than by delivery between custodians, then intra-day transfers become more practical, reducing daylight exposure. That’s the good news.
This good news does not just apply to tokenised assets – it applies to conventional money market funds in the current ecosystem too. If a money market fund is not deemed of sufficient quality to be eligible as collateral, then tokenizing it will not make it eligible. But if it is of sufficient quality, then tokenizing it will accelerate transfers. The acceptance of the fund as collateral reduces redemptions in the fund, as participants will no longer need to liquidate their holdings to post cash as collateral. So there is a benefit for the fund itself – although again this is strictly a benefit of eligibility, rather than of tokenization.
Q6: Looking ahead, what emerging trends or technologies do you believe will significantly influence the direction and success of RWA tokenization initiatives?
The main thing that will impact the future of tokenization is getting beyond the idea that tokenizing conventional assets delivers some kind of nirvana. It doesn’t. We need to see that commitments to future flows are as important (and arguably much more important) than current value, and that we need those future flow commitments to be represented by self-executing tokens of entitlement. We can then compose financial assets and financial products from the same underlying components, and composability becomes real, and universal. Composable regulations, composable assets and composable products. In all: composable finance. That is where the world is heading, if we let it, and it is a much simpler, more secure, and more client-focused world.
Connect with Zoniqx
For financial institutions interested in exploring or enhancing their capabilities in blockchain and tokenization, Zoniqx offers a powerful and versatile suite of solutions that streamline the tokenization process. You can tokenize any asset, and Zoniqx offers a secure, compliant, and interoperable solution tailored to meet your needs. To learn more about how Zoniqx can help your organization unlock the potential of tokenized assets, or to discuss potential partnerships and collaborations, please visit our contact page 👉 https://www.zoniqx.com/contact.