In the near future, the tokenization of most institutions will mainly occur on closed, permissioned networks. Although public networks have potential, there are currently challenges in terms of compliance, technology, and regulation.

Author: GRAEME MOORE

Translation: Plain Blockchain

At least in the near future, the tokenization of most institutions will take place on closed, permissioned networks.

Many people believe that BlackRock's $100 million investment in Ethereum signifies that the tokenization of institutions will eventually explode on public, permissionless networks. This is true, but BlackRock's tokenized fund is just the tip of the iceberg in unlocking a huge potential.

The crypto industry has repeatedly claimed that institutions will enter, and now we know they are interested in tokenization. Large institutions such as BNP Paribas, JPMorgan, Goldman Sachs, the Hong Kong government, Franklin Templeton, Hamilton Lane, and now BlackRock have been exploring blockchain technology for some time.

When the world's largest asset management company chooses a public chain over JPMorgan's Onyx or Goldman Sachs' solution, it is undoubtedly a watershed moment. BlackRock's tokenized fund on Ethereum demonstrates institutional trust in public, permissionless networks, bringing much-needed legitimacy to the emerging public ecosystem. This move will also encourage other traditional institutional players to turn to on-chain funds.

However, despite BlackRock's notable and bold move to tokenize on Ethereum, the reality is that tokenization is currently mainly taking place on private, permissioned blockchains.

So far, most institutional efforts have been focused on private networks. The Hong Kong government's $100 million tokenized green bond used GS DAP, deployed on the privacy-enabled Canton blockchain.

Goldman Sachs, BNY Mellon, Cboe Global Markets, and other companies have recently conducted a series of pilot projects on the same network. HSBC used its Orion digital asset platform to tokenize gold for retail investors in Hong Kong. And BlackRock tokenized shares of its money market fund using JPMorgan's Onyx-based private Tokenized Collateral Network on Ethereum.

Bitcoin has proven that a market worth billions of dollars can actually be created out of thin air. The industry believes that blockchain can tokenize and trade all assets, enjoying increased liquidity. However, the enticing promise of liquidity for real-world assets has (so far) proven to be an illusion.

The 2018 token frenzy hyped up tens of trillions of dollars of tokenized assets on public networks. Seven years later, the total assets managed on public networks amount to only a few billion dollars, which is negligible compared to the theoretically possible scale. Meanwhile, private networks handle billions of dollars in transactions every day.

The crypto industry likes to mention Boston Consulting Group's prediction of $16 trillion illiquid assets being tokenized by 2030. Even a more conservative estimate—McKinsey & Company's prediction of $5 trillion tokenized real-world assets—is still a huge number.

However, from the trends and reality, most of these assets will first be tokenized on private networks.

Unlike a completely new asset class of crypto assets that exist entirely in an open ecosystem, real-world assets inherit the legacy of traditional finance. This legacy leans towards control of assets and clients, closed ecosystems, and compatibility with traditional markets, which sharply contrasts with the spirit of public, permissionless networks.

This explains why financial institutions prefer private networks. Private networks are closer to existing financial infrastructure and can more easily meet compliance requirements. These networks are better suited to business needs as they provide flexibility in governance and customization, such as modifying blockchain consensus protocols, transaction verification rules, and permissions. These networks can also handle higher transaction volumes, which is crucial for scalability.

Another issue is regulation. Until recently, regulatory agencies have only begun to guide and enforce comprehensive frameworks for participating in crypto assets. Therefore, public blockchain technology has been untouchable for these institutions until recently, and compliance is crucial for them.

For securities, at least there is some clarity. Tokenized securities are still securities and must operate within existing regulatory frameworks. However, certain assets (such as real estate) may not be securities off-chain, but once tokenized, they will be considered securities. The industry is still exploring specific ways for these assets to meet existing requirements.

Today, no one doubts the benefits of blockchain technology. For traditional finance, the main issues are integration and technical costs, infrastructure compatibility, and regulatory issues. While public networks offer more transparency, immutability, and decentralization, private networks are more practical and familiar for financial institutions.

There are also some technical issues to be resolved, let's take the example of Ethereum chosen by BlackRock. Although Ethereum has made progress in second-layer solutions and merging into Ethereum 2.0, the network faces challenges in meeting the speed, privacy, and compliance requirements involving regulated platforms.

As technology matures and regulatory frameworks develop, we can expect more tokenized assets to migrate to public blockchains and usher in a new wave of innovation. However, at least in the near future, the tokenization of most institutions will take place on closed, permissioned networks.

Source: https://blockworks.co/news/future-tokenization-permissioned-blockchains

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