Beyond stablecoins: The tokenisation story

By Atul Bhatia, CFA

It has been just over a year since the Guiding and Establishing National Innovation for U.S. Stablecoins (GENIUS) Act became law. That legislation laid out a regulatory framework for stablecoins, or electronic tokens designed to maintain parity with traditional currencies. Since its passage, the conversation on the rules has focused on a provision prohibiting stablecoin issuers from paying interest.

Proponents of that limitation argue that it is an important safeguard against possible runs on traditional banks, while opponents point out the negative impact on stablecoin adoption.

As we argue in our recent special report, however, this debate seems to us largely misplaced. Interest payments on stablecoins are, we believe, a tangential issue at most in terms of banking stability. Instead, what we think is revolutionary about stablecoins is the launch of a tokenised version of a mainstream asset. That, we think, is where investors need to focus their attention, not on the minutiae of interest paying policy.

Stablecoins: From niche tool to US$300 billion market

Stablecoins began as a liquidity and temporary holding vehicle for cryptocurrency investors. The purpose of the coin was merely to hold its value, so investors could stay in the crypto ecosystem and not have to return to standard banks. The promise was that a dollar stablecoin would maintain a one-to-one valuation with the real-world dollar, a condition known as parity.

Despite a few well-publicised failures, money continued to flow into stablecoins, with the asset class growing from approximately $5 billion in 2019 to nearly $300 billion today. That growth drew regulatory attention, culminating in the GENIUS Act.

The Act includes a series of requirements for stablecoins, including pre-approval of issuers, a strict one-to-one reserve requirement and a very restrictive list of permitted investments. Issuers are required to hold highly liquid, short-maturity investments with low credit risk.

The interest payment debate: A distraction from what matters

The combination of liquidity and low credit risk makes stablecoins a potential competitor to traditional bank accounts. The potential for substitution drove the GENIUS Act’s prohibition on interest payments. The concern was that in times of banking crisis, the existence of an interest-paying substitute could spark or accelerate a run by depositors.

While the theory appears sound, there are serious practical difficulties with the argument:

• Existing alternatives: Investors who want an interest-paying substitute for a bank account already have multiple options, including money market funds, bond ETFs and even buying a Treasury bill directly from the government. Why stablecoins should be singled out as high risk is unclear to us.
• Return of capital: If a depositor is truly worried about his or her account being repaid, interest is hardly a major concern. Even at five or six percent, the accrued daily interest pales in comparison to loss of principal.
• Depositor restrictions: Most banks require corporate borrowers to maintain specific account balances, making it impossible to pull funds.

In short, while we believe the bank run argument has sound theoretical underpinnings, it flies in the face of actual depositor behaviour across multiple banking crises.

Tokenisation: Certainty and efficiency

Rather than the minutiae of interest rate payments, what we find interesting about stablecoins is their role as a tokenised version of a mainstream financial asset. Without interest, we can think of stablecoins as a tokenised dollar; with interest, we can think of them as a tokenised government money market fund.

There are various definitions of tokenisation, but the hallmark is the representation of ownership of physical assets in a blockchain/digitally verified form. What this means is that anyone with access to the digital ledger can instantly know who owns what, and that ownership can be securely and almost instantly transferred to anyone.

That may not sound revolutionary, but it effectively severs the current trade-off between establishing certainty of ownership and the efficiency of transferring assets.

Take real estate, for instance. There, certainty of ownership is prioritised through a central register, scrupulously controlled by government officials with multiple confirmations before any change is registered. It’s safe, but it comes at the cost of slow, inefficient and expensive transfer procedures.

On the other side, we have the market for borrowing against receivables, which operates largely on emailed spreadsheets. It’s extremely fast and efficient, but the documents provide no certainty of ownership, allowing the same collateral to be pledged to multiple lenders.

The strength of tokenisation is that it solves for both clarity and efficiency. Blockchain ledgers provide certainty of ownership; digital platforms provide for efficient transfer. Because the register is central and public, malicious actors can’t resell the same asset multiple times, but legitimate transactions are processed rapidly.

The path ahead

Tokenisation has already begun to play a role in how banks settle certain transactions, a process that we believe will continue to expand. Not only is it more cost-efficient to settle on blockchain, but shorter settlement times also reduce intraday counterparty risk, giving investors and regulators reasons to smile.

Beyond financial settlements, we expect tokenisation growth to continue in three main areas:

• Collateral expansion: The U.S. Federal Reserve estimates nearly $6 trillion in trade receivables is held by non-financial companies. By providing clarity of ownership and efficient transfers, tokenisation could help unlock financing opportunities, particularly for smaller companies.
• Cheaper transfers: Particularly in real estate, tokenisation could offer lower-cost transfers while preserving certainty of ownership.
• Divisibility of assets: Tokenisation allows for fractional ownership stakes, potentially allowing homeowners to diversify their investment portfolios while remaining in their houses.

The primary obstacle to tokenisation, in our view, is updating legal frameworks so that blockchain registers are legally enforceable in the physical world. Given the benefits of the process, we believe it is a question of when, not if.

Moving into the mainstream

At first glance, stablecoins appear to be about facilitating digital payments and a move beyond online banking into something approaching virtual currency. While that is a fair summary of what the product could be, we think it misses the forest for the trees. We think the true impact of stablecoins will be in moving the concept of tokenisation into the mainstream. For more on this topic, see our full report, Bridging worlds: Tokenisation connects digital and physical assets.

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