The tokenisation of assets has not progressed as many market participants had expected. The slow progress can undoubtedly be attributed to several factors. But one seems to stand out: The lack of an attractive secondary market. Naturally secondary markets emerge only with market depth and market depth depends on sustained large-scale issuance. Tokenisation needs a large-scale issuer everyone needs to hold. No entity would be better suited than the government. Tokenised government bonds therefore seem the preferred digital asset.
Digital assets denote here, securities and other assets issued natively on blockchain and other distributed ledger technology (DLT) platforms. They may constitute the same obligation as a conventional asset, but all claims attached to the obligation including to attest ownership and the right to transfer ownership are typically embedded into the token, given rise to properties akin to bearer instruments, whereby the DLT-platform would serve as transfer recording and transfer processing infrastructure.
It would seem a small step from dematerialisation to tokenisaton but would be a big step in terms of ecosystem integration and advanced functionalities. It would offer a new peer-to-peer settlement architecture and through programmability the possibility to embed the most complex transfer and settlement conditions. Therein lie the advantages of tokenised assets.
Digital assets are above all about the simplification of post-trade processing. Tokenised bonds to be transferred in delivery without payment and exchanged against other digital assets in delivery versus delivery (DvD) or against a money token in delivery versus payment (DvP) transactions by simple token transfers like sending an e-mail. They also offer advantages for distribution through advanced automation.
The simplification of DvD and DvP transactions promises important efficiency gains. Where DvP transactions involve the exchange of a government bond against a high-grade payment instrument like a central bank digital currency (CBDC) and where the transaction can settle instantly and atomically, meaning both legs of the transaction succeed or none does, the transaction becomes entirely riskless affording important capital and liquidity savings.
Tokenisation may give rise to new business models. Because the transaction enables immediate re-use of the tokenised bond by the buyer, the bond could instantly be pledged in a repurchase operation against money if required or form part of a set of conditions to be met in a series of simultaneous nested transactions. The ease with which transactions can be settled offers an opportunity to redesign the boundaries between pre-trade, trade and post-trade.
The adoption of tokenised assets will depend in large part on a liquid secondary market Secondary markets are critical to allow holders of an asset to manage their exposure actively and in large part determines the success of an issue. It requires typically multiple actors who are willing to make markets and a certain market depth to facilitate price formation and give rise to different trading opportunities. The relative scarcity of tokenised assets implies that an active secondary market has remained elusive. This represents a major obstacle to making tokenised assets investable.
The government is typically the largest issuer of debt in a given currency denomination. In the U.K., the government has debt outstanding of £2.7 trillion (about 100 percent of GDP).* There are high hopes that its DIGIT project to tokenise UK Treasury securities (gilts) could give rise to large scale issuance. There are £2.1 trillion gilts outstanding.** Because UK Treasury debt is normally the benchmark for sterling-denominated debt issuance, receives a highly favourable prudential treatment and forms part of leading debt indices, most financial institutions want or need to hold it. Tokenised gilts should be no different from other gilts in terms of their balance sheet impact and eligibility for repurchase operations including by the Bank of England (central bank of the UK).
The placement of gilts occurs in the primary market with so-called primary dealers or gilt-edged market makers (GEMMs). Inter dealer brokers (IDBs) act as intermediaries for anonymous trading between market makers. There are 18 GEMMS and 6 IDBs. The GEMMs have the obligation, against a number of privileges, to support the gilts market playing an active role in issuance and distribution, in purchasing gilts and in making two-way prices on demand and in all conditions. To incentivise GEMMs, there will need to be a commitment by the Treasury to issue regularly and in size a given share of gilts in a tokenised format, say 30 percent of new gilts issuance (£0.7 trillion of gilts come due and will need to be rolled through end-2030).
The large-scale issuance of tokenised gilt should be undertaken if the Treasury believes in the positive effect of digital assets for UK financial markets and the economy as a whole. It would enhance market diversification and competition. It may bring new investors to the gilts market. If promised efficiency gains materialise, it would have a positive fiscal impact as tokenised gilts should be trading at a premium to conventional gilts. As tokenised gilts will likely constitute the pricing benchmark for other tokenised debt instruments, it would offer a robust basis to improve issuance and trading conditions for many different tokenised assets.
There are some tokenised central government securities including by Austria, Hong Kong, Slovenia but those remain isolated undertakings of small-scale that will unlikely produce any broader adoption effects.
The tokenised gilts should be settled ideally on-chain against a high-grade medium. This could ideally be a central bank digital currency (CBDC) or through a synchronisation mechanism, similar to the trigger solution of the Bundesbank (central bank of Germany), between the DLT-platform and the Bank of England’s large value payment system.
Tokenised treasury securities if done in size may be the catalyst the digital asset market requires to take off. It would help instal favourable market conditions from the outset and support broader adoption for other digital assets. The wait for the killer app in digital assets may be over.
*IMF.
**UK Debt Management Office.