Tokenization, the blockchain-based ownership and exchange of real-world assets (RWA), was one of the buzzwords at last week’s Sibos conference in Toronto, the global banking industry’s annual technology convention.

Old hands in the cryptocurrency field are probably rolling their eyes, remembering the “blockchain, not bitcoin” narrative that was popular circa 2016. During that crypto bear market, vendors breathlessly pitched sanitized versions of blockchain networks (referred to as the somniferous mouthful “distributed ledger technology”) to financial institutions and other corporations. Little came of these pilot tests and proofs of concept.

But while it’s easy to feel déjà vu, blockchains, both public and private, are evolving and, some say, on a path to converging.

At one end of the spectrum are banks and financial institutions, whose blockchain activities have largely been confined to using permissioned networks, and are attracted by purported cost-saving efficiencies. These firms are now eyeing tokenization roadmaps that would digitize everything from money market funds to large but illiquid private markets and areas like real estate. Public blockchain ecosystems are at the other end of the spectrum, looking for asset diversification to fuel areas like decentralized finance (DeFi).

“Eventually the biggest market for real world assets from banks will be public blockchain protocols that need diversified collateral,” said Sergey Nazarov, the CEO of Ethereum data oracle provider Chainlink. “I think the public blockchain protocols are the ones that will be willing to pay the biggest premium for this diversified collateral. The yield from the public blockchain world will be very attractive to banks and public chains will greatly benefit from the assets that the banks tokenize and put into their protocols, making those protocols more resilient and reliable.”

To be sure, financial institutions will likely proceed cautiously in the U.S., where regulators are discouraging them from touching anything related to crypto in the wake of last year’s price crash and the FTX exchange’s collapse. Europe and Asia, by contrast, could steal a march on the U.S., given the relative clarity in these jurisdictions.

Even so, there also seems to be some convergence among enterprises on Ethereum-compatible products and services: Last week saw announcements from Citi, which is piloting tokenized deposits and a trade finance application, and details of a tokenization engine from institutional custody firm Taurus, which has begun working with Deutsche Bank among others.

JPMorgan and Ethereum

Tokenization isn’t new. It’s been the mission for mega-bank JPMorgan since beginning its blockchain program back in 2015 and releasing Quorum, its permissioned fork of the Ethereum code. The bank’s Onyx Digital Assets platform, settling with tokenized fiat JPM Coin, has handled over $900 billion of transactions since going live a few years ago (admittedly, a drop in the bucket for a bank that does over $8 trillion of payments a day.)

Edging towards the public Ethereum mainnet has always been a delicate business, given that banks have traditionally viewed public blockchains as more or less radioactive, both a reputational and compliance risk. JPMorgan’s head of Onyx Digital Assets, Tyrone Lobban, noted that the public Ethereum chain has evolved significantly over time, from the proof-of-work consensus mechanism to proof-of-stake. (The former is more energy-intensive and has made Bitcoin a bete noire of environmentalists, giving ESG-conscious banks reason to prefer the latter.) Plans to add better scaling technology and multiple data layers on Ethereum could also cater to the needs of enterprises over time, he said.

“You hear terms like ‘subnets’ or ‘supernets’ or ‘hyperchains.’ Basically, these things are a more controlled space on a public blockchain,” Lobban said. “You still get the benefits of having a highly redundant, ever-persistent settlement rail in the public blockchain, but you have the ability to operate in a more controlled environment with AML KYC [anti-money laundering, know-your-customer] requirements, for instance. So a smaller set of participants are validating transactions or are privy to those transactions, without necessarily exposing all of that to the full public ecosystem,” he added.

The Franklin Templeton Effect

Despite an uncertain regulatory environment in the U.S., $1.4 trillion investment giant Franklin Templeton, has gone straight to public blockchains.

Franklin Templeton started exploring the tech back in 2019 because the firm was doing its own transfer agency work, recording the ownership and buying of shares in a mutual fund, and understood how much cost was buried in that task, explained Franklin Templeton’s head of digital assets, Sandy Kaul.

“We ran a side-by-side pilot, demonstrating to the [U.S. Securities and Exchange Commission] that the books and records that we’re keeping on the public blockchain are correct and equal to the traditional transfer agency book of records,” Kaul said. “We got them comfortable, and we have been running that fund for a year and half now as a token on public blockchain.”

Kaul also referred to the evolution of the public Ethereum chain and its shift to proof-of-stake, which, she said, provided free benefits to anyone running a node on the network.

“It’s going to be very difficult for these private blockchains to keep pace with that rate of innovation and with the cost efficiency of having the big public blockchains operating almost like the utilities of the future,” she said.

Citi’s Token Services

Like JPMorgan, Citi is not a newcomer to digital assets, beginning blockchain-related work back in 2015 at its Innovation Lab. Earlier this year, Citi hired enterprise blockchain veteran Ryan Rugg, a former executive at IBM and banking blockchain specialist R3, to head up the bank’s new token services unit. The bank’s tokenization pilot operates on a permissioned basis and is only running in the U.S. and Singapore for now.

“I sometimes joke that I probably know more about what not to do, than what to do – because of my experience at tech companies big and small, and building consortia and watching applications evolve. One of the big lessons I learned is you can’t have a large entity owning the network,” Rugg said.

An example of Citi working on a shared market utility using digital assets is the Regulated Liability Network proof of concept with the Federal Reserve Bank of New York’s Innovation Center and several banks and industry participants, Rugg pointed out. She said interoperability between banks’ tokenized fiat offerings is the way forward.

“We recognize that clients want multi-bank, multi-jurisdiction, cross-border liquidity,” Rugg said. “They don’t want a siloed system; they want to be able to move liquidity freely across a multitude of banks and to streamline that operational process and optimize their liquidity across their markets.”

Lobban of JPMorgan said discussions about moving assets across chains come up, particularly as other banks’ platforms begin to emerge, and that the largest bank in the U.S. is exploring various interoperability solutions. But he added that it’s a complex problem with non-technical challenges that need to be addressed to become a reality.

“Deposit tokens are representations of commercial bank money, so you’re dealing with different credit ratings and credit risk associated with these commercial bank issuances, as well as important regulatory guidelines,” Lobban said. “There are also legal considerations when moving assets out of your official books and records to someone else’s official books and records.”

Aoyon Ashraf contributed reporting.