Why the financial industry should now rely on tokenized assets

Tokenization in the financial sector: Efficient and cost-effective

Tokenization is a global growth market that will last until 2024 according to estimates will grow to 4.8 trillion dollars, with an annual growth rate of 19.5%. What is driving this growth?

Many traditional financing instruments and capital market products are comparatively complex and expensive to trade and to store. Fund products incur significant one-off and ongoing costs: Initial costs are expenses and remuneration that arise when a fund is launched. Current fund costs include annual remuneration for management company and depositary, transaction and investment costs, and asset managers' salaries. These so-called “soft costs” of a fund reduce the return on the investment over the entire investment period and therefore have a direct effect on the shareholder's return.

When purchasing individual shares, there are usually two fees: ongoing custody costs and order fees for each transaction. If investors frequently reallocate their portfolio, transaction costs significantly reduce the return on securities business.

Blockchain technology, on the other hand, can handle many processes in a significantly more cost, time and resource saving way by tokenizing capital market products on the primary and secondary markets. Transparent traceability promotes more direct routes and faster transactions. A blockchain ecosystem In the financial sector, it can open up room for manoeuvre for issuers (larger liquidity pool) as well as for investors and restrict market manipulation.

Tokenization makes it possible to structure cryptocurrencies (=payment tokens) on the one hand and securitized assets (=security tokens) on the other. These can be securities, but also works of art, classic cars or real estate, which are divided up and issued as digital bonds. This allows several people to own digital shares of tangible assets and benefit from their income and increases in value.

In addition to simplified tradability and transferability, tokenization also has another advantage: Potential return maximization when cost savings in issuing, transacting, custody and trading digital assets are passed on to investors.

Up to 65% cost advantage in the digital value chain

Token-based financial instruments are structured and represented via the blockchain using smart contracts. Tokenized securities are usually issued and distributed digitally via trading platforms without intermediaries. Transaction processing can also be automated without a third party. Since, for example, there are no commissions for intermediaries, going to the notary, real estate transfer tax or expensive safekeeping in a bank vault, tokenized tangible assets are significantly more cost-effective than traditional banking products or assets.

Why token infrastructures are superior to documentary securitization and what savings potentials result from this in the entire value chain, was investigated by Study “Cost Disruption in the Issuance Market”.

The investigation came to the conclusion that the overall cost advantage of tokenized assets compared to traditional securities issues is 35 to 65% due to lower set-up and annually recurring costs. For better clarity, the value chain was divided into the following stages:

• Pre-issuance (legal and transaction structuring): 0% cost savings

There are costs for a securities prospectus, a securities information document, lawyers or approval from BaFin — both for traditional and digital issues. There is therefore no significant savings potential here.

• Primary market (issuance services and transactions): 14 to 68% cost savings

Due to digitized issuance processes without manual, labor-intensive registration with a central securities depository, digital token infrastructures can achieve high cost advantages of up to 68%.

• Custody and asset servicing (securing and managing assets over their entire life cycle): 33 to 64% cost savings

While traditional investment products must be deposited with central securities depositories and incur correspondingly high, ongoing fees, tokens are stored cost-effectively in digital wallets. As a result, savings potential of up to 64% can be realized.

• Secondary market (trading and redemption of assets): 17 to 50% cost savings

The secondary market for security tokens or tokenized securities is currently in the process of formatting itself. Nevertheless, there are already significant (cost) advantages here: Trading and settlement fees on the secondary market for digital assets are significantly lower than those of traditional securities. In addition, token infrastructures reach more potential buyers and offer greater transparency and flexibility.

Investors and financial institutions benefit equally from token infrastructures

The bottom line is that the total cost advantage of digital securities issues compared to conventional securitized equivalents can amount to between 35 and 65%. Savings potential from which investors and financial institutions can benefit equally:

For investors, the progressive digitization or tokenization of securities offers several advantages. Starting at just a few hundred euros, you get flexible, scalable, liquid and personalized financial solutions that were previously only available to large investors. Due to digitized processes and low setup and storage costs, investors also benefit from a better cost-return ratio than with traditional capital market products.

For financial institutions, asset managers or issuers, tokenized securities offer significant savings potential and significantly reduce administrative expenses. They can also provide their customers with selected, easy-to-integrate token products offer additional added value in the product catalog.