COO view: getting to grips with tokenization

Marty Burns, Chief Industry Operations Officer at the Investment Company Institute explains how tokenization opens the door to otherwise inaccessible asset classes

Sara Benwell POSTED ON 3/26/2021 10:43:56 AM

Sara Benwell; What role is tokenization playing in fund management?

Marty Burns: Tokenization is still in its infancy for the mutual fund world. It will primarily affect asset management on the investment side as it opens the door to asset classes that are either not available or are not easily accessed today.

For example, real estate and collectibles such as art, music, memorabilia, and cars are all assets that can have great value but are generally inaccessible except to individual collectors.

“It opens the door to asset classes that are either not available or are not easily accessed today.”

Using a non-fungible token, or NFT, to monetize those assets opens many new asset classes to asset managers and ultimately a broader range of investors.

This is not theoretical, as NFT exchanges are up and running today. Although most of the assets listed on the exchanges now are not mainstream, they prove the viability of tokenization as an avenue to expand asset class accessibility.

Sara: What are some of the benefits of tokenization and what are some of the potential pitfalls?

Marty: Like other digital approaches, tokenization reduces friction in transactions by likely eliminating the need for middlemen, providing efficiency in processing, and reducing the time of transaction to seconds rather than hours or longer.

Tokenization can be used in conjunction with smart contracts to simplify corporate actions such as dividend payments or proxy voting because the smart contract can standardize the terms for the activity and the instructions from the asset owner so that little, if any, interaction is needed.

Tokenization may provide additional transparency to simplify reporting and disclosure—benefits to the investors, to regulators, and the asset managers through reduced administrative burdens.

"There is a whole array of regulatory issues that need to be addressed as the interest in tokenization advances"

Tokenization is not the answer to all problems. It runs on digital ledger technology (DLT), or blockchain. Blockchain is still growing and some raise questions about the stability of digital ledgers and the ability to handle potentially massive amounts of transactions.

There are cybersecurity concerns that need to be mitigated, although, as we all know, no system will ever be cyberattack proof.

DLT is governed by consensus of the users and runs the risk of groups of users modifying the system, called a “fork,” which can create confusion and be a disadvantage to certain users of the original blockchain.

And of course, there is a whole array of regulatory issues that need to be addressed as the interest in tokenization advances.

Sara: What are the operational challenges of tokenization and how can these be overcome?

Marty: In addition to the challenges related to using DLT technology, the industry will need to tackle other considerations.

Although some asset managers are growing their expertise in tokenization, it is not widespread throughout the industry. Firms will have to acquire and develop staff expertise.

In some cases, firms may use vendor partners, but the asset manager will still need internal resources with a strong understanding of tokenization and DLT to provide appropriate oversight of any vendors.

"There are custodians providing digital asset custody today and more are developing this service"

Coordination with custodians will be paramount. There  are particular custodial concerns related to digital assets such as holding private cryptographic keys, which provide access to the tokens and segregating assets in “cold storage” to protect the tokens from cyber theft.

There are custodians providing digital asset custody today and more are developing this service. However, funds will need to be keenly aware of the capabilities to be sure appropriate custodial services are in place for the assets.

Sara: How does tokenization lead to better automation—and what does this mean for ops teams?

Marty: By itself, tokenization is not going to improve automation, but it does focus the strategic direction toward employing new technological approaches.

The incentive for the asset manager is the access to otherwise less or unavailable asset classes, which in turn drives the operational direction to employ new technologies to open the door to those assets.

"By itself, tokenization is not going to improve automation"

As fund operations become more comfortable and conversant with using the tools supporting digital assets, improvements can be carried to other operational areas, possibly internally as well as externally, to improve the efficiency of the overall operation.

 

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