Introduction

Imagine you own a buy to let property that is worth £500,000. You want to sell it for that amount, but you don’t have many buyers who can afford it, and don’t want to reduce the price. You might also not want to lose the ownership of the whole house. What if you could divide your property into 500,000 tokens, each worth £1, and sell them to anyone who is interested? You could keep some tokens for yourself, and let others buy as many as they want. You could also buy back the tokens later or sell them to someone else. This way, you can make your property more financially accessible, liquid, and flexible.

Tokenisation is an exciting development within the finance world that has the potential to help facilitate complex finance transactions, for people who wouldn’t usually be capable of accessing them. It is the process of splitting up traditional assets in the real world, into digital tokens that can be stored or transferred without the need for a dedicated platform. The tokens would represent a fraction of the initial asset, with the same rights and obligations as the original asset on which it is based. This would mean that tokenising a house could give the token owners the right to rental income from the property, or an opportunity to vote on how the house is managed.

In the financial sector tokenisation would allow new assets to be developed and exchanged on the market, increasing liquidity for asset holders, with the fundamental transparency present in blockchain underlying the process. Building Societies could benefit from the emergence of this new facet of the blockchain fad, where previous use cases have been largely irrelevant for much of the market.

When blockchain technology first stormed onto the market in 2016, inviting wider adoption, it promised remarkable innovation, and was set to change the world of finance as we know it. 8 years on from the bitcoin buying craze, not much has materialised. Cryptocurrencies have their place in the market, but largely have been viewed as scam opportunities, or the realm of would-be day traders willing to shoulder the risk of investment. The blockchain exists as a solution waiting for a problem, and tokenisation could be the kick that it needs to become properly mainstream.

In this vein tokenisation is not a new concept. It has gained momentum in recent years due to the wider adoption of blockchain technology, and the widespread knowledge of cryptocurrencies, such as bitcoin. The blockchain is a distributed ledger of transactions, open and verifiable by anyone, and underlines all technologies used by cryptocurrencies and therefore tokenisation. The creation and exchange of tokens is overseen by a huge network of users, who can validate and flag any issues.

There are different types of tokens, which cover a wide range of assets or across many markets and asset classes. Some of the most common ones are:

• Utility tokens, which provide access to a service or a network, such as a cloud storage platform, a social media platform, or a gaming platform.
• Security tokens, which represent a claim on an asset or a cash flow, such as a share of a company, a bond, or a dividend.
• Asset tokens, which represent a physical or digital asset, such as a piece of art, a property, or a cryptocurrency.
• Non-fungible tokens (NFTs), which represent a unique and indivisible asset, such as a digital collectible, a rare item, or an identity.

Tokenisation can offer various benefits for both the issuers and the holders of tokens, such as:

• Increased liquidity, as tokens can be traded on a global and 24/7 market, and can be fractionalised into smaller units, allowing for more granular and affordable ownership.
• Reduced costs, as tokens can eliminate or reduce the need for intermediaries, such as brokers, agents, or lawyers, and can automate processes, such as verification, settlement, or compliance, using smart contracts.
• Improved security, as tokens can leverage the features of blockchain technology, such as encryption, immutability, and decentralisation, to prevent fraud, tampering, or loss.
• Enhanced transparency, as tokens can provide a clear and auditable record of the ownership and history of the asset or right, as well as the terms and conditions of the token.
• Greater access, as tokens can democratise the participation and inclusion of a wider and more diverse range of investors and customers, who may otherwise face barriers or limitations in the traditional markets.

The key takeaways of this are the wide range of assets available for tokenisation, and the numerous benefits of providing access to them. They represent a massive shift in possibilities for financial institutions including Building Societies.

Building Societies and Tokenisation: Opportunities

Building Societies have a unique position in the market, they are highly trusted institutions with a dedicated customer base. This base leans heavily towards customers who would be classed as vulnerable or otherwise financially exposed. For these reasons the benefit of tokenisation is massive. The increased trustworthiness of the transactions facilitated by the blockchain are a huge boon, along with reduced transaction costs, the elimination of needless intermediaries, and the recording of transactions on a tamper proof ledger.

The increased liquidity and product options available to customers are another advantage, transforming real estate assets into tokenised investment opportunities, for both owners and buyers. Elderly people would be able to fractionalise their properties as they age, allowing them to access liquidity in their later years, without resorting to traditional equity release schemes and broker fees. The wider range of customers participating in the market would increase accessibility and opportunity.

Digital tokens are fundamentally tradable without the worry of borders and currencies causing issues. A global marketplace of tokenised assets would allow anyone to invest anywhere at any time.

Smart contracts are a lesser-known addition to tokenisation, which automates administrative tasks and repetitive tasks such as dividend distribution and governance of assets. In the example of a real estate transaction, smart contracts could automatically transfer property ownership after payment is confirmed, without the usual delays related to paperwork and manual verification. This would reduce the need for intermediaries such as brokers and solicitors, and allow contracts to be stored transparently on the blockchain, totally secure and immutable, with no chance of tampering or fraud. This also plays into the ability of tokenisation platforms to navigate the complex regulatory market, ensuring that transactions are compliant using the transparent ledger to audit in real time, protecting both investors and financial institutions.

Challenges and risks of Tokenisation

Key amongst the challenges facing companies wishing to get ahead of the curve on tokenisation is the big hurdle of regulatory uncertainty. There is currently little guidance on how to manage products such as tokenised assets. Different jurisdictions may choose to manage these assets differently, with different tax regimes and the view on whether assets are collateralised or not being paramount.

In addition, the technological expertise barrier required to properly offer tokenisation is an investment which would be required. With issues such as Data Security, Scalability, Interoperability, and Data Privacy requiring expert insight. A tokenised asset may be vulnerable to hacking, as a purely digital asset, or may not be compatible with certain blockchain platforms.

Finally, there is the fundamental concern of the market fit, do customers see a benefit to using tokenisation, without the buy in of customers the assets will not be able to reach full adoption. Investors and issuers will both require a shift in mindset and may face resistance from incumbents and regulators. People already misunderstand cryptocurrencies and blockchain, who’s to say they will understand tokenisation and its benefits any better?

How can Building Societies prepare for Tokenisation?

The evolving financial landscape is ripe with opportunities for the companies willing to take the risks. This transition to a more digital age offers a unique opportunity for a reimaging of asset management and the customer experience. The guidelines for adopting new technologies requires a dedicated approach with a significant amount of research. Fundamentally ensuring that adopting tokenisation is the correct approach for your business and customers:

• Engaging with regulators, is fundamental. Ensuring that any products or offerings that are developed are in line with what is acceptable and remain compliant in the future.
• Experimenting and piloting tokenisation projects and initiatives, testing the use case and making sure that there is customer appetite, and the business case is robust and free from any of the challenges discussed above.
• Building and developing the necessary capabilities and competencies, such as digital literacy, blockchain expertise and customer-centricity, to enable tokenisation. Specifically, within leadership to ensure that a top-down approach to technology implementation is possible.
• Assessing your current IT infrastructure is fit for purpose and if additional investment is required to ensure that any offerings are smoothly integrated.
• Create a comprehensive strategy for tokenisation, ensuring that it is embedded in culture, rather than added to the pool of products. This will ensure that the evolving nature of the market is not a barrier to success.

Conclusion

For financial institutions, the sudden addition of several disruptive technologies presents unique opportunities, as well as risks. Tokenisation embraces the useful, accessible components of the cryptocurrency craze, without the inevitable instability of value, and poor press attention that it brings (Wintermeyer, n.d.). The technologies behind the blockchain have always been a source of inherent opportunity, and Building Societies can be uniquely positioned to take advantage of them for the benefit of their members.

Some firms have embraced the opportunities of tokenisation already, with BCG and ADX estimating that the market for tokenised assets will surpass $16 trillion by 2030 (Sumit Kumar, n.d.). Companies such as Blocksquare offer a platform to tokenise real estate assets into cryptocurrencies, the fintech NYALA does a similar thing, targeting securities for tokenisation. uniquely, a company called Polymath aims to help regulate the tokenised asset market, with an approach involving streamlining the legal process of creating and selling tokenised assets, they have even created a new token standard, the ST-20, which enforces government compliance and can restrict transactions to verified participants only. Partnering with one or more of these companies could prove an accessible way to move into the tokenised asset market.

Considering the key principles of tokenisation will allow Building Societies to offer new financial products to members, make investing more accessible, and improve the customer experience with faster transactions and transparent financials. It’s an exciting time to be a member of an ambitious and truly modern mutual.