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Boring is Better

Updated: Apr 22

About half a year ago I published a research report, “The Role of Securitization in Tokenized Asset”, looking at the tokenization market and comparing institutional and crypto-native go-to-market focus. One being capital efficiency focused while the other being market access/distribution focused.


Since then I have had many conversations with both sides and dived deeper into their respective nuances and challenges. So what is the biggest takeaway?


It is this: tokenization’s best chance for gaining wide adoption is through targeting incremental improvements in operational or capital efficiency as opposed to reinvesting a multi-part value chain. 


Boring is better in this case.


Why you ask? Let me show you.


State of the Market

When it comes to market access focused approach, the onchain capital markets activity is a good indicator for traction. So what happened in the onchain capital markets in the last 6 months? Here are the stats and numbers.


  • Onchain tokenized private debt origination since Sept-2023: $22.2mil approx 

  • Onchain tokenized public debt origination since Sept-2023: $100mil approx

  • No new VC funding round for a crypto-native tokenization project.


The bulk (approx 80%) of new private debt origination came from Maple’s US IRS Tax Receivable offering at 16% and 14 days liquidity. This was a unique product that offered a far higher yield, better liquidity and credit risk profile when compared to other onchain private credit deals. Unfortunately, this is also a Covid-related product that is unlikely to last for long.


Almost all public debt origination platforms saw a decline or a plateauing of their AUM in the last 6 months. The new origination volume came from Mountain Protocol’s launch in Dec 2023.



A closer look into the protocol reveals that this extra $100mil “adoption” seems to come from capital lined up before the launch and is one-off in nature. Given the timing coincided with Manta’s, the only blockchain where Mountain USD is available, pre-launch incentive program, it is possible that a few small crypto family offices or trading desks are using the tokenized Mountain USD for incentive farming on Manta. In other words, the demand driver remains inorganic.



By comparison the institutional front have been seeing consistent activities in product expansions, pilots and capital inflows. A few recent examples:


  1. BlackRock comes to market directly with its own little $100mil natively issued TBill fund tokenization experiment.

  2. Figure Markets, the digital asset arm of Figure Technologies, the pre-IPO fintech, just raised a $60million Series A from Jump, Lightspeed and Pantera to build an exchange that enables collateral mobility.

  3. Zodia Market, a Standard Chartered and SBI backed startup, expands its product offerings to include collateral backed lending.

  4. Canton Network, a Digital Asset built blockchain with buy-in from a list of financial world’s who’s who, launched with a flurry of pilots and learnings



Stark Contrast

Why the diverging fortune? Well I have a long list of issues plaguing the crypto native approach, but in short the economics of it doesn’t work in 3 ways:


1.Lack of new capital sources to bootstrap a new market 

Current onchain capital sources are inadequate in its organizational maturity and size to bootstrap a vibrant onchain capital market. I have explained at length the reasons for this slow uptake. I will avoid wasting too much verbiage here. You can get more context here


2.Traditional players have no incentive to join

The current tokenized issuances are inferior in many ways to traditional fixed income securities, including return profile, regulatory clarity and lack of infrastructure. Traditional allocators have no reason to enter the market from a product perspective.


3.Prohibitive technology & legal costs

Given a lack of comprehensive legal framework and consensus on best risk management practices, convoluted workarounds are used to satisfy legal and technology requirements. All of which introduce new costs that are often higher than established processes in traditional finance. 


There lacks a fundamental business case for the buy-side to adopt tokenization for tokenization’s sake. On my recent visit to a traditional buyside shop, I learned why the “massive opportunity” in catering to this new capital source that is crypto native capital wasn’t high on the totem pole of priorities for institutional players. 


Let me illustrate with an example.  MakerDAO is the biggest allocator towards fixed-income assets in the crypto sector. At its peak, over $2.2 billion were invested in TBills through two offchain setups last year. I hoped the growth of onchain capital sources similar to MakerDAO would be a supportive tailwind for the industry but, despite projects’ growing treasuries, no actual big tickets have materialized so far. My post “Tokenized TBills: up only to being stalled” goes into details on this subject. And despite the talk of moving to an onchain structure, MakerDAO maintains it offchain investment structures. 


Now imagine a buy-side asset manager coming to the market and subsidizing all the extra legal and operational costs for MakerDAO to win the account, it would likely just breakeven or worse lose money on the venture. Even if it didn’t subsidize and charged a standard 8bps management fee per year, the annual revenue on a $2 billion SMA is merely $1.6million.


I talked in the report about how institutional players have been focused on various operational and capital efficiency gains. But why is that? 


It’s simply about economics and management buy-in. Imagine a mid-sized asset manager with $200-$500 billion in AUM. Suppose this is levered 4x. We are looking at $800 billion to $2 trillion in trading book size. Assuming a 10% margin requirement on 80% of this number, we are talking about $64 billion to $160 billion of cash. An 1% incremental increase of capital efficiency is $640 million at minimum. 


Quite a difference wouldn’t you say? $640 million in capital efficiency gain vs $1.6 million in annual management fee.


In addition to numerical differences, we must understand that these efficiency gain projects in a corporate context are most likely managed by middle managers who are neither incentivized nor encouraged to pursue revolutionary ideas that would cannablize existing businesses. 


It is much easier to get buy-in and budget for an incremental improvement project that has well-defined addressable market size and benefits than any project that involves questionable regulatory implications or inferior risk/return profiles. 


Conclusion

I was initially attracted to the tokenization space because of its revolutionary potential in transforming the capital markets. I still believe in that potential. But to get there, we need to first have a more robust ecosystem of buy-side, sell-side and intermediaries. 


Both market data and my own first hand experience suggest immediate economic benefits are much more persuasive in onboarding these partners than visions and potentials given the various organizational constraints institutions operate under.


Given blockchains’ natural fast settlement, composability and programmability features, an adoption strategy around upgrading existing technologies on which repetitive operational processes reside is more impactful and offers a much quicker go-to-market than upending the entire value chain of capital markets.. 


In fact, I would argue the more boring and manual the process, the more cost saving potential and thus the more attractive it is to adopt tokenization. I will be focusing my effort and time on scaling use cases that may be less sexy but far more fundamental to the well functioning of the financial system going forward. 


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Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

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