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First comes the ETF. Then comes tokenization.



In the 2010s, BlackRock brought iShares ETFs to the masses and gathered over $3.3 trillion AUM. 


In 2024, BlackRock brought IBIT ETF to Bitcoin and is currently sitting on $500 million AUM after 2 days of launching, a massive success.


Larry Fink then says on national TV that a potential Ethereum ETF is but a mere stepping stone to tokenization. 


If that vision were to come true, what will tokenization by BlackRock look like?


That is the topic we will dive into in this week’s newsletter. Let’s dig in.


Thanks but no thanks

If you do not follow crypto Twitter you probably missed the storm Larry’s comments cooked up. A few die-hard Ether holders took his comment and proclaimed that BlackRock will build its tokenization business on Ethereum.


Having been in the trenches of tokenization for the last 3+ years has taught that if BlackRock were to leverage tokenization for any benefits, it would almost for certain NOT be on Ethereum or any other public blockchains.


There are 3 main reasons for this.


  1. Value accrual capture

  2. Regulation

  3. Privacy


Let’s look at each in turn.


Value Accrual

Can you imagine how bullish it would be for Ether the token if BlackRock settles all its digital asset transactions on Ethereum the blockchain? It would be a signal to the world that the traditional finance titans are ready to bring its business wholesale onto Ethereum. Any Ether holder would be encouraged to extrapolate and project a bullish future.


If the value of these transactions brings out:


  • Greater capital efficiency in the form of 24/7 real-time transparent collateral management

  • Greater operational efficiency in the form of instant finality in transaction settlement

  • Greater distribution network and liquidity through fractionalization


Larry and BlackRock would certainly want to retain all those value accruals in its PnL instead of distributing them to pseudonymous 200,000 Ether validators around the globe. Why would BlackRock give up the value it generates to Ether holders? It would not.


If BlackRock were to build a tokenization business, it would be on a BlackRock Chain. Yes, if you are one of the world's biggest sovereign wealth funds or banks, you may be invited or permitted to be part of the foundational infrastructure set-up provided you bring additional value-add to the table. Profits can be shared amongst friends. 


Regulation is by nature permissioned



Public blockchains are permissionless environments that allow anyone and everyone to access and build and transact. However this is in direct conflict with the nature of regulated financial activities. 


A big reason for JPMorgan, Goldman Sachs and other big banks to build their own permissioned enterprise blockchains is that financial institutions not only want to but also need to have control over who can use their services.


Given the currently unclear/non-existent regulation across much of the world and in particular the US when it comes to governing digital asset transactions, big financial institutions will not take on unknown regulatory risks to conduct business in permissionless environments.


As regulation gets hammered out, at glacial pace, perhaps there will be a point in the future where public and permissioned blockchains can converge on a standardised set of access controls so that the interaction between them are gated by smart-contracts that enforce regulatorily complied set of rules.


However, that is not the starting point of tokenization. It is rather a stop somewhere much further down the line.


Want to showcase all your financial transactions?



Absolutely not would be the answer from financial institutions. Currently public blockchains lack the technical capabilities to provide adequate level of privacy protection for transactions.


For example, on Ethereum, if you were to execute a swap between two instruments via Uniswap, a public exchange protocol. Your transaction is completely visible to the world. From the wallet you sent the transaction from to the swap rate and the precise time of the transaction. 


While transparency can be great for certain purposes, it is certainly not a value-add to Goldman Sachs fixed-income desk for the transactions it executes to be visible to Deutsche Bank and the rest of the Street. Additionally, if there was a liquidation event in a private credit transaction, it certainly does not help to broadcast that on the airwave for the whole world to see. Again, a controlled environment is needed to gate access to information on a need to know basis. 


Public blockchains do not have the technical requirement to provide this must-have feature for financial transactions. This is also partly why existing private credit issuers are requiring a data-room setup for disclosing certain information. Feel free to check out Centrifuge or Maple’s deal page.


Where does this leave public blockchains?

For all their flaws and shortcomings, public blockchains hold a secret weapon - liquidity. Precisely because of their permissionless nature, public blockchains have the least amount of friction when it comes to gathering capital. 


And this may be a huge benefit when it comes to looking for new pools of capital. For example, when Hamilton Lane tokenized part of its fund, it wanted to attract a more diverse set of investor capital. 


Currently there are $130 billion worth of stablecoin on public blockchains. This number is set to grow as the market matures. What happens when that number gets to $13 trillion? Remember the Bitcoin network alone has close to $1 trillion unutilised capital. 


It is unclear how this pool of capital will interact with the financial rails built by traditional financial giants. My estimation is that in the future there will be protocols built on either the public or private blockchains that will enforce KYC and AML logic on any kind of value flow to ensure regulatory compliance. There will also be privacy technology to provide the necessary obfuscation to keep information on a need to know basis.


Conclusion

It has been 10 years since the Winklevoss twins first filed for a spot Bitcoin ETF. Now that has finally been approved. The next chapter of digital assets has been opened up. Perhaps in the next 2 years, a spot Ether ETF will be approved and we finally arrive at a point in time where tokenization is ready for more widespread adoption.


While many estimate that tokenization aka smart-contract enabled automation leveraging blockchains is a multi-trillion dollar opportunity, I do not expect institution driven adoption effort to be on public blockchains, at least as a starting point due to incentive alignment, regulatory hurdles and privacy concerns. 


I expect private permissioned blockchains to be the main environment for initial cautious adoption steps taken by institutions. Perhaps with clearer and more constructive regulatory clarity plus technological capabilities, somewhere down the line, there will be a merge point where largely enterprise level blockchains interact with public blockchains. 


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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