As more major financial institutions venture into the crypto space, they are growing increasingly vigilant about addressing potential challenges related to security and transparency to safeguard their clients and assets effectively. Tokenization, which refers to converting assets with tangible or intangible values into digital tokens, can add a level of transparency that banks seek when addressing issues involving anti-money laundering, compliance, and custody.
Almost every type of asset can be converted into digital tokens. Stocks, real estate properties, art, and collectibles—considered tangible assets because they have an intrinsic value due to their physical properties and substance—can be tokenized. Similarly, intangible assets, such as patents, copyrights, software, licenses, and trademarks, can be converted to tokens.
Since tokens only serve as substitutes for assets, their value lies in their ability to secure data. Tokens are linked to transactions stored on a blockchain. This technology allows financial institutions to represent and store their assets on a decentralized network that provides transparent access and a high level of security.
Tokenization improves accessibility among retail investors
Tokenized assets are more accessible to retail investors. A retail investor with $10,000 to invest would need more money to afford million-dollar real estate assets, thereby limiting their revenue potential. However, with tokenization, they can own a share of a prime real estate property and take advantage of capitalization as it increases in value.
In addition, banks typically offer products with high ROI to exclusive institutional investors. Even high-net-worth individuals may need help accessing the same investment pool available only to private banking clients. By converting assets into digital tokens, different investors have more options and freedom to invest their money into various financial instruments.
Microfinance is also more accessible through tokenization. Microfinance is an alternative finance that provides small loans to clients and institutions that do not have access to conventional financing. Through tokenization, financial service providers can reduce the administrative expenses associated with providing small loans. It also simplifies the application and verification process. This helps banks reach more clients and customize their approval process.
Tokenization enhances the efficiency of financial operations and security
As a byproduct of blockchain, tokenization brings many benefits to a bank’s operations. Banks can monitor asset performance in real-time to make quick and profitable decisions about allocation and risk management. Settlements, which typically take at least two days, can happen almost instantly.
Tokenization is also beneficial for improving the security of customer information. Banks use it to secure payment card details and sensitive data, such as email addresses, phone numbers, account numbers, and Social Security numbers. Unlike encryption, which can be reversed via an encryption key, tokenization is undecipherable since the token and the original number have no mathematical relationship. Only the token’s issuer can return it to its original form or value.
When customers use tokenization to pay for goods and services, the transaction details cannot be accessed or seen by agents or anyone else in case of a data security breach within the bank.
Tokenization improves the liquidity risk management of banks
Financial institutions must meet their cash and collateral obligations under normal or distressed situations without risking or resorting to losses. Banks may be unable to sustain their daily operations and retain their financial position without effective liquidity risk management. Failure to ensure liquidity can result in bankruptcy and closure in a market downturn. Such was the case of the recent FTX collapse.
While FTX’s collapse was largely influenced by using its token as collateral, implementing appropriate checks and balances could have averted its downfall. FTX was never transparent to its customers about how much liquid assets it had to cover its liabilities. To make matters worse, the company repurposed more liabilities from user funds to create more investments that were also illiquid. If FTX had tokenized its assets and liabilities, the company would have been able to measure and monitor its liquidity gap and warn its customer base and the market of any potential default as soon as possible.
It’s not enough for a financial firm to demonstrate how many assets or reserves it has. Solvency, or the ability to cover liabilities, is just as important. Tokenization can enable banks and centralized crypto exchanges to show proof of solvency in real-time, aiding decision-making and preventing collapse.
Tokenization enhances customer satisfaction
Customers want convenient, accessible, and speedy service for their financial transactions. Most banks aim to provide tailored, hassle-free, multi-channel experiences to meet those demands. Since tokenization allows for an accurate and secure customer data registry, financial institutions can seamlessly cross-sell and up-sell financial services to their existing customers.
Payments across borders can be time-consuming and expensive using traditional services. However, since tokenization is based on blockchain, payments across international borders are easier and less expensive.
With tokenization, customers can perform recurring transactions, such as subscriptions, by using the same token multiple times without having to input sensitive payment details repeatedly. Customers need to only provide their card information once, reducing the number of abandoned transactions, especially for online purchases.