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Tokenization is spearheading a movement transforming financial services
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Tokenization is spearheading a movement transforming financial services

Cryptocurrency tokens as billionaire Warren Buffett says most digital coins won't hold their value
Embracing the integration of TradFi and DeFi through tokenization isn’t just a trend: it’s a necessity, writes State Street’s Donna Milrod.

Chris Ratcliffe/Bloomberg

“Life is divided into three terms: what was, what is and what will be.” William Wordsworth expressed this sentiment over 200 years ago. And, while this is true, it does not reflect the importance of how the past and present inform and influence the future.

We are experiencing this first-hand as the financial services landscape change quicklyand the lines between traditional finance, or TradFi, and decentralized finance, or DeFi, continue to blur as technology evolves to meet growing needs. Investors are increasingly seeking exposure to new asset classes, highly personalized solutions and greater liquidity. Tokenization – defined as the process of converting physical assets or issuing a digital asset on the blockchain in a highly programmable and fractionalized format – has become a key method of participating in the digital economy.

Tokenization redefines asset ownership and trading, facilitating seamless transactions between TradFi and DeFi. This innovative approach has the potential to transform all financial transactions, from capital markets funds and assets to liquidity, and thereby create a cohesive financial ecosystem that improves accessibility, efficiency and security.

To effectively navigate this landscape, we must first understand its fundamentals. Traditional finance encompasses established financial infrastructures including banking systems, asset management and securities trading, while decentralized finance represents a new paradigm focused on blockchain technology and smart contracts.

Recent surveys tell us that industry players are at a tipping point and are preparing to trade digital assets on distributed ledgers (see State Street Digital Survey 2024). This preparation highlights how quickly companies are positioning themselves to capitalize on the growth potential of tokenization. Institutions expect substantial revenue gains and significant cost savings in areas such as recordkeeping and compliance. This could serve as a catalyst to finally see the adoption of digital assets, including tokenized securities, advance rapidly.

The role of tokenization in finance could be transformative. It promises substantial efficiency gains by enabling real-time settlement, greater transparency, reduced transaction costs and regulatory capital allocations, as well as increased liquidity. For example, tokenization can facilitate peer-to-peer transfers for money market funds. It may also enable money market fund shares to be leveraged as collateral and payment vehicles, thereby leading to an expansion of eligible collateral as well as increased stability of assets under management and net asset values.

For complex instruments such as bonds and loans, tokenization can reduce issuance and management costs; facilitate secure, efficient and transparent loan processing; and reduce the number of intermediaries in the value chain. Overall, tokenization can further drive democratization of investments, resilient workflows, and reduced capital risk. State Street’s research shows that companies are particularly focused on leveraging tokenization to improve their funds’ distribution channels through tokenization. Respondents expect cost reductions of almost 50% through the use of tokenized assets, demonstrating the clear potential for operational improvements across front, middle and back offices. These savings could help alleviate some of the pressure on profit margins in the investment management industry.

Widespread adoption of tokenization depends on three key factors. First, greater interoperability between different blockchains and ecosystems; second, interoperability between TradFi and DeFi; and third, a thoughtful and coherent global regulatory framework for digital assets. It is crucial that policymakers work collaboratively with financial institutions to develop frameworks that support innovation while ensuring adequate investor protection. Countries like Singapore and the European Union are leading the way with regulatory sandboxes that encourage experimentation and adaptation in this rapidly evolving space.

As we navigate this period of transformation, the outlook for tokenization remains promising. Integrating real-world assets into DeFi protocols opens up sources of income for TradFi and DeFi stakeholders. I foresee a future where cross-border payments are streamlined, asset ownership is diversified, and financial services are accessible to everyone. However, achieving this vision will require collaboration between traditional financial players, regulators and blockchain developers.

Embracing TradFi and DeFi integration through tokenization is not just a trend, it’s a necessity. We build on the past to create the future. By leveraging this innovative technology, the financial sector can reshape its future, fostering growth and resilience in an increasingly complex world.