A recent BCG and ADDX report projects asset tokenization to be a $16T opportunity by 2030. Considering that the asset-backed market itself is in the $2–3T in issuances each year, this number does not sound that crazy. BlackRock CEO Larry Fink recently said that “the next generation for markets, the next generation for securities, will be tokenization of securities.”
Tokenized investments have obvious benefits like transparency and immutability (together ensuring auditability) and instant settlement.
But the first step of tokenized investments is tokenizing an asset, which currently is neither transparent nor immutable.
So, how does the investor trust a token to be the legal representation of ownership of an asset, with no duplicates?
There are two possibilities:
- The asset originated on blockchain (blockchain native assets), OR
- A trusted intermediary provides the assurance
It is possible that five to ten years out, a large proportion of assets and securities will be blockchain native (i.e. they would have been created on the blockchain), but today that is a very negligible fraction.
Trusted intermediary is the alternative. Many DeFi ventures have taken the responsibility of onboarding the assets onto their platforms, thus assuming the role of the ‘trusted intermediary’. Digitizing the assets has a technical and a legal/regulatory aspect, as the digital version of the asset needs to get legal and regulatory sanctity. Hence, the prevalent DeFi approach of ‘trust me’ is is an inhibitor rather than an enabler of adoption.
In the case of structured finance, if loans are not given on-chain, then a tokenized security, backed by loans, needs a trusted intermediary to assure that the token represents ownership of the underlying loans (or cash flows from the loans, or whatever the terms in the indenture are).
For IntainMARKETS, we ensure this through a review of loan documents using Artificial Intelligence (AI). The exceptions report generated by the AI software is reviewed by a Custodian acting as a Verification Agent (VA). VA certifies the assets (loans) post review. The use of AI ensures that we replicate the current verification process by a Custodian, but at less than a quarter of the cost.
Last year we had announced a partnership with UMB Bank, for automated verification of loan pools. Q4, 2022 was the first full quarter in production for our verification agent platform partnership. In this quarter, we onboarded eleven deals across four issuers for AI-enabled verification.
As per agreed deal terms and the asset class, the attributes to be verified for certification can be configured.
The AI-generated report includes a check on whether the following documents are attached (Yes/No response)
- Funding Agreement
- Lawyer’s Acknowledgment Letter (For Pre-Settlement Advance or Post-Settlement Advance)
- Settlement Agreement(s) (For Post-Settlement Advance)
Wherever the exception is flagged due to an AI error, it is corrected. In case of an actual discrepancy, the Issuer can either correct the data or replace the loan.
After reconciled data is available, a certificate is issued by the VA and the documents are archived in a distributed system, IPFS .
Based on this certificate, these loans are converted into a non-fungible token (NFT). The asset-backed security subsequently structured, is mapped to the NFTs (loans in the pool), establishing a smart contract based linkage with each loan in the pool.
1. With the documents verified and archived, underwriters and investors have view into the data and the documents for each loan
2. It also eliminates the need for repeated verification (or due diligence) for all future transactions related to this pool, as an immutable record is available
While our current AI-enabled solution works well for most asset classes, for mortgages we are working with partners to develop a solution. This involves an upgraded version of AI to process complex mortgage files and then work for required regulatory approvals for these NFTs.
[In PART 3 of this series, we will discuss concerns about payment and settlement options in DeFi, and IntainMARKETS approach to this challenge]