Global Perspectives
HK Web3 Landscape Part 4: Tokenization trends
Deep-dive into global regulatory approaches to Web3 to help you learn more about global policies, opportunities, and cross-border synergies.
What is tokenization?
Tokenization is the process of linking assets to crypto tokens, and linking the token price to the value of the asset. In general terms, if you are the holder of the asset’s token, you are also the owner of the asset. Sometimes, tokens represent a fraction of an investment or an asset.
Tokenization is defined by five key features:
- Blockchain
- Reference asset
- Mechanism to link the token’s price to the asset’s value
- Means to store and/or provide custody for the asset
- Mechanism to redeem the asset
The blockchain used to issue the tokens can be permissioned or permissionless. Usually, government-issued tokens use private blockchains.
The reference assets can be:
- On-chain or off-chain
Off-chain token assets usually involve an off-chain agent, such as a bank.
On-chain token assets rely on Smart Contracts to enable transactions, storage, and other actions.
- Tangible or intangible
Tangible (or physical) tokens include real estate, commodities, art, treasuries, gold, etc. Intangible tokens usually refer to financial instruments such as stocks, bonds and other securities, as well as Intellectual Property.
Redemption can happen both for off-chain and on-chain assets. Usually, the redemption of intangible assets and some off-chain assets involves more complex legal procedures.
In its beginnings, tokenization was performed by private companies, usually VC-based, and soon after by financial firms. State actors — government agencies, security commissions, monetary authorities, etc. — have started to explore and experiment with tokenization too.
Real World Asset (RWA)
Recently, Real World Asset (RWA) protocols have become a hot topic.
An RWA protocol is a decentralized application that serves entities to tokenize and trade real-world assets, including stocks, government bonds, and other securities as well as real estate and commodities. They are also known as asset tokenization protocols.
Thanks to RWA protocols that fractionalize assets into tokens, you can now buy a “share” of a piece of art like you can buy fractions of a publicly traded company.
DefiLlama estimates the Total Value Locked (TVL) of real-world assets (RWAs) to be over $2.4 billion as of October 2023 — ca. 5% of the total TVL in DeFi. In 2023, RWA on-chain value (without stablecoins) has grown by $1.05B.
In recent months, top RWA protocols, e.g., Ondo Finance, have partnered up with top-tier asset managers, e.g., the well-known BlackRock, to enable stablecoin holders to directly invest in exchange-traded funds managed by the asset manager. Other institutions like Goldman Sachs and Deloitte have jump started their tokenization projects too.
Why?
Tokenization improves liquidity and market accessibility
- Liquidity boost
Some markets can be rather illiquid, e.g., real estate. By tokenizing real estate assets, the market can be turned into tokens, which increases speed of transactions and accessibility by a wider range of investors. As a result, market liquidity increases.
- Lower barrier to entry
Especially when representing investment shares, tokenization can significantly lower the barrier to entry to the market. This is the result of the fractionalization of investments in given assets, which thus also lower the minimum investment required and open the market to a wider array of actors.
- Lower costs
In many cases, tokenization can significantly lower costs for it removes middlemen like lawyers, brokers, banks, and replaces them with smart contracts.
- Programmability
Tokens can be programmed to be used at a given time (or during a specific time frame), in a given space (store, shop, venue, bank, etc.), in a given amount, and so on.
- Quicker transactions
For tokens are the digital representation of an asset, they can facilitate trades. For example, tokenized stocks can be traded 24/7, while traditional ones can be traded only during “working hours’’ (this may alter the price of tokenized stocks too, though).
What are some of the downsides?
The main challenge deriving from tokenization is that, by linking the real world with the virtual, blockchain dimension, we also bring the challenges of blockchain and crypto to the real world — first and foremost, volatility. In other words, by linking RWA to the blockchain, the shock factor of the crypto market could be transmitted to the traditional market more easily.
The Hong Kong tokenization market
During the Hong Kong Fintech Week, which took place between 30 October and 5 November 2023 (we were there), the Chief Executive of the Hong Kong Monetary Authority Eddie Yue laid out the key developments and expectations held by the city government regarding its future in Web3. He cited the followings as the three key areas that the city of Hong Kong will focus on:
- Central Bank Digital Currencies (CBDC)
- Tokenization
- Digital assets, specifically NFTs and token IPs
We have covered CBDCs in our previous article, while digital assets such as NFTs will be next. In this piece, we will focus on the stance of Hong Kong vis-a-vis tokenization and RWA.
Recent key tokenization projects in Hong Kong
The pace of blockchain innovation and tokenization is expected to increase in the coming years. Last year, Hong Kong issued the world-first green bonds, and it’s looking to expand the use cases of asset tokenization. Here is an overview of some recent developments in the Hong Kong tokenization landscape.
New circulars on security tokenization — November 2023
According to the SFC’s March 2019 statement on security tokens, these were defined as complex products targeting only Professional Investors for they required extra investment protection measures.
In November 2023, a new circular superseded the March 2019 statement. On 1 November 2023, the Securities and Futures Commission (SFC) of Hong Kong SAR issued two circulars:
- Tokenized Securities Circular to provide guidance to intermediaries in addressing and managing new risks arising from the use of new tokenization technology
- Tokenized Products Circular to outline the SFC’s requirements to be considered by intermediaries when dealing with tokenized SFC-authorized products
The circulars indicates tokenized securities to be traditional financial instruments (e.g. bonds or funds) that are securities (according to the Securities and Futures Ordinance) utilizing distributed ledger technology or a similar technology in their security lifecycle.
Security tokens are “blockchain-based tokens that represent or aim to represent ownership in an investment product.” They are “fundamentally traditional securities with a tokenization wrapper.”
In the circulars, the SFC stressed that the existing regulatory requirements for securities will continue to apply to Tokenized Securities, as they are fundamentally still securities.
Why is it important?
In the past, security tokens were defined as complex products with a Professional Investor-only approach regarding the distribution and marketing of the securities. With these circulars, the SFC has lifted the mandatory Professional Investor-only restriction (if meeting specific conditions), while encouraging intermediaries to adopt a “see-through approach” and determine the complexity of the tokenized security based on the complexity of the underlying security.
Hong Kong green bonds
In February 2023, the Hong Kong government announced
“…the offering of HK$800 million of tokenized green bonds (the Tokenized Green Bond) under the Government Green Bond Programme (GGBP). This is the first tokenized green bond issued by a government globally.”
The bonds, which allow investors to participate in Hong Kong’s green and sustainable market, use a private blockchain, with its on-chain records to be legally definitive and final records of ownership of the securities tokens and cash tokens for the parties on the platform.
In the announcement, Mr Eddie Yue, Chief Executive of the HKMA, said
“Distributed ledger technology (DLT) holds promise for revolutionising the operation of the financial markets. Building on Project Genesis concluded by the HKMA and the Bank for International Settlements Innovation Hub Hong Kong Centre in 2021, the Tokenised Green Bond issuance with on-chain DvP settlement using cash tokens issued by the HKMA is an important step forward in promoting the adoption and realisation of the full potential of DLT in the bond market. Building on the experience from this issuance, the HKMA and the Government will work with other stakeholders to conduct further tokenised issuances to push the boundary and encourage usage.” (HKMA)
The Central Moneymarkets Unit (CMU) of the Hong Kong Monetary Authority (HKMA) is the clearing and settlement system for the bond. It will leverage Goldman Sachs’ tokenization platform — GS DAPTM.
Tokenized e-HKD deposits
By tokenized e-HKD deposits it is meant the conversion of money held in banks into digital tokens on a blockchain ledger, backed by the bank’s balance sheet.
In 2023, Visa partnered with Hang Seng Bank and HSBC to explore the potential of tokenized deposits, focusing on B2B to test interoperability and atomicity of on-us and cross-chain payments across two interbank B2B payment flows (Hang Seng and HSBC) using tokenized deposits settled over wholesale CBDC (wCBDC).
With the main goal of enabling seamless transfers, faster payments, and higher transaction transparency, while also reducing settlement risk, risk of collateral, and protecting privacy (by making public only selected information), the pilot covered two use cases:
- property tokenization
- acquisition & atomic settlements
Tokenized deposits for corporate treasury management
HSBC has recently partnered up with Ant Group, an affiliate company of the Chinese conglomerate Alibaba Group owned by Jack Ma, to issue tokenized deposits. The goal of the trial was to enable a corporate client to move money between its multiple HSBC accounts.
Conducted under the HKMA Fintech Supervisory Sandbox, HSBC used Ant Group’s blockchain to issue the tokens (Ledger Insights). By doing so, the bank was seeking to facilitate large-volume transactions between its clients’ subsidiaries in real time and outside of banking hours.
Hong Kong’s First Real Estate Fund STO
In September 2023, Tykhe Capital Group, which provides tokenization end-to-end services, announced the launch of PRINCE Token, making the event the first real estate fund Security Token Offering (STO) in Hong Kong. An STO is a type of public offering in which tokenized digital securities, known as security tokens, are sold in security token exchanges.
STO is backed by Tykhe’s virtual asset licenses and its proficiency in Web 3.0 It is available to Professional Investors (The Tokenizer).
Tykhe Capital Group’s real estate fund TSO is the first one of its kind in Hong Kong.
The path ahead
Hong Kong is expected to see a rise in the tokenization of Real World Assets for real-world assets are predicted to be a key driver of digital asset adoption. A report by Boston Consulting Group predicted that by 2030, the tokenization of assets in general is going to be a multi-trillion dollar market.
This article is only intended to provide a summary of the key regulations and other practices carried out in the region at issue. It is not intended to cover all the legal or regulatory issues that may be involved in– or risks that may arise from–the engagement with virtual assets and any other asset or activities mentioned, and it does not intend to provide any kind of advice or suggestion to individuals and/or corporates.
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