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The risks of banks tokenising assets on blockchain

Blockchain technology is rapidly altering the global financial landscape. Yahoo Finance UK spoke to an expert about the efficiencies and risks of tokenising the world's assets on blockchains.

Tokenisation of real-world assets involves converting the rights to physical or intangible assets, like a building or a bond, into digital tokens that can be exchanged on blockchains.

The process is gathering pace. In November 2022 JPMorgan (JPM) executed the first live trade using tokenised versions of the Japanese yen (JPY=X) on the Polygon (MATIC-USD) blockchain. In April, French investment bank Credit Agricole (ACA.PA) and Swedish bank SEB agreed to develop a blockchain-based platform for digital bonds.

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On this week's episode of The Crypto Mile Ralph Kubli, a board member of the blockchain developers Casper Association, articulated the transformative power of blockchain technology for the global financial sector, labelling it the "single most important technological innovation in finance" since the computerisation of banking in the 1960s.

However, he warned the current state of financial asset tokenisation was "abysmal".

Kubli extolled four principles that highlight the benefits of blockchain technology — the facilitation of efficient value transfer, the unification of trade and settlement, the use of the private key as the perfect collateral, and the origination of assets via tokenisation.

Categorising tokenised assets

Tokenised assets are categorised into tangible and intangible classes. Tangible assets include physical items like buildings, machines, and cars that exist on a company's or individual's balance sheet.

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When tokenising such physical assets, a legal framework becomes necessary.

"You would have to have a legal concept that links the representation of the assets on chain to the real physical existence of the asset," Kubli said.

Countries such as Liechtenstein and Switzerland have blazed a trail in this respect, devising ways to reflect on-chain ownership rights of physically existing assets.

However, the situation becomes more complex when dealing with fractional ownership. For instance, reclaiming fractional ownership of a physical asset like a painting stored in a bonded warehouse presents a different set of challenges.

Compared to this, tokenising financial and intangible assets, which are by definition digital, is more straightforward.

Risks of tokenisation

"One risk is to have unclear definitions of the cash flow obligations of the parties involved in these financial contracts. We do not want to repeat the same mistakes that happened in the 2008 financial crisis, where there were ill defined cash flow obligations," Kubli said.

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He noted that non-machine-readable and non-machine-executable term sheets could lead to a chaotic and less secure financial system.

Critiquing the current state of financial asset tokenisation as "abysmal," Kubli voiced his concerns over tokenisation platforms taking a simplistic approach by simply making a PDF of the offering document into a digital token. He emphasised the importance of representing both the asset and liability sides in these tokens, without which the financial instrument would be incomplete.

Potential of tokenisation

On the positive side, Kubli said the tokenisation of cash and cash equivalents, such as stablecoins, holds immense potential, and noted that some firms like JPMorgan are already capitalising on this.

"The reason why a lot of the private equity firms are really trying to work on the tokenisation of their functions is that it is just much more efficient," said Kubli.

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Reflecting on recent financial mishaps, including the collapse of Silicon Valley Bank and the buyout of ailing Credit Suisse by UBS (UBS), Kubli underscored the necessity of improved transparency and efficiency.

He concluded: "If you combine a properly defined financial contract with the unique capabilities of blockchain you get an assurance layer that will create the kind of reliability that you need in order to fully securitise financial instruments. That is really the holy grail."

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