Tokenization: A tale of three cities (Part III)

In the last part of The FR’s series on tokenization, we’ll explore the use cases that may drive growing adoption of tokens to digitize a range of assets on the blockchain. We’ll also consider the regulatory roadblocks preventing tokenization’s proliferation at this current juncture. 

My conversation with Justin Chapman, who leads Northern Trust’s Digital Assets and Financial Markets group, suggests that Northern Trust sees a series of use cases for tokenization, with some asset classes more immediately feasible than others. Chapman notably cited carbon credits as one such example. 

“It's a perfect asset class,” Chapman said, noting that firms will eventually have to disclose their environmental impacts to governments due to ESG-related regulatory frameworks. “[Businesses] will have to create a strategy to get to net zero, and we will have to supplement that strategy with a number of offsets and try to create some transparency in that particular marketplace by adding data to the asset itself so that demonstrates it actually is doing what it says it does. It’s a huge opportunity.”

At present, carbon credits and offsets are an imperfect mechanism. As economic researcher Adrienne Buller notes in her book The Value of a Whale: On the Illusions of Green Capitalism, credits are often bought and sold without an undergirding material value. That is, a carbon credit can claim to correspond to a certain amount of carbon dioxide emissions being prevented without any proof of that claim. Through tokenization, Chapman argues, site-specific data—the number and wellbeing of trees in a forest plot, for instance—can ensure that there’s a there attached to these financial instruments. 

Tokenizing these assets, however, creates different types of carbon credits, some more luxurious than others. Carbon credits with a tokenized ledger may be orders of magnitude more expensive than their non-tokenized counterparts. That may create an opt-in market, according to Chapman, driven by companies particularly interested in proving their net-zero emissions. Since there’s no established trading infrastructure for carbon credits, Northern Trust sees an opportunity to establish market share through these new technologies. 

To Dr. Rachel O’Dwyer, Lecturer in Digital Cultures in the National College of Art and Design, Dublin, and the author of Tokens: The Future of Money in the Age of the Platform, the opt-in nature of tokenized financial instruments like carbon credits makes them mirror the conspicuous consumption undergirding other digital goods like NFTs and objects available for purchase in video games. 

“It all comes down to this question of prestige goods,” O’Dwyer told The FR. “It’s not what you’re buying, it’s what you’re buying into… It’s a worthless flex until you’re doing business, and that prestige value gets transformed into other kinds of value.”

In other words, the marginal utility of a tokenized carbon credit may have less to do with the data it carries than the symbolism it conveys: a commitment to decarbonization and ESG initiatives, which may satisfy some consumers, investors, and regulators. 

Over the longer run, Chapman said, fixed income securities may also benefit from tokenization. The same kind of thinginess that makes carbon credits a viable token can help in this field, ensuring that the debt raised is being spent and deployed appropriately. 

But there’s more than just cost that’s getting in the way of runaway adoption. In the eyes of Jeff Owens, Co-Founder of Switzerland-based on-chain financial solution Haven1, while institutional adoption of real-world assets is a promising sign, there is an ongoing “need to bridge the gap between institutional giants and everyday investors.” 

In addition, a lack of regulation complicates the mass adoption of tokenization. “Take KYC: streamlined, blockchain-native identity verification would make onboarding smoother without sacrificing the protections investors and institutions expect,” Owens told The Financial Revolutionist. 

In the US specifically, there are “ambiguous requirements for qualified custodians, with additional uncertainties surrounding the capital treatment of digital assets,” according to Maureen Doyle-Spare, General Manager of Asset and Wealth Management and Insurance at CA-based digital transformation solutions provider UST. 

Doyle-Spare told The Financial Revolutionist that the SEC’s regulation-by-enforcement methodologies have affected the US’s ability to lead global blockchain adoption in the financial services space. She noted proposed legislation, such as the Responsible Financial Innovation Act, which would name the Commodity Futures Trading Commission (CFTC) as the main regulator for spot and derivatives markets. 

“A sensible and balanced congressional approach is crucial for providing much-needed clarity amid the current regulatory uncertainty,” Doyle-Spare said. 

Tokenization ultimately remains on the cusp of… something. Institutional backers have identified sites where its application may be of use. Businesses may find its utility—both functional and reputational—to justify short-term costs. Its adoption may trickle down to retail investors and others. And lawmakers may react to international competition and establish the US as a leader. But these futures are not set in stone, may take years to develop, or may dissipate as attention pivots elsewhere. In the meantime, tokenization’s staunchest advocates are waiting for and attempting to build out the future they envision.