Tokenization: A Sales Pitch Worth Some Skepticism

By Amanda Fischer, Policy Director & COO

If you follow finance, you may be hearing a lot these days about “tokenization,” a term often tossed about by crypto entrepreneurs and increasingly being touted by those in the wider financial industry. In fact, there’s an SEC roundtable on the topic today and just last month Larry Fink, the CEO of the country’s largest money manager, BlackRock, mentioned it in his annual letter to shareholders.

So what is tokenization, why is the nation’s securities regulator devoting time to it and why is a hulking legacy financial firm touting it? It’s important to understand the hype around tokenization because it explains a lot about how big financial firms—both on Wall Street and in crypto—have set their sights on subverting time-tested investor protections under the guise of “innovation.”

First, it’s important to understand that tokenization is just a buzzword for bookkeeping. Currently, ownership of assets like stocks and bonds are tracked by using electronic databases managed by financial firms, which are tightly regulated by government watchdogs. When you place an order for a stock through your brokerage app, for example, that trade goes to the seller’s broker. Each party then sends the buy and sell information to a clearinghouse to make sure the money and the stock are both transferred.

The process of “tokenizing” an asset just means moving the recordkeeping related to its ownership to a blockchain—an immutable ledger where groups of persons, typically anonymous and across the globe, use algorithms to ensure that each transaction is recorded at the correct value and at the right time. Blockchains are typically used to trade crypto assets like Bitcoin.

Cheerleaders at the SEC, along with Fink, market tokenization as a way to revolutionize the investing process, unlocking more wealth-creation opportunities for Main Street. But is that really the case? Though Fink in his annual letter claims that “tokenization allows for fractional ownership,” his firm, BlackRock, already sells investment products that allow Americans to buy baskets of different companies’ stocks and bonds, sliced and diced in myriad ways for myriad investment strategies. Beyond that, other financial firms have already invented ways for investors to buy fractions of artwork, sculpture, and even elite race horses. None of these investment “innovations” required a blockchain and all of these investments comply with existing SEC rules.

Fink also claims that tokenization can “democratize yield,” allowing Main Street to get access to the same high-return investments as Wall Street power players. What Fink is likely referring to is forms of private equity and credit, which are not nearly as transparent or well-regulated as publicly-listed securities like stocks. These private investments have very little disclosures, can be illiquid, and lack reliable valuations.

Again, what does tokenization have to do with any of this? Very little. Any prohibition on selling these investments to Main Street has nothing to do with recordkeeping technology used to track ownership. Instead, invoking tokenization is merely a smokescreen to shovel riskier, unregulated products to less sophisticated investors.

In fact, one big money manager recently said that the private credit market is teetering, with assets trading at half the value they were initially worth. Another CEO from a big investment firm said to expect “accidents” (read: investor losses) to happen in private assets as the country potentially heads into a recession. So talk of “tokenization” may just be a marketing push to find willing buyers for teetering product.

And BlackRock’s tokenized money market fund, which it already launched? Well, it comes with a management fee of 20 to 50 basis points (or 0.2% to 0.5% of the amount invested). Meanwhile, the fee on BlackRock’s standard, non-tokenized money market fund is as low as 12 basis points, or 0.012%. So tokenization has the added benefit of allowing firms to charge higher fees to investors for the dubious benefit of changing the bookkeeping technology.

Beyond these concerns, blockchains are known to be plodding, expensive and difficult to scale, growing slower and costlier the more that people use them. The reason investors use this transfer mechanism for assets like Bitcoin is because you can do so pseudonymously and without the reliance on a centralized intermediary. Such decentralization is attractive if you are trying to escape the censorship or surveillance of the government or regulated financial firms, particularly if you don’t want law enforcement to track your transactions. That same decentralization is not particularly useful or necessary for the average person trying to buy or sell some investments in their brokerage app.

So why on earth would BlackRock—and their enablers at the SEC—promote an inefficient blockchain to replace the existing recordkeeping infrastructure? It is important to see beyond the hype. There’s nothing wrong, per se, with expanding the types of recordkeeping technology that fit within SEC rules. But that’s not what this push is about. Tokenization cheerleaders are likely hoping that applying a new technological wrapper on a bookkeeping system can create a disruptive business opportunity, allowing them to find more willing buyers for their assets, increase management fees and maybe even escape the scrutiny of financial watchdogs. After all, that’s what the crypto industry did: slap a blockchain on a securities product and call it “innovation.” So why shouldn’t others have a shot?

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