As more and more traditional institutions begin to dabble in digital assets, some believe the best way for both old-school finance and decentralized finance (DeFi) to grow together is through a cross-chain world and tokenization.
At Chainlink’s SmartCon 2022 conference, the “Bridging Traditional Finance and DeFi” panel discussed how interoperability could drive greater success for crypto in traditional markets. (Blockchain interoperability is when different chains communicate with each other. Tokenization is turning assets into digital tokens so investors could own fractional bits of the underlying asset.)
“By default, I’m definitely bullish on tokenization,” Victor O’Laughlen, managing director of head of enterprise tokenization at BNY Mellon, said. “We’re actually looking at tokenizing all different types of assets internally and, really, tokenization for me is an enabler for interoperability.”
Historically, financial institutions haven’t connected well, O’Laughlen said. “We have our own islands and try to operate in the best way that we can, but there’s always fear and uncertainty if we connect … but there’s a lot of integration that needs to happen within banks.”
Institutional investors want to have simultaneous access to digital and traditional assets, Jonathan Ehrenfeld Solé, strategy director of SWIFT, said. “In theory, this means they want to use a network that connects to all of these capabilities.”
In recent months, some traditional institutions have shown an interest in cryptocurrencies, but few have implemented crypto offerings for clients due to a lack of regulation and uncertainty.
“Once regulators are comfortable, absolutely banks will be there — they have to be there,” O’Laughlen said. “Slowly [banks will] shift over to DeFi protocols.”
Much of the focus within capital markets is targeted at building out that infrastructure and determining how to implement it into existing tax and legal frameworks, Stephen Prosperi, head of product management and digital securities management at The Depository Trust & Clearing Corporation, said. But more guidelines need to be developed for financial institutions to become comfortable with DeFi, he added.
“We need institutions to feel like they won’t be busted on KYC/AML,” Prosperi said, referring to protocols surrounding “know your customer” and anti-money laundering. “DeFi markets are different in how they interact, but they are fundamentally markets. In order to achieve what’s possible, institutions need to find a way to get involved.”
But that isn’t stopping all firms from exploring opportunities in the digital asset world today.
“We’re very focused on the blockchain and the opportunity it can present,” Prosperi said. “Cross-chain interoperability, we think, is very important. … We thought there wouldn’t be one blockchain to rule them all. There would be multiple out there.”
Tokenization in capital markets is “definitely here” and “it’s not going to go away,” Solé said. “I think for the capital markets industry, it’s not necessarily crypto where we see the big takeup now or in the long term. It’s more on the digital securities [or] tokenization of equities or bonds.” This means anything linked to cash, like a central bank digital currency or stablecoin, will be tokenized, Solé added.
During the conference, SWIFT announced a partnership with Chainlink to integrate the decentralized network’s “Cross-Chain Interoperability Protocol,” which will allow financial institutions to connect and operate across a number of blockchains. This will enable the 11,000 banks that SWIFT works with to exchange information through blockchain technology without a need for upfront integration costs or development time, it said.
“By tokenizing an asset, there’s things you can do from a settlement and clearance perspective that helps create efficiency,” O’Laughlen said. “You can accelerate transactions and we think that’s also a big opportunity.”
Separately, earlier this month, one of the biggest investment management firms in the U.S., KKR, which had over $491 billion in assets under management as of June 30, joined forces with digital assets securities firm Securitze and tokenized a healthcare private equity fund on the layer-1 blockchain Avalanche.
“There’s a whole wide range of assets that are ripe for infrastructure,” Prosperi said. “If we’re at this crossroads where we can leverage this new technology, we’re going to opt for the new route.”