In January this year, Larry Fink, the CEO of BlackRock, said that “the next step going forward will be the tokenisation of financial assets, and that means every stock, every bond … will be on one general ledger.”

Last month, crypto asset exchange Mesh.trade launched its first public offering of tokenised preference shares for South African financial company Water Financial.

This allows investors to purchase a Water Financial preference share in the form of a token on Mesh which will pay investors a monthly dividend. Water Financial has issued the preference share to raise R30 million to fund its lending business.

If all this jargon has your head spinning, you are not alone. While most people will be familiar with Bitcoin which is a crypto asset or token created through the Bitcoin blockchain, what few people are aware of is the ability to use blockchain technology to tokenise mainstream financial assets.

What is tokenisation?

Global consulting firm McKinsey explains that tokenisation is the process of issuing a digital, unique, and anonymous representation of a real thing. Tokens can represent assets, including physical assets (like real estate or art), financial assets (like equities or bonds), intangible assets (like intellectual property), or even identity and data.

It is sort of like a piece of paper saying that you own a specific asset, such as a gold bar. You don’t want to carry the gold bar around to prove you own it, but the piece of paper confirms your ownership.

However, tokenisation is so much smarter because the digital token can be programmed with code which controls the token. This is known as a smart contract. This contract means the token knows who its owner is and can execute actions. Once a transfer takes place then the smart contract can update you on its new owner.

It also knows what it needs to calculate. For example, a token knows when to pay out a dividend or when a contract has expired. It effectively automates many of the administration processes that a fund manager or administrator would undertake.

It is a lot safer than a piece of paper, which can be stolen or fraudulently amended to change ownership. A digital token can only be created and changed through a blockchain, which is a network of computers which independently verify all transactions through what is known as a digital decentralised ledger.

There is no single entity in charge of updating the information. As new data is added to the network, a new block is created and added permanently to the chain. This means no one can remove that data. All nodes, or computers, on the blockchain are then updated to reflect the change.

As Connie Bloem, MD of Mesh.trade explains, if something happens to Mesh.trade or someone acts not according to how they said they would act, the blockchain would retain all the information and keep the transactions transparent. The financial record is no longer reliant on a single entity.

In summary, a token is a piece of computer code that tells someone what the asset is, who it belongs to and what the asset can and cannot do. This code can never be deleted. This could bring great efficiency and cost savings to the investment world.

Tokenisation of financial assets

While tokenisation of financial assets is still in its infancy, fund managers such as BlackRock and Franklin Templeton are already using tokenised money market funds.

According to analysis by McKinsey, “tokenised market capitalisation could reach around $2 trillion by 2030 (excluding cryptocurrencies like Bitcoin and stablecoins like USDC). Specifically, we expect that organisations working with certain asset classes will be the quickest adopters; these include cash and deposits, bonds and exchange-traded notes, mutual funds and exchange-traded funds, as well as loans and securitisation”.

While tokenisation can improve efficiency for mainstream financial instruments, its appeal will lie with those entrepreneurs who want to raise capital for expansion or growth. Listing instruments on the traditional markets is extremely onerous and expensive and crowds out smaller capital raisings.

“The South African economy needs its entrepreneurial base to keep on growing because that’s the base that generates jobs and also increases or empowers the economy. So that is our segment, but it’s not being served by the traditional network,” says Bloem.

Opportunities for smaller businesses

It is good news for smaller companies, and for investors it could bring a whole new range of investment opportunities to the market.

The preference share issued by Water Financial is a good example. In this case the token is the financial instrument so when you buy one preference share it equals one token.

“What we have created is this relationship between the legal agreement, which in this case is a prospectus, with the unit that is a token, that allows you to transfer, trade, and show ownership,” explains Bloem.

Water Financial offers homeowners over the age of 70 the opportunity to release the equity in their homes in the form of a loan, without having to repay a monthly installment. This is known as a reverse mortgages or equity release. and is very big business in most developed markets.

Many retirees are asset rich but income poor. They have an asset in their home but struggle to meet monthly expenses. Through their product called Financial Freedom, Water Financial provides these people with a loan, paid as monthly income, which is settled on the sale of their property some time in the future.

To provide these loans, Water Financial needs to raise ongoing capital. Traditional debt markets such as banks and large institutions are traditionally conservative, are not open to alternative investments, and often have very high minimum deal levels.

By using tokenisation, Water Financial CEO Chris Loker says he has found a cost-effective way to bring his preference share to the market. The preference share pays a dividend equal to 87% of the prime interest rate. Currently, the dividend pays a rate of 10.22% per annum and the income is paid monthly.

Bloem says they are in discussions with several companies and expect to bring more investment opportunities onto their platform.

“We are going to be putting out more debentures, more bonds, more debt kind of instruments with more of our clients. We’ll do more equity in the next three to four months”.

Tokensation will no doubt grow over time, and while you may not need to have a deep knowledge of blockchain technology, you do need to know which platforms to trust.

There will be many scams around tokenisation and the promise of returns. All regulated crypto platforms must be licensed Financial Services Providers, so only ever invest on a platform that is registered with the FSCA.

Also ensure that the underlying asset is legitimate and regulated. As these instruments will be issued by a registered company, do your homework on the company and its directors.

This article first appeared in City Press.