The Monetary Authority of Singapore's (MAS) Project Guardian has been generating significant buzz in recent months for its progressive approach to digital assets.
For instance, MAS launched the world's first live trade of a digitally-native bond on a public blockchain. This and numerous other innovations mark a significant milestone in its ongoing digital asset strategy.
However, while optimistic about MAS's developments, Ralf Kubli, a board member of the Canton Network Association, the organization responsible for overseeing the Canton Network, highlights that this innovation isn't without its challenges.
Kubli believes a critical yet often overlooked aspect of the tokenization process is the issue of liabilities.
In an interview with CryptoSlate, he explained that current practices in asset tokenization primarily focus on digitizing the asset itself but fail to incorporate the associated liabilities and cash flows into this digital representation. This results in the issuance of asset-backed tokens appended to blockchains, typically accompanied by a simple PDF outlining terms and conditions.
Kubli believes this approach, while seemingly efficient, still necessitates manual intervention for cash flow calculations, potentially leading to errors and discrepancies. He points out that this lack of transparency and verifiability in cash flows closely resembles the issues that precipitated the 2008 banking crisis. Furthermore, Kubli argues that the key to avoiding a similar systemic disaster is ensuring that cash flows are digitized, tokenized in a machine-readable format, and, crucially, standardized.
In this exclusive discussion, Ralf Kubli delves deeper into these challenges and explores the potential pathways to a more secure and efficient future in asset tokenization.
You've highlighted the lack of liabilities in asset tokenization practices as a critical issue. Could you expand on the risks and challenges this presents, especially in the context of MAS's recent initiatives?
The recent launch of Project Guardian by the Monetary Authority of Singapore is a great step toward showcasing the benefits that tokenization can achieve. However, these tokenized assets still aren't utilizing any standards that will make them both secure and interoperable across the entire financial ecosystem. The current projects do not define the payment obligations, meaning the cash flows of the financial instrument are in a machine-readable and machine-executable format. Failing to do so means we still have the same risks that have already plagued the financial industry for decades.
As for challenges, it may take some time to get everyone to adopt the same standards, but if projects like the one from MAS want to truly make progress, they need to do so.
You mentioned that tokenization platforms often ignore liabilities and cash flows. How critical is it to include these elements in the tokenization process, and what would be the best approach to achieve this?
As it stands, most tokenized assets don’t include algorithmic descriptions of their liabilities or cash flows. They only tokenize a PDF version of a contract, meaning that humans still have to read, understand, and process them manually and reconcile the same documents detailing the financial instrument. This completely undermines the point of tokenization and doesn’t meaningfully move the financial industry forward.
Implementing cash flow logic into the smart contracts that govern these assets turns them into “Smart Financial Contracts” that are now machine-readable, executable, and auditable. With these, we can truly enjoy the benefits that tokenization brings, allowing for much faster, more efficient, and more transparent management.
Ultimately, the inclusion of cash flows and payment obligations in Smart Financial Contracts resolves the reconciliation problem both within and between financial firms while allowing for systemic risk oversight.
Drawing parallels to the 2008 banking crisis, you've suggested that a lack of transparency in cash flows can be dangerous. How can blockchain and tokenization technologies be leveraged to prevent such systemic risks in the future?
By automating finance via tokenization, every company's balance sheet can be completely audited almost in real-time. Because the financial assets which are on these company's balance sheets are forward-looking, noisy, and dynamic, “what if?” simulations can be conducted at any given time.
Firms will be able to see exactly where they stand in terms of liquidity and can easily model how they would fare under any conceivable economic conditions. This should effectively reduce the risk of events like the ones that led to the 2008 crisis, as well as more recent volatility and contagion that we have seen.
Having the current state of each financial instrument on any firm's balance sheet in an algorithmic and standardized form will also reduce the regulatory burden, allowing for effective and progressive regulation and systemic risk analyses across many firms.
Do you view MAS's approach as a step towards addressing these tokenization challenges globally, or is it more of a localized effort? How can other regulatory bodies learn from this?
Several initiatives by the MAS are developed in cooperation with multiple regulators; therefore, what happens in Singapore with large international financial firms is of a global nature.
In your opinion, what does the future hold for the tokenization of financial assets? How crucial is international cooperation in standardizing these practices?
Tokenized financial assets will revolutionize the way financial systems operate. You can think of it as upgrading the operating system of capital markets. Tokenization is already happening with cash and cash equivalents on a massive scale (deposit tokens, money market funds, T-Bills, etc.). For money tokenization, several large players are moving aggressively (the likes of Fidelity, Franklin Templeton, and KKR).
For debt, structured instruments, and derivatives, algorithmic definitions of the cash flows of the underlying financial instrument are a prerequisite for the successful adoption of DeFi for tokenized financial assets.
A bond or a mortgage remains a bond or mortgage when it is tokenized. Therefore, the regulators should be happy to have DLT-enabled financial infrastructure, where it is much easier to track which party holds which obligation.
Without the Cash Flows inside the tokens representing debt, structured instruments, or derivatives, these tokens will remain dumb and not provide the needed efficiency in price discovery and post-trade automation.
What are some potential solutions or innovations you foresee that could address the liabilities issue in asset tokenization?
A broad set of open banking standards that algorithmically define how financial contracts interact. Combining tokenization with clearly defined standards can bring a new level of efficiency, transparency, and legitimacy to finance and businesses. Luckily, standards already exist that can address these concerns, specifically the standards outlined by the Algorithmic Contract Types Universal Standards (ACTUS) Research Foundation. Implementing a framework like this is what needs to happen to tokenization if it wants to be truly adopted.
Do you believe the issues you've identified with tokenization are limited to stablecoins or part of a broader pattern in the financial system?
The reality is that using stablecoins for payments brings little innovation to finance. The innovations in payment rails have been mistaken for innovations in finance since finance is the exchange of money over time, and payments are the exchange of money today.
DeFi currently consists primarily of over-collateralized lending, which will keep it a niche form of finance, as in the real world, very small amounts of over-collateralized loans exist. The reason why DeFi loans need to be so heavily collateralized is because DeFi is incapable of embedding the cash flows or liabilities of a loan without human intervention.
As I’ve said, to onboard and attract institutions, liabilities and cash flows must be tokenized, machine-executable, and, perhaps most importantly, standardized. With proper financial infrastructure underpinning the blockchain-based tokenization we see today, DeFi can grow beyond its niche status into the revolutionary technology it aims to become.
What advice would you give to innovators and regulators in the blockchain space to address these challenges effectively?
For innovators, don’t just build another payment rail – that only creates another silo that needs to be independently audited. Instead, implement smart financial contracts that can be audited via automation. This is the true innovation.
As for regulators, understand that asset tokenization that follows agreed-upon standards will actually make your jobs much easier. All of these instruments and rails will be transparent and implemented by code. This means it won’t even be possible for companies to do things like misvalue positions and hide liabilities, and it would be completely visible if somehow they tried.
Ultimately, what is your vision for the future of blockchain and tokenization in creating a more efficient, transparent, and stable financial ecosystem?
This is the first time in 60 years, since the introduction of computers in banks, that we can address and solve the fundamental problems plaguing the banking and financial systems. By implementing open-source, algorithmic financial contracts, the financial world of tomorrow will operate so much more efficiently, and balance sheets will be solvable within minutes or hours with low or eliminated instances of fraud.
Done right, the Blockchain can truly offer the reliability that is required to improve worldwide risk management and make systemic risk oversight possible again. I believe this is happening; it will just take a little longer to get everyone on board.
Ralf Kubli plays a pivotal role in nurturing the decentralized economy as a board member at the Canton Network Association.
