Incumbent financial institutions as well as new entrants are investing heavily in projects seeking to transform securities into digital tokens – digital representations of value that are not recorded in accounts, or “tokenization”. A key motivation is to lower the estimated $17-24 billion spent annually on trade processing. Tokenization could also transform how the underlying risks are managed.
The clearing and settlement landscape could change rapidly in response to tokenization. Today, securities such as equities and bonds are maintained in electronic book-entry accounts at centralized securities depositories. In the future, they could “live” on distributed ledgers held across a network of traders where each has a synchronized copy.
This article describes the extent to which tokens and distributed ledgers might alter clearing and settlement processes. It first reviews the main features of traditional account-based clearing and settlement arrangements. It then introduces the concept of tokenized securities and explains the potential implications. Finally, it introduces a taxonomy to illustrate how securities settlement might change with tokenization.
Key takeaways
- Tokenisation of securities – the conversion of financial assets into digital tokens – could transform the clearing and settlement of securities trades.
- Tokenisation might reduce costs and complexity, but does not eliminate risks associated with one party failing to settle transactions.
- The success of token-based systems will depend on how well they interact with traditional account-based systems.