The influence of asset tokenization on financial stability is investigated by the Fed.
In-depth research on asset tokenization and risk-weighted assets (RWA) has been published by the Federal Reserve. These cutting-edge financial instruments are attracting a lot of attention as the financial environment changes because of their potential to transform investing strategies and disrupt established markets.
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According to the report, tokenization has five essential components, similar to stablecoins: a blockchain, a reference asset, a valuation mechanism, storage or custody, and redemption mechanisms. These components create links between cryptocurrency markets and reference assets, which improves comprehension of their influence on traditional financial systems.
Assets that have been tokenized have been increasing
The report estimates that as of May 2023, the market value of tokenized assets on permissionless blockchains will be a staggering $2.15 billion. This valuation includes tokens issued by well-known organizations like Paxos Trust and decentralized protocols like Centrifuge.
Getting thorough time-series data is difficult due to the diversity of tokenization designs and levels of transparency. DeFi Llama data, however, reveal a developing tendency in tokenization inside the DeFi ecosystem.
Since June 2022, the total value locked (TVL) in the DeFi ecosystem has stayed mostly consistent, while real-world asset-related categories have increased both in absolute value and as a share of the DeFi ecosystem as a whole. About $700 million of the projected $2.15 billion in tokenized assets is now secured in DeFi.
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According to the study, asset tokenization enables investors to own shares in particular properties in marketplaces that were previously closed to them or prohibitively expensive, like real estate. Its programmability and smart contract features enable settlement processes to use liquidity-saving strategies, increasing efficiency.
Tokenizations open up a new source of funding by making it easier to lend using tokens as collateral. Tokenized assets settle transactions more quickly than conventional reference assets, which could revolutionize settlement procedures in the financial sector.
Financial Stability: A Concern
There are significant financial stability concerns despite the promise of tokenization. Though the value of tokenized markets today is still small in comparison to more general financial systems, the possibility of expansion prompts worries about market fragility for cryptoassets and potential repercussions for the conventional financial system.
The links between the ecosystem of digital assets and the conventional financial system through tokenization redemption mechanisms are the main long-term concern. Stress transmission vulnerabilities may develop when reference assets are not liquid. The article shows that the liquidity, price discovery, and volatility of ETFs closely track those of their underlying assets, hence this risk is similar to those raised in the ETF market.
Traditional financial institutions may become more exposed to the crypto-asset markets through direct ownership or collateralization as tokenization grows. This change provides new dynamics and links that could have unexpected effects on market behaviors.
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