👀Tokenization in the context of money and other assets: concepts and implications for central banks👀
October 2024
Joint report by the Bank for International Settlements (BIS) and
Committee on Payments and Market Infrastructures (CPMI)
Report to the G20
Executive summary:
For centuries, economic and financial transactions have been facilitated by tokens acting as a medium of exchange and/or representing some type of value. This report focuses on the much more recent creation of digital tokens on programmable platforms that provide an infrastructure on which multiple issuers, investors, payers and payees may issue, trade and settle transactions with money and other assets.
For the purposes of this report, tokenization is defined as the process of generating and recording a digital representation of traditional assets on a programmable platform. This definition, which builds upon the definition in BIS (2023a), reflects that the issuance, recording and transfer of tokens relies on the execution of applications that exist on programmable platforms.
• Digital tokens are entries in a database that are recorded digitally and that can contain information and functionality within the token themselves. Digital tokens can represent financial or real assets.
• Programmable platforms are the technologies that allow eligible participants to develop and execute applications that update a common ledger. In the context of money and other assets, one of the technologies that has gained prominence is Distributed Ledger Technology (DLT).
This report uses the term token arrangement to indicate the infrastructure that supports the use of digital tokens in financial transactions. A token arrangement may include more than one programmable platform to the extent that functions are performed on several platforms or there is some other interdependency across platforms. Further, an arrangement includes financial market functions whereas a platform could theoretically allow for applications or programs to perform other non-financial functions.
Token arrangements can be designed to enable multi-asset, multi-function and multi-party financial transactions and services. A token arrangement might record both money and other assets. This differentiates it from existing payment, clearing and settlement arrangements, which typically hold money on separate ledgers. The standardization of certain digital token features may facilitate the coexistence of different asset types on a single programmable platform. Tokenized assets can then be traded and settled
using applications built on the platform. These applications may allow for bundling different functions and creating new ones. For instance, an application could combine pre- and post-trade services – financial market functions that are typically separated in existing arrangements. Token arrangements may also employ automation and conditionality of transactions across a range of functions and/or asset types, potentially affecting the execution of financial market functions if allowed by legal and regulatory frameworks. Overall, this could expand the set of operationally feasible options for carrying out financial transactions.
Tokenization can bring both opportunities and risks. Platform-based intermediation brings the potential to reduce the frictions present when disparate systems are needed to issue, trade and settle different types of assets. This can potentially decrease transaction costs, enable new use cases and better match supply and demand. Lower frictions may improve the allocation of resources and hence support capital allocation. The technology provides features such as conditionality, data reconciliation and automation, which may also decrease costs and support the development of innovative use cases.
As with existing recording, payment, clearing, and settlement systems, the potential capacity of token arrangements to improve financial system safety and efficiency will require sound governance and risk management. The well known risks of existing systems apply, such as those related to credit and liquidity risks, custody, access policies, operational and cyber risks.
These risks may materialize in different ways due to the effects of token arrangements on market structure, eg due to a change in the roles played by intermediaries when previously separate functions are combined on one platform. Risks may also emerge owing to conflicts of interest due to the combination of functions within a single entity, or a concentration of activity in one or a few arrangements.
Tokenisation in the context of money and other assets 5 On balance, the future development of token arrangements remains uncertain, and many outcomes are conceivable. Looking forward, tokenisation may have implications for the roles of central banks in payments, monetary policy and financial stability.
A primary consideration for central banks is whether, and to what extent, to react to ongoing private sector tokenisation initiatives. For example, central banks could consider ways to foster interoperability if markets develop in a fragmented manner.
A second consideration is whether and how central banks assess the trade-offs and the appropriate balance between different types of settlement assets in token arrangements. This may include how or in what form central banks could provide central bank money as a settlement asset for token arrangements.
A third consideration concerns identifying token arrangements that may already, or potentially in the future, meet the criteria to be subject to regulation, supervision and oversight at the individual jurisdiction level. They might also be subject to international standards such as the PFMI. Relevant authorities might consider how to cooperate, both within and across jurisdictions.
A final consideration relates to the potential impact of token arrangements on monetary policy implementation, for example through changes in the structure of regulated markets or the demand for central bank versus other types of money.
