The tokenisation of assets is often a feature of distributed ledger technology (DLT) when used in the financial markets. However, cash and securities can be transferred quickly, efficiently and with settlement finality without the need for tokenisation. Arjun Jayaram explains how Baton Systems makes this possible with its Core-FX solution.

Asset tokenisation is often a feature of blockchain-based innovation in financial markets. It refers to the digital representation of assets on distributed ledgers or the issuance of traditional asset classes in tokenised form. 

Looking at what a token is and how it might be used in the context of financial markets, we can see that there are four elements to the tokenisation of assets:

  1. The issuance of the token, after which it is stored in a ledger.
  2. For asset backed tokens, ensuring that the assets backing the token are fully collateralised at all points in time. 
  3. The creation of a workflow which enables the exchange of the particular asset or token. 
  4. The provision of a legal framework which ensures that there is legal title of the asset and that it is, very importantly, final and irreversible.

There is certainly a place for tokenisation in financial markets such as in the issuance of new corporate bonds, or where there is fractional ownership of the underlying asset – for example a building. In these cases, tokenisation is both practical and desirable. However, real use cases for asset tokenisation are still very few and far between

If we turn our attention to cash and securities, these are already digital as they’re issued on the ledgers of central and commercial banks (if we’re referring to cash) or, in the case of securities, they’re equities and bonds issued at a central securities depository (CSD).

As far as these assets are concerned, therefore, digitisation is already happening. But if cash and securities were to be tokenised, enabling the workflows to allow them to be exchanged across a broad base of industry participants would present a huge technical challenge. This would be coupled with the thorny problem of establishing a watertight legal framework to ensure that the underlying ownership of the asset is finally and irrevocably transferred. 

Tokenisation and PvP settlement

There would be broader market implications if tokenisation were to be made a prerequisite for DLT-based payment versus payment (PvP) – i.e. riskless settlement. The PvP process fundamentally involves the exchange of two currencies, so tokens would need to be asset backed. Specifically, tokens are issued on the basis of locking up the underlying assets. If assets were not locked up, the tokens would have no meaning and would be nothing but unbacked IOUs.  

So, although the exchange of tokens may be achievable with immediacy, and on a 24/7 basis the moment a bank decides to issue tokens for PvP settlement, it commits to tying up liquidity and essentially prefunding. Furthermore, at this point any tokens that might be funded and created for this purpose have very restricted usage opportunities compared with conventional assets.  

No pre funding

In developing Baton Systems’ Core-FX™ platform, we took the decision to develop a process that does not require tokenisation, and therefore prefunding. 

Because FX requires an enormous amount of liquidity, the locking up of liquidity by banks makes management of liquidity an expensive and inefficient process – especially when you’re referring to high value payments.

Rather than issuing limited-use tokens and locking up assets, Baton’s technology moves real assets in real accounts held at commercial banks – that’s to say, we orchestrate and accelerate the movement of the (already) digitised representation of these assets across different ledgers. 

This structure means that Core-FX offers market participants the opportunity to settle all currencies (including emerging market currencies) rather than just a select few. Furthermore, participation is open to all wholesale participants with access to accounts at commercial banks, not just the very large institutions with Central Bank accounts.

Not reinventing the wheel

There were other reasons for not developing a solution which required tokenisation. I have already outlined the three components to tokenisation: issuing the token, creating new workflows and putting in place a legal framework.

If a new set of assets were to be created in the form of tokens backed by real cash, each of these elements would need to be addressed. New technology would be required to create the tokens, then parties would need to be connected to the new workflows. Most important, however, would be the issue of legality.

The legality around the movement of assets in the case of cash is well understood in central banking and in correspondent banking. The regulations regarding electronic fund transfers apply.

Baton relies on these existing legal frameworks which ensure that asset movements are final and irreversible and that the receiver of an asset has legal ownership that’s unencumbered and that allows them to be used going forward. We also rely on existing workflows, consisting of legally binding contracts such as those from ISDA. So essentially we are codifying an existing contract (sometimes this is referred to as a smart contract; at Baton we refer to this codification of a workflow as a distributed workflow) – so we are digitising an existing process and workflow but not creating new tokens.

Tailoring the solution to the problem (not the reverse!)

Before developing Core-FX, the Baton team spent a considerable amount of time studying the trade lifecycle from the perspectives of different market participants and documenting the issues faced regarding the entire post-trade process from matching through to the final settlements and payments. It was clear that the problems had nothing to do with digitisation of assets but rather manifested in delays, which added risk, direct and indirect costs (along other operational inefficiencies), and suboptimal liquidity management. 

To address these issues there was no need to create tokens nor was there a reason to entirely rip and replace. While the technology, especially books and record systems and payment stacks were ageing, Baton’s technology could interoperate with a bank’s existing systems and bring efficiencies immediately. Importantly we chose to solve the above problems by mobilising assets on a 24×7 basis, and providing the parties with real-time visibility and real-time control. In this process, we seek to upgrade books and record systems, and other legacy payment infrastructure, to a modern tech stack. The new payments infrastructure and asset movements operate with legal and operational frameworks that are already well understood by the banks today. Ultimately, we digitised an existing process, adding new rails to an existing infrastructure without needing to tokenise.

This interoperability with existing systems is what makes Baton’s solution unique. Furthermore, a commitment to reliability and security is at the heart of our operation. We build systems that are highly secure and highly resilient. Trusted by the world’s largest financial institutions, as of October 2022, Baton’s technology has handled over 85 million transactions and facilitated the settlement of more than $10.3 trillion.   

The benefits of the Baton approach

The traditional road to settlement gives rise to capital charges, liquidity charges and an expensive, inefficient workflow in which, for example, increasing STP rates frequently results in a reduction in netting. Baton’s technology brings efficiencies to the entire settlement process, significantly reducing charges, optimising workflows and reducing risk.

Smart workflows are established using distributed ledger technologies, with each settling party operating as a node within Core-FX, and each node profile operating on a secure, single-tenant cloud infrastructure, ensuring that there is no data pollution.

Core-FX is backed by a rulebook so users can benefit from the latest decentralised technology alongside the certainty of a defined governance process with settlement finality. The Baton rulebook defines the rules relating to the exchange of assets and liabilities and  has been designed to comply with requirements in multiple jurisdictions using well established legal constructs related to electronic funds transfer.

By settling without tokenisation on a PvP basis, the need for prefunding is eliminated – counterparties are funding ‘just in time’ which is an extremely effective way to manage liquidity. Settlement risk is eliminated, capital and liquidity charges are reduced and workflows are made more efficient, which also leads to a reduction in operational risk.

I hope you found this blog useful in explaining how DLT-based PvP settlement can be achieved without the need for tokenisation or the digitisation of assets. To learn more about Core-FX please don’t hesitate to contact me at [email protected].