Deeper Look into The Monetary Authority of Singapore’s “Project Guardian”
Asset Tokenization
Asset tokenization is a term for the use of smart contract and blockchain technology to represent ownership or rights to an asset as a tradable, on-chain token.
Digital asset tokenization is the process when ownership rights of an asset are represented as digital tokens and stored in the blockchain systems. In this manner tokens can act like digital certificates of ownership that can represent nearly any object of value, including but not limited to physical, digital, fungible, and non-fungible assets. Due to the fact that they are stored on a blockchain owners can maintain custody over their assets.
In order to understand how asset tokenization works, we need to revisit the basics of Web3:
To issue tokens, a developer writes a smart contract that maps out positive balances on to a series of smart contract addresses (“Wallets”) along with the functions which enable control of these wallets to add and/or subtract from those balances.
- Identify the asset you want to tokenize. This could be a myriad of different assets spanning from equities, commodities, currencies, securities, fine art, carbon credits, intellectual property, or another asset class.
- Token Type once the asset is identified that asset needs to be fir into a token type. Token types range from ERC-20, ERC-721, ERC-1155, etc.
- Identify the blockchain on which the tokens will be issued. There are a few criteria to consider two of which are whether to use a public or permissioned blockchain or whether to use a custom network or a rollup (e.g ZKsync).
- Auditor to verify off-chain Assets tokenized assets backed by RWA collateralization data needs to be relayed on-chain from off-chain bank accounts or vaults to ensure that the tokens are backed by an equivalent amount of collateral assets.
Benefits of Asset tokenization
- Data Management: Tokenization fundamentally involves standardizing data, mutualizing workflows, and automating processes. This streamlines information sharing, enhancing efficiency and supporting investor-friendly features. By reducing the need for manual reconciliation through mutualized workflows, tokenization cuts costs and complexity. Smart contracts automatically transfer ownership upon payment, easing the manual burden of recordkeeping.
- Liquidity: Selling alternative investments is typically a manual, labor-intensive process. Simplifying ownership records can improve liquidity and make smaller transactions viable. Tokenization could make illiquid assets more accessible, though a strong network of buyers is essential for creating liquidity. This network could consist of existing holders, secondary funds buying at discounts, or new market makers providing liquidity for traditionally illiquid assets.
- Collateralization: Currently, only a few firms offer collateralized loans against fund interests, typically to their wealthiest clients, due to the effort and underwriting risks involved. Tokenization can address this issue through the following features:
- Blockchain records can quickly and reliably verify ownership of collateral.
- Smart contracts and blockchain data can enhance collateral monitoring by restricting token transfers, which is crucial for loans backed by actively distributing funds.
Hubs for Asset Tokenization
- Singapore: Singapore provides the most advanced legal framework among other countries. Indeed, the Monetary Authority of Singapore (“MAS”) has introduced two different licensing requirements for RWA tokenizers. The first is the Capital Markets Services (“CMS”) license.[1] The second is the Recognized Market Operator (“RMO”). Companies wishing to obtain these licenses must comply with the Securities and Futures Act and ICAP RMO regulations.
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- Singapore MAS has been working on a new project called “Project Guardian”.
- Hong Kong: The Hong Kong Monetary Authority (“HKMA”) has launched the Project Ensemble Architecture Community (“PEAC”) to collaborate with industry stakeholders in advancing Hong Kong’s tokenization market.[2] This initiative aims to create industry standards that improve interoperability among various digital assets, including wholesale Central Bank Digital Currencies (“wCBDC”), tokenized money, and tokenized assets.
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- PEAC’s initial focus will be on developing a mechanism for seamless interbank settlement of tokenized deposits using wCBDC, particularly for transactions involving tokenized assets.
- Switzerland: The Swiss Distributed Ledger Technology (“DLT”) Act[3] has significant implications for tokenization, investments, and capital markets by establishing a legal framework for electronic records and enabling blockchain digital assets. It ensures that crypto assets can be segregated from other assets in the event of custodian bankruptcy, and allows banks and financial institutions to keep crypto assets off their balance sheets, opening up new business opportunities for both new and established players.
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- The DLT Act closes many gaps in Switzerland’s legal structure, creating a more secure environment for crypto assets and custodians. As a comprehensive law, it modifies ten federal statutes, including adjustments to the regulation of offering documents and the introduction of ledger-based securities. These amendments to the Code of Obligations, the Federal Intermediated Securities Act, and the Federal Act on International Private Law enable the use of blockchain-based securities, providing a reliable foundation for tokenizing assets like shares, bonds, and other financial instruments. This effectively bridges the gap between traditional stocks and digital assets, allowing for their storage, transfer, and trading through electronic registration.
Importance of Project Guardian
Project Guardian is a collaborative initiative between policymakers and the financial industry aimed at enhancing the liquidity and efficiency of financial markets through asset tokenization. The project seeks to establish industry standards for asset tokenization on a commercial scale, create policy guidelines and frameworks, and develop a sound and sustainable digital asset ecosystem. These efforts are guided by the principles of governance, technical standards, and policy considerations to ensure that digital assets can be seamlessly integrated into the broader financial landscape.
The initiative focuses on four key areas to achieve its objectives.[4]
- First, it emphasizes the development of open and interoperable networks that allow digital assets to be traded across platforms and liquidity pools. This is crucial for preventing the formation of isolated markets and ensuring compatibility with existing financial infrastructure.
- Second, Project Guardian aims to establish a trusted environment for decentralized finance (“DeFi”) protocols through a common trust layer of independent trust anchors, regulated financial institutions responsible for screening and onboarding participants. This trust layer ensures that all entities engaging in DeFi protocols are verified and credible.
- Third, the project explores asset tokenization, with an initial focus on tokenized deposits issued by financial institutions. Future efforts will extend to tokenized securities, building upon existing token standards and incorporating trust anchor credentials. This will make asset-backed tokens interoperable with other digital assets used in DeFi protocols on public blockchains.
- Finally, Project Guardian is committed to producing institutional-grade DeFi protocols by studying the introduction of regulatory safeguards and controls to mitigate market manipulation and operational risks. The project will also explore smart contract auditing capabilities to detect and address code vulnerabilities, further strengthening the security and reliability of digital asset networks.
In conclusion, Project Guardian represents a significant step forward in the integration of digital assets into the global financial system. By focusing on the development of open networks, trusted environments, asset tokenization, and institutional-grade protocols, the initiative aims to create a robust and secure digital asset ecosystem. Through its comprehensive approach, Project Guardian is poised to enhance market liquidity, efficiency, and trust, paving the way for a more interconnected and resilient financial landscape.
[1] https://www.mas.gov.sg
[2] https://www.hkma.gov.hk/eng/news-and-media/press-releases/2024/05/20240507-4/
[3] https://www.pwc.ch/en/insights/regulation/swiss-dlt-new-regulations.html
[4] https://www.mas.gov.sg/-/media/mas-media-library/development/fintech/project-guardian/project-guardian-open-interoperable-network.pdf