Investment banking in a tokenized world


Investment bankers make money by creating liquidity.  Bitcoin and Ethereum have triggered a tidal wave of liquidity through the process of tokenization, in which assets of all types, from currency to equity to art, are recorded on a public blockchain and traded on new exchanges. 

Is this good or bad for investment bankers?  It is very good. Below are a few thoughts on the many ways in which investment banks can benefit from tokenization. 

Note that this is not a discussion of blockchain's benefits to the back office.  This is about new sources of revenue.   

New Asset Classes: Tokens (or cryptocurrencies) as a whole are not a new asset class. Tokens are simply a new form for representing ownership. However, there are at least two completely new asset classes that have been created as a result of the process of tokenization - decentralized currencies (e.g., bitcoin) and utility tokens (e.g., ether).  Both asset classes will create new opportunities in trading and asset management as well as new advisory and placement activity.  Utility tokens will become a third option to traditional debt and equity for fundraising for any company raising money.  This will not be limited to start-ups seeking crowdfunding. Large companies will issue utility tokens to benefit from network effects and to diversify funding types and sources.  Banks will offer "token capital markets" services, possibly as an extension of an equity capital markets desk.  

New Risks: New asset classes means new risks to be managed for clients and traded on a proprietary basis. The banks that first develop appropriate expertise and a book of trading partners will earn high returns as these risks become more liquid over time. New types of cash and derivative instruments will likely evolve to facilitate risk distribution in these new asset classes.    

New Liquidity: Liquidity is the ultimate objective of Bitcoin's focus on decentralized transfer of value and Ethereum's extension of this concept to other apps. It is all about transparency of information and exchange with minimal or no intermediation.  All types of assets are being tokenized into "security tokens" or "asset tokens."  This is being done both in whole and in various forms of divided ownership. As mentioned above, this opens new opportunities for trading for investment banks. This also increases the ability of prime services to lend to hedge funds.    

New Clients:  Investment banks now have a new type of client - the decentralized organization. Bankers who understand this new form will have an advantage in earning various types of advisory and placement engagements.    

New Funding:  Investment banks that are also depository institutions can lower their funding cost by issuing deposits denominated in cryptocurrencies, such as bitcoin.  Even if deposits are not available, investment banks should be able to earn a very attractive spread by borrowing and lending in these currencies. Bitcoin denominated debt instruments will be very attractive to the market, even at low rates. If the bank is the issuer, this bitcoin can then be lent to short sellers. So long as bitcoin remains highly volatile the bank can run a matched book or hedge in the futures market if practical.  Over time, traditional lending markets will develop in bitcoin, creating additional opportunities for spread revenue.  This will also create debt capital market opportunities to place bitcoin denominated debt for clients.   

New Deals: Investment banks that develop expertise in decentralized currencies will be in a very good position to advise the various currency projects on how to grow within the global currency markets. Even though these projects are decentralized they still can have large budgets to hire advisory firms.  In time, advisory engagements could include trillion dollar M&A assignments in the global currency markets.  M&A among decentralized utility token projects may also become very active as these markets consolidate after a period of over issuance.    

New Arbitrage:  The coming years of mass tokenization will present enormous opportunities for arbitrage by investment banks and their hedge fund clients. Arbitrage opportunities will exist between assets trading in both traditional and token form as well as between token markets.      

New Size: All of the above opportunities will be available on a very large scale. At the limit, all instruments of ownership could be tokenized. Many new trillion dollar markets could be created.  Utility tokens could displace a large portion of the traditional equity markets.  Tokenization of traditional illiquid assets could allow for liquid trading of such things as residential real estate. Global currencies could grow to replace traditional fiat currencies.  This is all in addition to the tokenization of traditional liquid markets such as the equity and debt markets.       

The opportunities presented to investment banks by tokenization are enormous. The question is, which banks will jump in and take advantage of them and which will stay on the sidelines. The lion's share of these new markets will go to the first movers.

Investment banks who want to participate in these markets should be trading cryptocurrencies as soon as possible. They should be developing expertise in the risk as well as sales relationships throughout the marketplace.  They should be thinking about new token-related revenue sources for each of their lines of business and how they might be able to create new lines of business to meet the needs of the new markets. 

The keys to success will be creativity and openness to decentralization.    

Author:  Shane Hadden

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

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