In a world where tokenization is becoming mainstream, with a wide variety of assets digitally represented on blockchains, these tokenized assets will replace cash for everyday payments. That’s the intriguing argument made recently Forbes by David Birch, an experienced British expert on digital identity and money.
Marcelo M. Prates, a CoinDesk columnist, is a lawyer and central bank researcher.
Instead of selling your mutual fund shares to get dollars that can then be used to buy a car, you can simply transfer some of the shares to the dealer via a blockchain. You would have the car, and the dealer would have tokenized shares that could remain invested or transferred to the automaker to pay for replenishing inventory.
The greater the number of tokenized assets, the easier it becomes to use them directly for payments without first cashing them out in bank deposits, CBDCs or stablecoins, thus reducing transaction costs. If any asset can be tokenized, fractionated, and then transferred seamlessly on blockchains, you can always use your tokens for payment, no matter what your tokens represent – from securities or Bored Apes to houses or plane tickets.
The mainstream adoption of tokens relies on the assumption that someone within the network will be willing to take over the tokenized asset you own, making all exchanges possible. Supercomputers and AI would help speed up trading by instantly determining the value of each token and its matching counterparties.
But obstacles
In such a system, digital money would only create friction and possibly become useless. Or would it? While fascinating, this reality faces at least two major hurdles before it can become a reality.
First, the number of transactions could quickly overwhelm even the most efficient blockchain. The The US payment system alone processes nearly 550 million retail transactions every day, using money, in the form of dollars, as the vehicle. This number would increase several times if payments were made not with a common vehicle, such as dollars or other sovereign currencies, but with tokenized assets that could be traded globally.
Read more: Michael J. Casey – Has the moment of tokenization finally arrived?
Today, a car can be purchased with a single payment transaction, with dollars flowing from the buyer’s bank account to the seller’s bank account. In a tokenized system, I could instead pay for a car that combines some tokenized securities with some bitcoin and tokenized fractions from a warehouse that I own with ten other people. In this case, three payment transactions would need to occur to complete a single purchase, one for each type of tokenized asset used.
It would become even more complicated if my tokenized assets existed in different blockchains or if sellers did not already have their own addresses or wallets in all these blockchains to receive the tokens offered as payment. Interoperability between blockchains is possible, but usually entails additional costs and risks. Tokens tend to be more easily stolen or lost when a bridge or protocol must be used to move them from one blockchain to another.
The second hurdle for tokenized assets to replace money is legal. In addition to its traditional functions (particularly as a generally accepted medium of exchange), money now also serves as a checkpoint for compliance requirements. In most jurisdictions, the prevention of money laundering and terrorist financing has been delegated to institutions that help people and businesses move money.
Financial institutions play a primary role in this. They must know their clients, identify the beneficiaries of transactions, develop risk-based tools to prevent suspicious or illegal transactions, and alert authorities immediately if something appears to be wrong. And all these actions are performed when money is moved to or from their customers’ accounts. It is a legislative and regulatory strategy that depends on the flow of money and the institutions that enable its implementation.
If money is then displaced by symbolic assets in everyday payments, the strategy loses its central operating point and its gatekeepers. Without a common good flowing through specific institutions, regulators would struggle to gather the information they need and enforce the associated rules. If someone can use and even combine different tokenized assets to make payments over the blockchain, who would be responsible for flagging or blocking suspicious transactions? Every seller there?
Blockchain forensics and automated surveillance tools can help regulators track transactions in real time. But the ability to suspend or block suspicious transactions amid billions, if not trillions, of payments taking place across jurisdictions every day seems infeasible, especially for transactions on truly decentralized blockchains, which are not managed or controlled by identified parties.
As crypto enthusiasts have already realized, replacing fiat money is not an easy task. Whether for practical or legal reasons, sovereign money still has the upper hand in everyday payments, despite the many alternatives that exist today. Tokenization, even if widespread, will not change this reality anytime soon.