Can securities and funds token markets can grow without genuine digital money on-chain?

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What are the costs of lack of digital money on chain?

The absence of on-chain money to settle the cash leg of transactions on blockchains and pay entitlements has many negative effects on the security and fund token markets. Ultimately, every tokenisation use-case depends on the availability of on-chain cash to realise its potential value to users. After all, a large part of the appeal of blockchain is its ability to capture transactions, settlements and transaction records on single shared ledger instantaneously, eliminating the need for reconciliations between the counterparties. Without that benefit, it will be difficult for token markets to achieve scale and liquidity, and without scale adoption will be limited. Tokenising securities without tokenised cash makes settling transactions and paying entitlements and redemptions more complicated and expensive. The need to come on and off blockchains via the conventional banking system makes it difficult to grow the market quickly. It also entails managing payment system cut-off times and complying with manual customer due diligence checks. It preserves expensive intermediaries such as banks and card payments companies. Both transaction costs and risks are higher. A further difficulty is presented by the potential fragmentation of fiat currency money into different forms – e-money tokens, Stablecoins, tokenised deposits and central bank digital currencies (CBDCs) – because fragmentation could, by making it difficult to use some forms of cash on some blockchains, undermine the fluidity of trading activity in security and fund tokens. This is why central banks have begun to emphasise the need to balance innovation in forms of money with preserving the “singleness” of money.

Why cannot e-money do the job?

Although e-money tokens can be issued under European Union electronic money regulations set by the second Electronic Money Directive of 2009, they have not proved an attractive option. The need to maintain segregated accounts and 100 per cent cash reserving (or the equivalent via an insurance policy) makes e-money tokens unprofitable for banks to issue, since there is no net interest margin. Nor does e-money escape reliance on the traditional banking and payments infrastructures.

Are Stablecoins a stop-gap solution or a durable innovation?

Market participants are using Stablecoins, which have emerged as the most important on-chain alternative. They account for only 7 per cent of the capitalisation of the cryptocurrency markets but 90 per cent of the trading volume, giving them a crucial role in almost every cryptocurrency transaction. Beyond the cryptocurrency markets, some small and medium-sized companies in countries and regions without stable fiat currencies are using Stablecoins to pay suppliers and meet payroll. Statistical analyses often claim that Stablecoin volumes now match or exceed those of major card companies, though they are not being used for comparable purposes and the Stablecoin volumes are being inflated artificially. Like cards, the largest Stablecoins are issued by non-banks. They can be volatile in terms of market value and banks exposed to Stablecoins will from 1 January 2026 incur additional capital costs under the capital adequacy rules set by Basel Committee on Banking Supervision (BCBS). Regulators also lay down other potentially costly controls, including management of cyber-security risk, but especially the specification and disclosure of the collateral eligible to back a Stablecoin. The Bank of England, for example, has indicated it will insist that Stablecoin issuers hold central bank money only to back their coins, to ensure Stablecoin holders can redeem their Stablecoins at all times without running market or liquidity risk. Regulators have shown a marked preference for Stablecoins issued by banks, but few banks have taken up the invitation. One is Société Générale–FORGE, which issued a Stablecoin named EUR CoinVertible (EURCV) on to the Ethereum public blockchain in April 2023. Being fully compliant with the Markets in Crypto-assets Regulation (MiCAR) of the European Union (EU), which came into force on 30 June 2024, EURCV can be used by both retail and wholesale investors. It is available via the BitStamp cryptocurrency exchange and the digital asset market-makers Wintermute and Flowdesk, so it can be used by cryptocurrency market participants. Société Générale–FORGE as issuer, the quality of the collateral and the engagement of market-makers are intended to reassure users that the EURCV Stablecoin is always redeemable at par and exchangeable in the market at par, at all times. In December 2023 Axa Investment Managers used the EURCV Stablecoin to purchase €5 million of digital green bonds issued by Société Générale, so it is reaching institutional investors as well. However, it will take time for Stablecoins such as EUROCV to secure adoption by institutional investors. A third use for Stablecoins is cross-border payments. Fully regulated Stablecoins such as EUROCV can be used by, for example, corporate treasurers to make cross-border payments between digital wallets. They are likely to be cheaper than using correspondent banks for the same purpose. A forth use case for Stablecoins is to store value on-chain, to avoid the transactions costs of switching to fiat currency or triggering a taxable event. However, regulators and consumers may be on a collision course on Stablecoins. Regulators want Stablecoins to be issued by banks. But retail consumers hold cryptocurrencies and use non-bank Stablecoins because they do not trust banks.

Where do tokenised money market funds fit in?

As a substitute for cash in cryptocurrency trading. Unlike Stablecoins, money market funds promise not only a stable value but also a regular yield. Cryptocurrency traders can use tokenised money market funds as “cash” collateral for margin trading on cryptocurrency derivatives exchanges. Which is why a number of asset managers have tokenised shares in money market funds. In March 2024 BlackRock issued a tokenised fund issued on a public blockchain, the BlackRock USD Institutional Digital Liquidity Fund (BUIDL) through Securitize Markets. In June 2024 Fidelity International tokenised shares in a money market fund for the first time through the Ethereum-based private blockchain network owned by J.P. Morgan, Onyx Digital Assets, which has also issued a tokenised deposit for use by members of the Onyx network only. A Franklin Templeton tokenised money market fund (the OnChain U.S. Government Money Market Fund or FOBXX) has been available since 2021 and is accessible through the Benji Investments app on the Ethereum, Coinbase Base, Aptos, Avalanche and Stellar blockchains. But tokenised money market funds remain a niche product for cryptocurrency traders, which will not encourage asset managers to tokenise funds at scale – that still requires genuine on-chain cash, though whether cash drives tokenisation of securities and funds or tokenisation of securities and funds drives demand for tokenised cash is an open question.

Has cryptocurrency definitively failed as a form of digital money?

Since 7 per cent of the global population own cryptocurrencies, and it is estimated that more than 90 million Americans own one or more cryptocurrencies, it is premature to declare cryptocurrencies redundant as a form of digital money. Obviously, cryptocurrencies are difficult to use in everyday transactions, but they fulfil several of the uses of money: a medium of exchange, a unit of account and store of value. Although cryptocurrencies are used by criminals to steal and launder money, institutions should not hold them to a higher standard than fiat currency (where regulated banks are fined regularly for money laundering). Indeed, cryptocurrencies issued on to blockchains offer a higher degree of transparency than conventional money and payments systems, so it can be argued that the compliance departments at regulated financial institutions have better data about cryptocurrency transactions than fiat currency transactions.

What is holding up the issue of tokenised deposits?

Banks ought to prefer tokenised deposits to Stablecoins, while consumers ought to prefer Stablecoins to tokenised deposits. Tokenised deposits enable banks to retain net interest margin and - as long as they remain useable intra-bank only - to keep the business on their private networks. As deposits backed by deposit insurance schemes, tokenised deposits are equivalent to commercial bank money today. Central banks prefer them because unlike Stablecoins, which can be used and transferred by anyone, tokenised deposits do not fall outside the conventional, regulated banking system. They could operate using existing payments infrastructures and transfer value through the updating of bank balance sheets in the same way as net balances are settled through central bank Real Time Gross Settlement (RTGS) systems today. Unlike a Stablecoin, users of tokenised deposits would also hold a claim against a bank instead of a non-bank issuer. So customers would enjoy added security too. Yet only a handful of banks are exploring tokenised deposits, and they are not under pressure from customers to change the system, although they are under pressure to lower the price. But it seems that existing payments methods are sufficiently profitable for the banks not to invest in change, and fast and cheap enough for their customers to be satisfied with the status quo too. However, tokenised deposits do have a major advantage over existing payments methods: programmability. Programmability enables banks to offer users conditional forms of payment, for example, in which money is transferred only on delivery of what is being bought. This would enable companies to manage counterparty risk more efficiently.

What happened to central bank digital currencies (CBDCs)?

Central bank digital currencies (CBDCs) emerged as a central bank response to the threat of a global Stablecoin, but the sense of urgency has waned as the threat has receded. The European Central Bank (ECB) says it will take no decision on a digital euro until 2026 and, if the decision is positive, implementation will take even longer. The Bank of England expects to issue a digital pound no earlier than the end of the decade. A US dollar CBDC is trapped by US domestic political divisions, with opponents currently in the ascendant. Central banks that have issued a CBDC have found it hard to gain traction with merchants and consumers. However, the first bank to issue a CBDC in a major reserve currency might gain a first mover advantage that other central banks will find difficult to dislodge. Blockchain technology has also advanced rapidly since Facebook proposed the Libra global Stablecoin in 2019, so central banks are becoming less uncomfortable about the cyber-security risks of issuing fiat currency in digital form.

What happened to programmable money?

One of the advantages of blockchain-based representations of fiat currency is that they are expressed in code, and the code can be programmed to do things that current forms of money cannot. Smart contracts can be used, for example, to initiate payments when goods are delivered, or contractual conditions are satisfied, which is potentially useful to corporate treasurers and consumers. But the uses of programmable money can also be restricted to certain goods and services, potentially empowering the State to interfere in private spending. For now, programmability remains theoretical. This is chiefly because the challenge of issuing fiat currency onto blockchains is not yet complete, and programmability would further complicate the transition. A more important task is to standardise the representation of digital assets on blockchains via a single data model, which would improve interoperability between proprietary systems as well as blockchains and established financial markets.