November 13, 2023 - 10 min read
Can the tokenization of US T-bills save the US from losing its international currency hegemony?
Demand for US sovereign debt is waning, and rising geopolitical antagonism across the world has not helped matters in this regard. Though sanctions have long been a key component of US diplomacy, Teddy Roosevelt’s “speak softly and carry a big stick” have seemingly inverted, depending on whom one asks.
Looking at things objectively, world leaders have been looking around the room nervously and eyeing the exit doors when it comes to US dollar exposure. Whispers of alternative financial systems are growing into full-throated endorsements even amongst nations which are friendly or neutral to the US, take El Salvador bucking dollar-based debt in favor of Bitcoin Volcano Bonds, for instance. BRICS members have also made forays into gold-backed payment settlement systems and other international CBDC channels.
Consequently, the price of US T-bills have been falling dramatically due to waning demand, meaning that interest rates are rising rapidly in order to attract buyers. Many have argued that this resulted from a loss of trust in US monetary and fiscal discipline, as debts have ballooned to over $33 Trillion and it’s only piling up faster as time goes on. It also suggests that investors are looking to diversify their accumulated wealth into alternatives like digital assets and commodities like gold, or oil. See Project Dunbar and Project mBridge for just a few examples of the moves being made.
This begs an important question though. How did we get here? The US may have swung Excalibur one too many times, leaving nothing but the hilt in King Dollar’s grasp, clumsily charging at windmills Don Quixote-style.
Sanction after sanction over the past decade (not to mention the lack of fiscal discipline by Congress and the Treasury) has spooked outside observers, and the most recent weaponization of the SWIFT system against Russia has put even amicable onlookers on notice that their own investments might need reconsidering.
Having said that, losing its status as the world’s reserve currency doesn’t mean that the dollar goes away overnight. That would actually be a historical anomaly, when in fact it could take decades or even centuries for the process to fully play out.
After all, Spanish and Dutch silver used to enjoy that status before losing it to England’s gold, who subsequently lost it to the US following World Wars I and II. See the Bretton Woods System for further reading on how this transition took place.
Many have argued that the rapid rise in interest rates at the US Federal Reserve, and around the world as well, may be an attempt at regaining credibility for the US dollar in the eyes of global investors who’ve become spooked by the inflationary impulses of the previous decade or two. While higher rates are more attractive to foreign buyers, they simply cannot buy what is unavailable to them, and so perhaps upgrading the financial infrastructure underlying US T-bills could induce buyer demand as well.
If access to US stablecoins and their accompanying yields are just a few clicks or taps away, then it’s not hard to imagine the resulting capital which will flow into such a financial product. Could the tokenization of treasuries make them more attractive and reverse the trend of rising rates and a dearth of foreign buyers? Let’s get into it and find out.
Tokenization refers to the process of representing ownership or rights to tangible assets, in this case sovereign debt instruments, in the form of digital tokens on a blockchain’s distributed ledger. Think of it as a digital wrapper which enshrouds a traditional treasury within it. The underlying asset is legally protected as a treasury instrument wrapped in a token, represented digitally.
Of course, blockchains provide secure and transparent records of ownership and ledger balances, including a full list of transactions. That is, the history of transactions is publicly auditable. The tokens, then, are unique, traceable assets on the blockchain, enhancing security and effortlessly reducing fraud throughout the system via automation.
Tokenization opens a hyper-liquid market of T-bills to a broader range of investors, including underbanked or unbanked individuals, who have been mostly deterred by the high barriers to entry or legal inability to do so. Moreover, liquidity in tokenized T-bills markets will be effectively supercharged. Perhaps the most obvious benefit is that it would almost certainly increase demand from foreign investors, particularly in the short to medium term.
Streamlining administrative processes is another major optimization, as tokenized T-bills don’t require paperwork, are entirely automated, and can be more easily audited. The transparency and efficiency gains in this realm are absolutely staggering, not to mention the opportunities for growing the overall investor base of anyone offering these tokenized funds.
On the other hand, fear of punitive regulatory actions regarding tokenized T-bills is probably the most crippling roadblock in its development and rollout. Governments are not necessarily known for their technological prowess, but instead a desire to make and control it after it has become useful enough to adopt. Supportive regulations and above all, more explicit clarity, will be the catalyst which encourages institutional investors to move into tokenized T-bills.
Negative perceptions of tokenized T-bills, regarding security, reliability, and ease of use, will likely put a ceiling on demand as well. Positive sentiment and trust is built over time, and when institutions get into the game, this will give the rest of us the green light, sparking a furious FOMO rally in the asset class, pushing the price of treasury bills higher. Such a scenario would inevitably mean lower bond yields and consequently, lower interest rates for borrowers and things like mortgages.
Tokenization streamlines the process of transferring ownership, reducing much of the administrative burden and associated costs usually involved. Smart contracts essentially automate all aspects of transactions and audit reporting, bringing about improved efficiency in a variety of ways. Again, tokenization means cryptographically wrapping traditional financial instruments.
Discussions of tokenizing off-chain assets have been taking place for the better part of the past decade, yet tokenization has seen limited success in terms of any meaningful adoption, particularly in the case of traditional financial institutions.
Retrospectively, limitations were both technological, and arguably more important, regulatory. Fast forward to the current day, and both stronger business fundamentals and regulatory developments suggest that the time for widespread tokenization of off-chain assets has nearly arrived. Having said that, it is indeed a fragmented market with many disjointed ecosystems and no clear frontrunner in the sector, for now.
Now, imagine an emerging market player wants to invest $100M dollars in US bonds. Typically, they would need to buy-in at a certain threshold- but with the tokenization and fractionalization of US treasuries, smaller players can participate with investments with a smaller footprint. The opportunity for the US to offer bonds like these could strengthen demand and consequently, the overall value of the US dollar in comparison to other fiat and digital currencies. That’s why big names are making moves in this sector in order to capitalize on what’s to come.
Tokenizing U.S. T-bills involves the digital representation for the ownership and transfer of these assets with near real-time settlement. This kind of cross-border liquidity will undoubtedly have far-reaching implications for the global economy. We’re talking about improved accessibility, liquidity, and efficiency in trading what was once traditional financial instruments – but now on Web3 rails.
For every tokenized t-bill an investor purchases, OpenTrade will be buying an actual treasury bill and providing on-chain identifiers for the underlying assets. Secured lending of USDC against treasury bills will also allow lenders to generate returns while maintaining operations entirely on-chain—using their existing wallets and custodians. Ensuring compliance with relevant regulatory requirements like securities laws, KYC and AML rules, and other legal aspects will be one of the greatest hurdles to overcome.
For now, the global financial system is built on top of US treasuries, making it the most important financial instrument in the world. This is due to the use of US treasuries as collateral for loans. With Tokenized treasuries, these instruments can be settled automatically by leveraging if-then smart contract conditions.
US Treasuries are preferred as collateral due to their reputation of being a risk-free asset. This safe-haven nature has also prompted foreign governments and multinational corporations to diversify and protect their portfolios with US treasuries.
A 2023 report by Citigroup called the tokenization of off-chain assets the “killer use case” of blockchain, expecting tokenization to penetrate private markets and reach at least $4 trillion in TVL by 2030. The report went on to declare that before going mainstream, the technological infrastructure surrounding decentralized digital IDs, zero-knowledge proofs, Oracles, and cross-chain bridges must be well established.
The possibilities area actually much rosier than this implies. In fact, the wealth management channels in the US alone top $38 Trillion dollars, meaning that tokenization of even a fraction of this number is a huge opportunity. The tokenization of real-world assets will continue to be a drop in the bucket compared to the overall potential for some time to come, in other words.
Of course, long-term impacts are difficult to foresee, and speculation regarding the demand for tokenized treasuries in the US or abroad is highly dubious, to say the least. To really grasp the ramifications of migrating and offering traditional financial instruments on blockchain rails will be measured by statisticians and debated over by historians who’ve yet to put ink to paper.
In fact JP Morgan is already offering its own Tokenized Collateral Network. The network leverages an Ethereum-based private blockchain called Onyx to enable investors to utilize and transfer collateral ownership without moving or divesting themselves of the original assets in their respective underlying ledgers. Asset management firm BlackRock has already announced that it has successfully tokenized one of its money market funds and used it as collateral.
This tokenization of MMF allows JP Morgan’s clients to leverage their traditional financial instruments as a quicker and more cost-effective way of meeting margin requirements. Other mainstream financial institutions are similarly working on tokenization initiatives based on the Ethereum blockchain and its smart contracts.
This means that not only can if-then smart contracts be automated, but event-based payouts can also be utilized so that users can automate payments based on trigger-events like margin calls, the delivery of assets in the case of supply chains, not to mention the settlements of goods and services regarding the fulfillment of contracts.
In November 2023, JPM Managing Director Naveen Mallela shared on LinkedIn the rollout of programmable payments with JPM Coin. Functionality includes dynamic funding, which allows for specifying rules for dynamically funding bank accounts in the case of shortfalls. Moreover, Siemens AG was the first institutional client to make use of JPM’s programmable payments, with both FedEx and Cargill Ocean Transportation expecting to plug themselves into the network soon after.
Combined with the news that BlackRock has filed an application to offer a spot Bitcoin ETF, it is looking more and more like we’ll see fireworks in markets in the short to mid-term as capital floods in. The aforementioned moves look to be the prologue for widespread adoption and tokenization of real world assets, and the next chapter in the blockchain industry’s broader story as it gains the favor of major financial institutions.
Regulatory developments will be key going forward as market participants and governments make adjustments in reaction to an emerging technology and unexplored legal landscapes. In other words, the playing field and rules of the game are shifting in real time; nobody ever said this would be easy.
So long as trust in the US dollar continues to wane amongst certain market participants, adoption is likely to trend down, no matter if their settlement network has gone through a technological upgrade. That is to say that tokenization may have a positive effect on demand for the dollar in certain markets while it will have no effect in others.
Indeed, spikes in demand may even create enough excitement for traders to make some profits, but the trend of demand for the dollar is likely to be down given a long enough time horizon. Regarding global trade in US dollars over the long term, it is more likely that geopolitical tensions affect adoption and use rather than on which rails the payment systems run. This is a more effective way to boost demand for tokenized treasuries.
As for widespread tokenization of real world off-chain assets like gold, mass adoption could still be a few years away, but momentum has clearly picked up recently. After all, governments have begun to pilot their own CBDCs, and even the likes of JPM and Blackrock have gone from investigating the benefits of tokenization to actual trials and proofs of concept. It is no longer city-states and nimble economies dipping their toes into the blockchain waters, so it may be time to buckle up for a more accelerated pace as we move forward.
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