#67 - The Rising Tide of Asset Tokenisation

What asset tokenisation is and why more and more significant players in the global financial industry are taking it seriously. Plus some considerations on its adoption in Africa.

Illustrated by Mary Mogoi - Website

Hi all - This is the 67th edition of Frontier Fintech. A big thanks to my regular readers and subscribers. To those who are yet to subscribe, hit the subscribe button below and share with your colleagues and friends. Support Frontier Fintech by becoming a paid subscriber🚀

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Introduction

Over 250 years ago, an idea started bubbling in the streets of London. Travel at least amongst the elites was becoming more common as the early ripples of industrialisation set in and trade expanded. Merchants, diplomats and the affluent needed a safer way to carry their wealth across borders. The London Credit Exchange Company responding to this market gap, introduced a new financial instrument—precursors to what we now recognise as Travellers Cheques. This simple yet profound concept allowed merchants and travellers to settle payments without the need to carry bulky coins or risk theft of gold. It was the beginning of a journey that would impact global travel forever.

Around 100 years later, the ripples of industrialisation had turned into massive waves and travel had been made much easier by the steam engine, a cornerstone of the industrial era. In the mid 19th century, travel was no longer a preserve of the diplomat, merchant and affluent class - it was accessible to everyone. Thomas Cook, a travel agency, responded to the same demand that the London Credit Exchange Company noted in the late 18th century. Thomas Cook introduced their own variant of the Travellers Cheque. Thomas Cook’s modifications centred on creating a global network of agents where the cheques could be accepted and issuing them in multiple currencies.

After a frustrating trip to Europe, J.C. Fargo, president of the American Express Company, felt that further improvements could be made to Travellers Cheques. He briefed his executives on how difficult it had been to make payments during his trip. Surely, a company that had built its reputation on solving such logistical challenges could come up with a solution. One brilliant executive called Marcellus Flemming Barry took on this challenge and came up with their own variant of the Travellers Cheque. Barry modified the existing system rather than building it up from scratch. His key modifications were;

1. American Express Travellers Cheques would come in fixed denominations of US$ 10, 20, 50 and 100 at the time;

2. To enhance security, a traveller would sign the cheques twice - upon obtaining the cheques and at the point of utilisation e.g. at a hotel or restaurant;

3. American Express would guarantee the cheques and reimburse the customers if the cheques were lost or stolen;

These modifications enabled wider spread utilisation of the cheques but pivotal events cemented their trustworthiness. During the depression, when banks were collapsing and failing to honour their commitments to depositors, American Express stood firm and honoured all their obligations. During the 2nd World War as diplomats and soldiers were marooned in Europe, the one thing they could rely on was that they could access cash through their American Express. American Express enhanced the role of Travellers Cheques as a staple of the 20th century.

This historical journey highlights entrepreneurship, monetary innovation, and the role of iterative processes in transforming niche ideas into widespread adoption. Understanding this history is crucial when examining today’s financial innovation. Of note is that Travelers Cheques were tokens and that tokenisation of assets has been happening for as long as humans have existed.

The evolution of financial tools, from Travellers Cheques to modern digital tokens, reflects how innovation adapts to societal needs. With tokenisation now gaining traction among global banks, this article will explore tokenisation, its growing appeal among global banks, and its importance in the 21st century. It will examine its fundamentals, use cases, key players, and adoption challenges, particularly in Africa.

Tokenisation and its Drivers

The history of American Express and their Travellers Cheques provides valuable context for understanding tokenisation. They exemplify an early form of tokenisation. At its core, a token is simply a representation of something. For instance, in gaming arcades or casinos, you exchange cash for physical chips or coins that represent that cash you just exchanged. Some fundamental traits that define tokens are;

1. Substitution - They often stand in as substitutes for something of different or even greater value e.g. a token of appreciation;

2. Transferability - They can be exchanged or traded;

3. Limited Scope - Tokens are usually limited to a specific purpose, event or system e.g. arcade tokens can only be used in that specific arcade.

Travellers cheques were tokenised representations of cash that exhibited these properties of substitution, transferability and limited scope in the sense that they could only be used within a network that accepted them.

Tokenised representations of value have always existed. What changes is the database that represents or stores their value. In the 19th century, travellers cheques existed in physical ledgers where their characteristics such as their value, their owner, their issuer and identifying details such as a signature and a serial number were recorded. Later, the computer age largely obviated the need for physical tokens of value given that money could be moved electronically. One outcome was that travellers cheques were slowly replaced by a system of debit and credit cards. The cards were not tokens of money but rather they facilitated the electronic exchange of value. The ledgers that facilitated this value exchange were no longer physical. They were digital and maintained in relational databases that were centralised through a multi-tier system of Central Banks, Banks and Payment Networks. Moving money was and continues to be an elaborate dance of messages between these databases.

For many, the next evolution of the ledger system would see a shift from the relational database to the blockchain. I’ve written before about how at its core, the blockchain is simply an innovation in database and information management. With this in mind, one can understand the current discussions behind tokenisation. Simply, tokenisation refers to the process of creating a digital representation of a real-world asset or right on a blockchain. This representation, called a token, can represent physical assets (e.g., real estate, gold), intangible assets (e.g., intellectual property, rights to a service), or purely digital assets (e.g., cryptocurrencies, NFTs). These tokens are managed on a blockchain, benefiting from its decentralized, secure, and transparent nature.

From a database and information management perspective, tokenization enables assets to be divided into smaller, more accessible units, allowing fractional ownership and making traditionally illiquid assets easier to trade. For example, a property worth $1 million could be tokenized into 1,000 tokens, allowing investors to purchase fractional ownership for $1,000 per token.

Additionally, some of the benefits of the blockchain are programmability i.e. creating smart contracts that enable rules to be embedded within the token. Some of these embedded rules could include compliance checks, dividend distributions, or transfer restrictions.

To really understand the current tokenisation discussion in a comprehensive manner, some characteristics of modern money and payments are worth exploring. They are;

1. The two tier system & the Singleness of Money;

2. The trinity of messaging, reconciliation and settlements in payments.

Characteristics of Money and Payments

The Two Tier System & The Singleness of Money;

The monetary system that exists in almost all countries is the two-tier system of money. In this system, there are two core players. Central Banks and Commercial Banks. At the top tier are Central Banks who issue what is called (Base Money or M0). This is currency in circulation and the money that banks hold in reserve with the Central Bank. At the bottom tier are commercial banks who are regulated and governed by the Central Bank. Commercial Banks create what is called Broad Money through a system known as fractional reserve banking. Through the process of issuing loans, banks create additional money thus expanding the overall money supply. This video explains fractional reserve banking well enough if you ignore the initial histrionics.

The core function of the two tiers is to ensure that a unit of currency maintains its equivalence i.e. the value of a one dollar note is the same as the value of a one dollar deposit. If this principle, which is called “the singleness of money” holds true, then the monetary system is stable. Sometimes the singleness of money doesn’t hold true for instance when there’s a bank run. In a bank-run, the public is essentially saying that I value cash more than I value a deposit at a bank. As the Bank of International Settlements states;

Among its many functions, the central bank issues the economy's unit of account and ensures the finality of payments through settlement on its balance sheet. Building on the trust in central bank money, the private sector uses its creativity and ingenuity to serve customers. In particular, commercial banks issue deposits, the most common form of money held by the public. Supported by regulation and supervision, this two-tiered structure preserves the "singleness of money": the property that payments denominated in the sovereign unit of account will be settled at par, even if they use different forms of privately and publicly issued monies. - Bank of International Settlements

The Trinity of Messaging, Reconciliation and Settlements in Payments

Given that there has traditionally been a two-tier system of money where the Central Bank at the apex works in concert with a number of regulated commercial banks; payments have at core had a clear separation between messaging, reconciliation and settlements. When you make a payment from one bank to another, that payment starts with a payment message e.g. SWIFT, once the message has been received, the two banks have to reconcile their accounts i.e. confirm balances and once all this is done, money must move between the accounts (Settlement). This clear separation is a function of each intermediary having a separate siloed database that is designed using relational database techniques. This foundational feature is a cornerstone of modern Fintech where most participants either help with frictionless messaging (digital remittance providers) or even make reconciliation easier. However, each payment has separation between messaging, reconciliation and settlements.

Two Tracks of Tokenisation

Having understood these issues, and having understood that tokenisation at its core is about recording transactions and assets on a blockchain rather than a relational database, it’s clear to see what the appeal of tokenisation is. It also becomes to see why there are two tracks to tokenisation.