In our previous blog, we explored tokenization’s institutional use case and potential within capital markets, a key segment of investment banking.
In this blog, we focus on the infrastructure that underpins tokenization. This infrastructure is the bedrock upon which companies can build their tokenized offerings. At first glance, this often refers to the blockchain network used, along with its associated level of data security and privacy.
However, blockchain networks themselves do not exist in isolation. This architecture is part of a wider tokenization ecosystem. This includes the assets, token standards, digital wallets, and much more. By understanding the blueprint of tokenization infrastructure, institutions are better prepared to harness the full potential of distributed ledger technology, streamlining processes like bond issuance, repo trading, and collateral management.
For more comprehensive insights into tokenization, check out our recent Tokenization Data Insights paper, or read on to learn more about the key infrastructure and design considerations.
Tokenization Infrastructure in Context
Blockchain infrastructure forms a core pillar of the wider tokenization process. This cycle begins with the underlying asset itself, and culminates with a token’s ultimate institutional use-case.
1. Traditional Assets
In today’s context, traditional assets are at the very core of tokenization. The scope of these markets cannot be understated. They currently sit at over three hundred times the size of the crypto-native markets. This is before considering global banking deposits or cross-border payments.
Banks and institutional investors who custody assets, such as bonds, equities, and real estate are actively exploring tokenization. They recognize that certain traditional assets stand to gain from the benefits offered by tokenization. These benefits are explored in-depth in our previous blog.
Once institutions identify traditional assets for tokenization and assess the legal frameworks that govern them, they engage a specialized entity known as a tokenization agent. These agents are crucial in transitioning assets from the physical to the digital ledger, overseeing the tokenization process from inception to completion.
2. Tokenization Agent
Tokenization agents can either be third-party providers, like Bitbond, who specialize in this service, or they can be internal divisions within the institutions themselves, such as those at J.P. Morgan Onyx or HSBC’s Orion division. Their choice reflects the institution's strategy, whether it prioritizes external expertise or in-house control over the tokenization process.
Tokenization agents have many responsibilities. They are tasked with the issuance and distribution of the digital tokens, ensuring that each token accurately represents the underlying asset's value and rights.
This process involves several standards, such as ERC-1404, ERC-20, ERC-3643, ERC-1155, and ERC-721, each with its own properties and use cases, catering to the diverse needs of the market.
Among these token standards, two have emerged as key to the tokenization efforts of institutions:
ERC-3643: A standard for streamlined multi-token management.
- The ERC-3643 standard offers an efficient approach to managing diverse token classes under a unified contract suite.
- It simplifies the management of various asset classes, enhancing oversight, auditing, and integration processes.
- This standard has tokenized over $28 billion in assets.
ERC-1404: A standard for issuing tokens with built-in compliance controls.
- ERC-1404 allows the issuance of tokens with embedded transfer rules at the smart contract level.
- It enables institutions to enforce regulatory compliance, setting conditions such as transfer restrictions to approved addresses or limits on token quantities per address.
- This feature is crucial for institutions aiming to align their asset tokenization strategies with regulatory standards.
However, an agent’s role extends beyond the initial mint. They must maintain the integrity of the underlying assets, which involves ongoing management and verification.
Furthermore, tokenization agents must maintain compliance. They must navigate a complex web of regulatory requirements, ensuring that every token issued meets the stringent standards set by authorities. This includes adherence to anti-money laundering (AML) directives, Know Your Customer (KYC) policies, and other legal obligations that vary by jurisdiction.
By fulfilling these roles, tokenization agents ensure that the bridge between traditional assets and their blockchain counterparts is not only built but also maintained to the highest standards of security, reliability, and compliance.
3. Blockchain Selection
Following the role of tokenization agents, the next crucial component in the tokenization lifecycle is choosing which blockchain to issue a digital asset on.
Private vs. Public vs. Hybrid Blockchain Models
- Fully private blockchains, like J.P. Morgan's Onyx, offer a closed-loop system, granting institutions complete control over user access and transaction visibility. This control can be paramount for meeting certain regulatory requirements, such as data residency and privacy. Private blockchains can also achieve higher transaction throughput, which may be currently more desirable for certain use cases, especially when serving internal clients within a confined network.
- Private permissioned blockchains, such as Corda, restrict participation to invited parties. They provide a balance between control and collaboration, often used in business-to-business scenarios.
- Public blockchains, such as Etheruem, do not restrict access, promoting interoperability between assets and networks and facilitating composability. However, they are more exposed to risks, and while the degree of data transparency can be adjusted to show users only their own transactions, full transparency can make the market susceptible to manipulation.
- Public permissioned blockchains, like Hyperledger Besu, can be accessible to the public but still require permission to participate in certain activities. They are chosen for their transparency while maintaining control over who can perform transactions or access data.
- Hybrid blockchains, utilized in initiatives such as Project Guardian, attempt to blend the best of both worlds. They might support primary private issuance with a public secondary market, or private issuance coupled with public cash flow distribution, offering a balance between privacy and market exposure. A hybrid system might enable primary private write operations with public read capabilities, allowing the necessary information to be transparent while maintaining control over the asset issuance.
Each of these blockchain types serves different strategic purposes.
By selecting the appropriate blockchain platform, issuers can ensure that their tokenized assets are not only secure but also align with their operational needs and compliance requirements. This alignment is critical for the successful mobilization and utilization of tokenized assets on their respective blockchain platforms.
4. Wallet Infrastructure
Institutions have a choice to self-custody or use qualified custodians when tokenizing assets.
For self-custody, tokenization demands precise control over wallet infrastructure, with a number of considerations. Institutions often prefer self-hosted wallets, minimizing reliance on third parties. This ensures full control over asset management.
Blockchain selection impacts the required wallet features. Wallets need to support specific chains where assets are tokenized. In hybrid models, additional considerations for interoperability arise. Institutions must choose wallets capable of handling multiple chains and interoperability.
The Blockdaemon Institutional Wallet™ is designed for such demands. It facilitates tokenization, allowing digital management of real-world assets. This wallet supports Ethereum's ERC-1404 and ERC-3643 token standards.
A crucial feature of this wallet is its ability to interact with smart contracts. Before authorizing transfers, the wallet confirms compliance with smart contract conditions. This step is vital to avoid failed transactions due to non-compliance. It ensures seamless token management by:
1. Managing Token Transfers: It streamlines sending, receiving, and managing ERC-1404 and ERC-3643 tokens.
2. Seamless Integration: The wallet integrates with existing custody solutions and compliance frameworks, providing a cohesive tokenization experience.
3. Enabling Policy Engine Support: Institutions can set transfer restrictions based on their policies, enhancing control and compliance.
The Blockdaemon Institutional Wallet™ thus offers a robust infrastructure, crucial for the growing tokenized ecosystem. Its smart contract interaction feature is key, ensuring transaction integrity and compliance.
Purpose-built for financial institutions, the Blockdaemon Institutional Wallet™ provides industry leading security, compliance, and control. The Blockdaemon Institutional Wallet™ supports cold storage, integrating advanced Multi-Party Computation (MPC) technology and policy controls like quorum approvals for enhanced security. This setup ensures that digital assets remain safeguarded against threats, while enabling institutions to manage transactions with precision.
Through these mechanisms, we address the essential needs for institutional-grade security, aligning with regulatory compliance standards. Our focus on robust, clear-cut solutions empowers institutions to manage their digital assets effectively, supporting all of your treasury, custody, staking, and tokenization management needs.
Blockdaemon Wallet supports critical differentiating features from one wallet dashboard:
- 100% Self-Hosted (complete and exclusive control)
- Warm Wallets (online, advanced policies)
- Staking (directly, with policy controls)
- Advanced Policy Engine (complete and exclusive control)
- Cold Wallets (air-gapped, advanced policies)
- Tokenization (directly, with policy controls)
- Segregated Wallets (accountability, auditability)
- Treasury Management (enterprise-wide control)
- Intuitive UI or API (use off-the-shelf or integrate)
- Hot Wallets (automated controls)
- Qualified Custody (fully compliant)
- Advanced MPC Security (third-party audited, field proven)
Audit Trail
Finally, it is vital to address audit trail capabilities in the context of blockchain's immutability and transparency. In the ever-evolving landscape of crypto finance, transparency and security remain paramount. Blockdaemon Institutional Wallet™, featuring audit log capabilities, equips institutions with the data they need:
- A Comprehensive Audit Trail: With integrated audit log features, every action within the wallet — from initiating to approving — is meticulously tracked and recorded. This ensures an auditable trail, showcasing each party's involvement in every transaction. Such granularity not only fortifies security measures but also provides institutions with a detailed chronicle for compliance, troubleshooting, and internal review purposes.
- Timestamped Actions: Every recorded action is timestamped, offering an added layer of clarity. Institutions can precisely pinpoint when each transaction was initiated and approved, simplifying the process of timeline reconstruction during audits.
- Ensuring Accountability: The expanded audit reporting function emphasizes the commitment to transparency, ensuring that every user action is accounted for. This feature reinforces the wallet’s dedication to upholding the highest standards of transaction integrity, giving institutions the confidence they need in their operational procedures.
By coupling transaction notes with these audit log enhancements, Blockdaemon Institutional Wallet remains at the forefront of institutional crypto wallet solutions, providing a seamless blend of user experience, security, and compliance-readiness.
5. Additional Infrastructure Considerations
As mentioned, infrastructure considerations go beyond the blockchain platform. Below are additional points to consider for tokenization efforts.
Regulatory Compliance Tools
It's crucial to discuss the tools facilitating regulatory compliance in the tokenization ecosystem. Tools like Chainalysis and Elliptic play a pivotal role here. They provide advanced analytics crucial for detecting and preventing fraudulent activities and money laundering within blockchain transactions.
Identity Verification and KYC Solutions
Ensuring the legitimacy of participants in the token economy is paramount. This is where Identity Verification, Know Your Business (KYB), and Know Your Customer (KYC) solutions come into play, prominently offered by vendors like Onfido and Trulioo.
These KYC solutions are integral to maintaining the integrity and security of the token economy, ensuring that all participants are verified and transactions remain compliant with global regulatory standards.
Conclusion
Our deep dive into tokenization infrastructure has led us from the core of traditional assets through the strategic choice of blockchain, and the pivotal role of wallet technology.
The Blockdaemon Institutional Wallet™ provides a robust foundation, offering advanced MPC technology with stringent policy controls for unmatched security. Its seamless integration capabilities for tokenization reflect our unwavering commitment to delivering a secure, compliant, and streamlined management platform for financial institutions.
For deeper insights into tokenization, download our recent Tokenization Data Insights paper.
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