Debt tokenization, the process of converting traditional debt instruments such as loans and bonds into digital tokens on blockchain or distributed ledgers, has gained significant traction throughout the financial services industry. In 2023, major financial institutions such as Goldman Sachs, UBS, and HSBC actively engaged in digital bond issuances. Goldman Sachs, for instance, launched the Goldman Sachs Digital Asset Platform (GS DAP) in January 2023, closely following HSBC's introduction of the Orion platform. GS DAP later facilitated a $102 million digital Green Bond in collaboration with the Hong Kong Monetary Authority (HKMA) and the Hong Kong government.
As indicated by a recent EY report, the trend toward tokenized debt is only gaining momentum. By the end of 2024, an estimated 64% of accredited/high-net-worth (HNW) investors and 33% of institutional investors intend to invest in tokenized bonds. This grows significantly through 2026, during which an impressive 91% of HNW investors and 83% of institutional investors anticipate allocating funds to tokenized bonds.
In this article, we will explore the significant benefits tokenization brings to debt creation and issuance. We will begin by examining the benefits of debt tokenization, then shift our focus to Switzerland, where we will analyze a real-world use case that demonstrates the successful trading and settlement of debt instruments using Taurus technology.
The benefits of tokenizing debt
The current methods of debt issuance, settlement, and trading present certain challenges for banks and financial institutions. One significant drawback is the manual and paper-heavy nature of these processes, leading to operational inefficiencies and an increased risk of errors. Relying on physical certificates and manual mark-ups in the debt creation process not only consumes valuable time but also exposes the system to potential mistakes in manual processing.
Moreover, the existing framework for debt issuance involves intricate interactions between multiple organizations and teams within each entity. These interactions occur through disparate systems, introducing complexities in managing and running the entire lifecycle of debt issuance, settlement, payment, and redemption processes. The lack of a centralized and standardized platform often results in fragmented workflows, creating bottlenecks and challenges for seamless collaboration. As a result, settlement processes, conducted through separate channels, contribute to delays and heightened settlement risks, ultimately impacting the efficiency of the overall system.
Leveraging blockchain technology, tokenization addresses various challenges within the conventional debt market while offering notable benefits:
1. Paperless creation
By eliminating the requirement for a physical global certificate and manual mark-ups in the traditional debt creation process, valuable time is saved and the risk of manual processing errors is eliminated.
2. Facilitate interaction between different parties on a common DLT platform
In a typical debt issuance, various organizations and teams within each organization interact through different systems to handle the issuance, settlement, payment, and redemption processes. The implementation of a common Distributed Ledger Technology (DLT) platform enhances processing efficiency by consolidating all involved parties. This platform acts as an immutable source of truth, facilitating multi-party workflows with participant-specific authorization, real-time verification, and enabled signatories.
3. Atomic DVP settlement
Debt transfer and cash payment can now be seamlessly conducted on a common DLT platform, eliminating the need for separate channels. This enables instant and simultaneous settlement on a DVP basis, effectively reducing settlement delay and minimizing settlement risk.
4. End-to-end DLT adoption across the debt lifecycle
The use of DLT from primary issuance, secondary trading settlement, coupon payment and maturity redemption can significantly streamline manual processes, reduce servicing time and costs, and eliminate the need for synchronization between different channels. The adoption of DLT ensures a substantial improvement in operational efficiency, as the DLT ledger serves as an immutable and trusted source of truth for participants on the digital platform, across primary and secondary market processing as well as post-trade services.
5. Enhanced transparency
DLT enables real-time data synchronization among different parties, promoting transparency, consistency, and enhanced privacy for platform participants.
Case study: Successful debt tokenization with Taurus
To illustrate the effectiveness of tokenizing debt, let's examine a real-world example. On February 28, 2023, Taurus collaborated with SCCF Structured Commodity & Corporate Finance ("SCCF") and Horizon Capital AG to facilitate a trade finance transaction using tokenized debt instruments through Taurus' platform.
This initiative involved the tokenization of private debt securities, specifically in the form of a ledger-based note. SCCF, a Swiss trade finance expert, partnered with Taurus to issue this tokenized note to finance a loan for a commodity trading firm involved in the biofuels sector. The tokenization process was executed using the CMTAT smart contract framework, developed by the Capital Markets and Technology Association (CMTA), a Swiss nonprofit organization promoting technology adoption in traditional capital markets.
Below we list the basic functionalities that a token must have to be associated with any form of security, as described in CMTAT’s Functional specifications for the Swiss law compliant tokenization of securities.
Mandatory attributes, applicable to all CMTAT tokens:
- Ticker symbol (optional)
- Token ID (ISIN or other identifier) (optional)
Reference to the terms of tokenization, the terms of the instrument, and other relevant documents (e.g., prospectus or key information document). The reference can take the form of an URL, a combination of an URL and of specific directions allowing the user to retrieve the relevant documents (e.g., "[domain].com/shares > Tokens") or a fingerprint. Note that decimals number must be set to zero (which means that the tokens admit no fractional parts).
Optional attributes, applicable to tokens used for debt securities:
- Guarantor identifier (if any)
- Bondholder representative identifier (if any)
- Maturity date
- Interest rate
- Par value (principal amount)
- Interest schedule format (if any). The purpose of the interest schedule is to set, in the parameters of the smart contract, the dates on which the interest payments accrue.
- Interest payment date (if different from the date on which the interest payment accrues).
The entire transaction was carried out in a streamlined manner:
- SCCF issued a 3-month "Tokenized Note" as ledger-based securities, using the CMTAT smart contract framework, and recorded the transaction on the Ethereum blockchain.
- Horizon Capital AG purchased SCCF's Tokenized Note through Taurus' regulated marketplace, TDX, for tokenized securities.
- The funds raised from the Tokenized Note sale were then lent by SCCF to a Swiss commodities trading firm specializing in biofuels.
This transaction leveraged the end-to-end capabilities of Taurus, including TDX, Taurus' regulated marketplace for tokenized securities, and Taurus-CAPITAL for smart contract management and asset servicing. Lenz & Staehelin, a Swiss law firm, provided legal counsel for SCCF during this transaction.
For a deeper understanding of tokenization use cases, we encourage you to delve into Tokenization: A Practitioner's Point of View.