July 14, 2022

TOKENIZATION IN STRUCTURED FINANCE

New technologies developed in the 1980s (increasingly faster computers, more powerful programming languages, and desktop financial modeling applications like Lotus 1-2-3 and Excel) all helped usher in the era of structured finance. The industry took off in the 1990s, hitting its stride and, in spite of some challenges, has not really looked back since. By allowing more efficient risk allocation, structured finance has successfully lowered the cost of funds for borrowers and helped fuel global economic growth. The current state of the art in structured finance has been enabled through technology, but technology that was largely developed some 30 plus years ago.

We believe that we are about to enter a new era of structured finance, where risk can be allocated more granularly, records of ownership can be recorded and transferred more efficiently, and settlements can happen more seamlessly, all of which will lower the cost of funds yet again for borrowers and enhance returns for investors. The technology exists to do this, and this evolution is inevitable.

The technology we are talking about is cryptography, which allows transactions to be linked together and digital representations of ownership (called “tokens”) to be created, and which we expect will have profound implications for the structured finance industry. A burgeoning economy has already grown around applications of this technology – applications we generally refer to as tokenization – with structured finance remaining so far largely on the sidelines.

Recent years have witnessed the explosive growth of cryptocurrency, a tokenized form of money traded and held electronically on blockchains. With venture investments in crypto-related companies of approximately $30 billion in 2021 according to Forbes Magazine’s estimates – more than all prior years’ investments combined – the sheer size of cryptocurrency markets has commanded the financial services industry’s attention and offered a glimpse of the potential tokenization may offer the industry more broadly. After all, cryptocurrency is just one form of a tokenized asset and, we believe, the tip of a much larger iceberg of potential use cases for tokenization in the credit and securities markets.

Download Redwood Residential: Tokenization in Structured Finance – Perspectives and FAQs

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