Co-Authored by Susan Joseph, Executive Director of Fintech at Cornell

Introduction

The slumbering giant awakens! Imagine a world where the norm is transactions that settle instantly, assets move seamlessly, and investors have immediate easy access. Our once-staid financial system is hurtling towards a future where an estimated 16 trillion dollars in assets will be tokenized by 2030 unlocking instant liquidity, fractionalization, and frictionless transactions across primary and secondary markets. More importantly, instant liquidity becomes the standard in market expectation. Stablecoins, CBDCs, and other forms of tokenized cash become the critical connective tissue between traditional finance in the modern financial system. It is in our national security interest to support this transformation.

Our Current Course Does Not Fully Support Tokenization

With any wholesale change, the question is how do we get there? Our current approach of aggressive enforcement without fit-for-purpose light touch regulation hinders our competitiveness. It is the wrong narrative. We need to think and act differently. Instead of demonizing new technologies, public blockchains, cryptocurrencies, and their tools, we must respect and encourage their potential as the foundation for ubiquitous, frictionless liquidity systems through tokenization.

Specifically, we need to welcome and encourage the evolving parallel, beta financial system with its collaborative nature with continuous live experimentation and large-scale community testing. The beta system’s strength in part is its stress testing in the wild that ensures the modern financial system is built upon the most secure and rigorously battle-tested implementations available.

Current Financial Infrastructure Cannot Handle 24/7 Instant Liquidity

Recently, the NYSE's contemplation of extended hours highlights the traditional financial world’s desire to understand a potential move towards a 24/7 trading environment. ¹ Operationally and regulatorily, this type of move will create significant challenges, not the least of which is unsynchronized banking, a mismatch in timing, and activity which poses severe counterparty risk, and may even bring on systemic risk.

Operational and Regulatory Challenges

Innovation Built the USA into a World Leader

An entrepreneurial competitive spirit has been the hallmark of our country since its formation. From the cotton gin (1793) to the telephone (1876) to the personal computer (1970’s) and more recently at the dawn of the internet, we supported innovative technological frameworks with a light touch (1990’s) to protect our competitiveness. In contrast to today’s approach, we did not vilify new technologies when they were first introduced.² Instead, our government led from the top to promote the internet with light touch regulation and clear rules that fostered innovation. As a result, the top top six companies by market cap, Apple, Microsoft, Alphabet, Amazon, Nvidia, and Meta, are all USA companies. We should learn from this example. I am sure we would like to see a similar pro USA result for the market cap of the financial system's top six firms post tokenization.

Change is hard. Periodically across history, financial systems have experienced cataclysmic changes for the better. With the benefit of time, we can look back at certain milestones and recognize the enormous impact they have had moving forward. Starting with the founding of the Royal Exchange in London in 1571, the first IPO in 1602 (Dutch East India Company), and the first modern stock exchange in Amsterdam in 1611, one thing for certain is that our financial markets are ever evolving, reinventing themselves based upon the needs of stakeholders and the influence of technology.

It is important to remember that market reinvention is not typically the result of participants doing something wrong. Rather, it is driven by delivering efficiencies and enabling access. As we look across the current landscape, we can make the case that we are once again at an inflection point, in this case, driven by a market need, democratization, new technology, blockchain and with the service, tokenization. So, let’s dig into and ponder what could be.

The rise of tokenization is one of these market reinvention events, unlocking new possibilities for fractional ownership, frictionless transactions, and instant liquidity. The beginnings of this structural transformation are being led by first-mover asset managers including Blackrock, Franklin Templeton, and Wisdom Tree, who are employing public on-chain rails for transaction activity for certain money market and mutual funds. Since their debut in a short period of time, these funds are valued collectively at $605 million and are easily on track to take in billions this year.³

Open Questions

The Future Is Liquidity Unleashed Supported by Open Source

We are fortunate that today we have living labs of emerging decentralized financial infrastructure. Cryptocurrencies, fully-backed stablecoins, and nascent asset tokenization demonstrate the reality of liquidity unleashed. Public blockchains and their companion, open source financial applications, are hard evidence of the new system being developed. Token speculation and liquidity, while controversial to many because of the casino mentality, is useful because it can offer capital formation, stress testing, and real-time risk assessment. Anyone can examine the code associated with these protocols and potentially discover vulnerabilities. Users are incentivized to “break the system” and identify and fix bugs which lead to a more robust and secure environment. Artificial intelligence is also being leveraged for risk mitigation.

Some players have raised concerns related to the use of open source and public blockchains and have opted to developing tokenization solutions in their private domains. An argument can be made that the private route centralizes risks and creates high value targets along with their single points of failure. While penetration testing and other security assessments may offer a technical clean bill of health simulating real-world attacks, something that happens as a matter of course in public open systems, is challenging in closed proprietary systems.

Luckily, a third model is emerging, one which leverages both public and private blockchain technologies to manage risk and solutions for the concerns of all parties. In such a model we leverage public blockchains for processing transactions and facilitating the transfer of value and private blockchains for the management of private information related to participants, corporate strategies, regulatory compliance, cyber security, and contracts.

As the emerging open beta systems evolve and mature. This model of decentralized validation on the blockchain assures transactions and ownership. We will be able to take comfort that the trillions in transactions will be running on the best infrastructure rails we can develop. It is imperative that we take steps to support these emerging systems for these reasons alone.

Beyond security and technology risk we also need to factor in counter party and intermediary risk. Today these risks are hedged through a combination of government backing through regulation and private insurance. In a hybrid model it is easy to see transactions on the public chain with built-in transparency and proprietary information on the private chain being preferred by insurance companies, resulting in reduced premiums. The overall result of this model is less risk, which means less cost to the ecosystem and the end participant.

So how can the market prove this? Experimentation.

We should view this move to decentralized models as real-time experiments that will help to answer some of the outstanding questions that exist related to the technology. Many detractors suggest that public blockchains are unable to process the volume of transactions processed daily on global stock exchanges. Rather than view this concern as a negative, the market should view it as an opportunity. Said differently, the market has the opportunity to use crypto currencies, the tokenization of funds and real-world assets as experiments to iterate and mature the technology. Over time this will provide the confidence the market needs to move other types of assets.

Change the Narrative and Embrace the Future

As firms adopt these new systems, the rest of the financial world will have to follow. The future of instant liquidity and collateral trading is the first example of what instantaneous trading can be. With this model, we can also reasonably expect significant savings through the replacement of traditional back-office infrastructure with blockchain technologies supported by AI and machine learning to facilitate anomaly detection, decision making, and regulatory compliance which in turn would exponentially increase liquidity through the implementation of an instant liquid system.

Conclusion

Fundamental change is not an easy process, and our financial world stands at a crossroads. When instant liquidity comes 24/7 through tokenization, the existing infrastructure might struggle to keep pace and where chaos and instability could ensue. New infrastructure is needed. This transition to tokenization will reshape the very fabric of our financial system. The question is not whether change is coming, but whether we are prepared to navigate it in a way that continues the USA competitiveness and leadership. Only with proactive adaptation and a forward-thinking regulatory approach can we ensure a smooth transition into this new era of modern finance.

^[1]The United States emerged as a global leader in digital policy in the 1990s by moving early on key policy issues and adopting a light-touch, pro-innovation regulatory regime. As a result, the early Internet was largely built on American values of democracy and freedom and the United States gained a new, important source of soft power.

^[2] Blackrock offers the USD Institutional Digital Liquidity Fund (BUIDL), that aims to offer a stable

^[3]$1 value, and Franklin OnChain U.S. Government Money Fund (FOBXX) allows peer-to-peer transfers of tokenized shares. Blackrock brought in 245 mm in its furst week and is on track to quickly  reach 1 billion. FranklinTempleton has 270mm AUM as of March 31.