Though many muni specialists acknowledge the value that blockchain and tokenization technology can bring to the market, pace of change has not caught up to ambition.
Advancement of the integration of the technology into the municipal bond market is not on the forefront of many market participants'' agendas, but this has not stopped exploration. Some banks and authorities are investing time and capital into developing their own or getting access to private blockchains to tokenize muni bonds.
Tokenization is the process of making a digital representation of a financial asset. Once an asset is tokenized, then it can be distributed on a digital ledger such as blockchain, an immutable digital ledger of transactions maintained across a "peer-to-peer" network and secured through cryptography.
The co-founders of BKC Group, Megan Kilgore and Gregg Bienstock, have been involved in the muni market for years, and they believe tokenization is an inevitability. Recently, they have spent months speaking with issuers, investors and municipal analysts about the new technology, and they have left these conversations feeling optimistic.
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"There's consensus that tokenization, digital settlement and everything associated with blockchain and tokenization are coming," Bienstock said. "It's inevitable. It's happening."
Last week, the Bond Dealers of America held a webinar to discuss the relationship between the blockchain and the municipal bond market. The event was moderated by Bienstock and hosted panelists Emma Lovett, credit lead for the markets distributed ledger technology team at J.P. Morgan; Shawn Quant, chief information and operations officer for Piper Sandler; and Kilgore.
"Digital settlement and tokenization are increasingly being viewed as a matter of when, not if," Kilgore told viewers.
The panelists discussed how banks and firms are inquiring about the utility of the new technology and deciding when to enter the market. Even though the practice of tokenizing securities is less than a decade old, some firms want to get out ahead of what's coming instead of falling behind.
The speakers encouraged industry professionals to at the very least educate themselves.
If you are not thinking about how the industry is changing, "you're behind," Quant said.
"What I don't want to happen is two years from now, my client, who has been my client for 20 years, calls me and says, … I want to do this tokenization thing, and you say I can't do that," Bienstock said in an interview. "People want to be ready, because when that happens, you lose your client, and the client goes to [someone] who can."
The cryptocurrency industry is continuing to blend with the world of public finance as some states embrace the new frontier. Right now, there is no practice of tokenizing munis, but Bienstock said that there has been a "proof of concept."
J.P. Morgan is one of the banks that has started exploring tokenization. The company was a part of
Blockchain has been discussed in connection with the municipal bond market
The path to transforming the muni market is visible, but people are not ready to adopt the new processes just yet. JP Morgan's deal with Quincy revealed the possibility of adaptation; however, the actual need to fully embrace the change has not reached the overall market.
"There's got to be a buyer base, and I still have not run into any institutional investors that are clamoring to say I have to have a digital muni," Quant said in an interview.
New Hampshire has not done muni tokenization, but a state-affiliated agency is planning to use a cryptocurrency as collateral for tax-exempt bonds.
The New Hampshire Business Finance Authority is working to issue -backed bonds
The benefit of this system to buyers is that if the bitcoin increases in value, then they will receive a percentage of that increase on top of their coupon. The BFA's transaction fee, paid in bitcoin, will go into a new Bitcoin Economic Development Fund, which the BFA will use to invest in economic development in New Hampshire.
Other financial institutions are also evaluating tokenization outside of the muni market. The Depository Trust & Clearing Corporation has started exploring how to incorporate these new technologies into its workflows.
The clearinghouse utilizes a combination of private and public blockchain networks in order to diversify and advance its capabilities. DTCC's subsidiary, the Depository Trust Company, partnered with the Canton Network, providing the company with a permissioned blockchain, which facilitates the tokenization of securities housed at the DTC.
DTCC recently put out a
"Tokenization is an important and critical step toward building tomorrow's digital infrastructure," Nadine Chakar, DTCC managing director and global head of digital assets, said in the release. "DTCC is committed to remaining at the forefront of innovation and championing a scalable, interoperable and risk-managed Web3 ecosystem that harnesses the power of digital ledger technology and delivers real value to the industry."
The DTCC, banks and other firms are primarily tokenizing U.S. Treasury securities; Piper Sandler's Quant says that munis will get there eventually.
"I think what you're going to see is that the natural progression of tokenization and leverage of digital assets, coupled with blockchain as an underlying technology, will move through some of these asset classes first," Quant said. "And will then begin to move into markets like munis over time."
While other financial markets and platforms have been quick to modernize, the municipal market has stayed relatively unchanged throughout the years. When considering taking this step towards evolving, there are benefits to reinventing the wheel.
"When we talk about the municipal bond market, we can look at it both through an issuer and an investor's eyes," Lovett said on the panel. "From an issuer standpoint, issuing a tokenized bond, as opposed to a bond on traditional rails, can provide more efficiencies."
During a period of volatility, if the issuer needs the proceeds of a bond for something, instead of waiting days for the new issuance to settle, with this new model, it could theoretically settle that day or the following day.
On the contractual side, issuers benefit from the automation of corporate actions, including coupon payment, which is mostly manual.
"The amount of capital that is kind of tied up then by DTCC during that [issue] period, … if that timeline, through leveraging blockchain-based technology, can become more automated, can streamline," Quant told webinar attendees, "there would be the ability to have further capital efficiency in that area."
The bond deal process can also be improved by the blockchain because of the ability to observe the deal in its entirety in real time. All parties working on the deal are operating on the same ledger, so if a trade fails, everyone can see immediately what went wrong and move accordingly.
The process presents a drastic update for the market. Some of the greatest pushback is coming from those who are hesitant to embrace the crypto industry and those who don't think the process adds enough value.
"Many people are still hearing digital assets, and they're immediately thinking, well, it's crypto, or it's speculation, or just, you know, technology for technology's sake," Kilgore said on the panel.
"It comes back to what's the end benefit for me as an investor, and today there aren't necessarily those," Quant said.
Bienstock said that the change will be a "slow adoption."
"Our job right now is to provide as much thought leadership and education, and to demystify what blockchain and tokenization are," Kilgore said. "Then people kind of become a little bit more at ease, and they realize the utility of it moving forward."
