Lisa Cook on Tokenisation: A Great Opportunity, Not a Substitute for Traditional Infrastructure
During her recent speech at a Central Bank of West African States conference, Lisa Cook, a Federal Reserve governor, highlighted the potential of tokenisation in the financial sector. Cook’s endorsement of this innovative technology was tempered with caution, as she acknowledged potential issues that could affect the operation of the global financial system.
What is Tokenisation?
Tokenisation refers to the creation and recording of a digital representation, or token, of an asset. These tokens are generated on new platforms or technologies, like distributed ledger technology (DLT), and transactions involving tokens are constructed using ‘smart contracts’. These are pieces of computer code that can execute predefined actions once certain conditions are met.
Tokenisation’s Potential in Emerging Economies
According to Cook, one of the significant benefits of tokenisation, particularly for emerging economies such as those in West Africa, is the facilitation of faster cross-border payments. The technology is capable of supporting complex multicurrency and multi-asset transactions, facilitating settlement across multi-leg transactions, and reducing the time gap between trading and settlement.
Furthermore, Cook highlighted that tokenisation could greatly expand market access. This is achieved by allowing fractional ownership, whereby an investor would purchase a share of an asset instead of the full price. This could be particularly attractive in developing economies, where savers and investors may have fewer resources to invest, but there is a need to bolster capital markets as a complement to the social safety net.
Potential Risks and Challenges
Despite these advantages, Cook also warned of potential liquidity implications should tokenisation scale. She stated, “Some tokenised assets can be redeemed on demand and at par with the issuer, who typically invests in a pool of less liquid assets, thereby introducing run risk”. The 24/7 nature of trading and settlement on public blockchains could also accelerate a run on the issuer if disruptions in the market for tokens outside normal market hours were to escalate.
Another challenge Cook identified is interconnectedness. The use of tokenised assets as collateral, as instruments to access liquidity and as reserve assets “expands the channels of shock transmissions within the digital asset ecosystem and to the traditional financial system”.
Lastly, Cook added operational fragilities and security concerns to the list of risks. As processes become more automated with smart contracts, humans will be “less able to correct for bugs or respond to outside threats”. New products and systems tend to attract malicious actors looking to exploit vulnerabilities, and Cook highlighted the relatively high number of cyber attacks affecting the decentralised finance ecosystem.
Ongoing Research and Final Thoughts
Cook stated that research is ongoing within the Federal Reserve board to fully comprehend tokenisation and its implications. While the technology holds tremendous potential for innovation in the financial sector, Cook does not see tokenisation as a substitute for traditional market infrastructure. Rather, it is another tool that could help address frictions in financial markets and offer compelling benefits, especially in emerging economies.
Find out more about Lisa Cook’s thoughts on tokenisation Here.
