In the year 2024, the global bond market was valued at around $141 T, and it is expected to reach $166T by the end of 2030. But despite the rising growth, the demand-supply of the bond market is not in equilibrium, putting a lot of pressure on dealers’ balance sheet capacity, as per OECD report.
Tokenization is well placed to fix this since it can open up new markets. That’s why in the McKinsey Report, cash & deposits, loans, and securitization and bonds and exchange-traded notes were placed in Wave1 window since an innovation at the infrastructural level can resolve their pressing issues.
In this blog, we shall see the problems that bond tokenization can address and its impact on the demand. But before we do that, let’s start with the basics,
What is Bond Tokenization & Why Do We Need It?
Bond tokenization is the process of converting traditional bonds into a digital token using blockchain as the underlying infrastructure to manage their ownership and issuance. With the traditional bond market facing infrastructural issues, bond tokenization is no longer a need but a necessity to overcome the following problems;
1. Operational Friction
Right now in the traditional bond market, institutions are looking forward to abstracting the old methods where they have to track;
- Who’s holding what?
- When were payments made?
- How to verify the claims with certainty?
Using an intermediary in between, forcing them to spend 1% to 2% on bond issuance, which can reduce their profit margins.
2. Global Bond Issuance
Presently, NBFCs, private credit funds, and fintechs face hurdles due to regulatory risks, high cost of hedging, credit rating dependencies and structural limitations while exploring foreign markets to issue bonds .
3. Transparency
If an asset class has shady operations, it is bound to lose the interest of the investors. With the bond market, the OTC style operations jeopardize the interest of the investors since there’s no means to validate price discrimination based on volume and demand.
What Benefits Digital Tokenized Bonds Bring?
Digital tokenized bonds are delivering on the following parameters to fix the issues that traditional bonds couldn’t like;
After learning about the benefits that they can deliver, one must be curious how they can do that. This is specially encrypted in their working which makes this possible;
How Bond Tokenization Works?
Bond tokenization works in the following manner as shown in the image below;
Where the process starts with an issuer (corporate or sovereign) creating a bond just like in traditional markets, often backed by collateral, after which custody and structuring are handled through custodians and smart contracts to ensure regulatory compliance.
The bond is then converted into digital tokens, which are either as a backed representation of an existing bond or issued natively on-chain and deployed on a blockchain platform where smart contracts automate key terms like coupon payments, maturity, and compliance.
To enable seamless payouts and settlements, the system integrates tokenized money (such as deposits or reserves), allowing near-instant transactions, and once live, the bond’s entire lifecycle is managed on-chain with automated payments, real-time ownership tracking, and transparent record-keeping.
Who Are Issuing Their Own Tokenized Bonds?
1. Open Eden
Open Eden has used bond tokenization to make BNY Investments’ Global Short-Dated High-Yield Bond strategy highly accessible. They have introduced HYBOND which would allow investors to move beyond cash-equivalent and government bond products that investors are stuck with all this while.
2. HKMA
Hong Kong Monetary Authority is all set to market their multicurrency digital green bond for the third time using tokenization. These new bonds will be denominated in US dollars, Euro and Yuan. Which means, investors will be getting the advantage of settling their transactions in seconds in multiple currencies.
Hong Kong’s plan is to dominate the bond market in Asia and so far they already capture 30% of the market share in Asia. Now, they wish to take this forward using bond tokenization since they have already scaled from $102 million to $1.3 billion and now they want to use tokenization to further access the global markets to take this further by integrating new settlement rails like CBDCs.
3. Nomura
Nomura is another major player who is issuing crypto backed tokenized bonds. They are using BTC as an underlying asset to allow exposure to investors who are looking for income beyond going long on BTC. They are launching this bond program to provide 5% additional returns to investors who want to explore the crypto market with near instant settlements.
4. Asian Infrastructure Investment Bank
The Asian Infrastructure Investment Bank has also used bond tokenization to issue a $300 million sustainable development note rated AAA by Moody’s, S&P, and Fitch. They have partnered with Euroclear in August 2024 for this initiative. This bond carries a 4% coupon rate and it will be maturing in 2027. So far more than 15 institutional investors have invested in this bond program.
Along with these, there are other names as well who are penetrating the tokenized bond market as shown in the infographic below;
What is the State of Jurisdiction Readiness To Issue Tokenized Bonds?
So far, the regulatory readiness has been growing but considering the tokenized bonds are akin to securities, they must be issued with compliance guarantee. At the moment, the state looks like this across the globe.
As per GFMA Report
Will Bond Tokenization Impact Demand If Regulations Go Native To Operations?
In the beginning, we spoke that demand-supply of the bond market is not in equilibrium, which is putting a lot of pressure on the issuers to remain sustainable. For that matter, tokenized bonds are well placed since they expand the horizon because when regulations become simpler, they can address the following challenges to amplify the demand;
1. Access to Secondary Markets:
At the moment, due to heavy institutional participation in the secondary markets, government bonds can offer lower returns to traditional retail investors on any secondary market trading platform due to bid-ask spreads.
This can hinder their participation in the market. Through bond tokenization, a new liquidity market opens up, uplifting the demand for such transactions.
2. Address cold start problem:
Most of the traditional bonds are fearing to switch to the digital side because despite the scope, there’s always a psychological barrier that investors don’t want to cross. For example, to date, most of the investors still feel safe with traditional bonds.
However, if they get the digital representation of collateral, delivering material benefits, which include much greater mobility, faster settlement, and better liquidity. The demand can explode since it is a complementary scenario building up, where, along with issuance, the likely benefits are as resurfacing that can equalize the demand supply paradigm.
As you can see from the Mckinsey report below that the following things must be brought in unison where sell side, buy side, intermediaries and regulators are all integrated with a common ledger for faster processing and better impacts.
So far, the Monetary Authority of Singapore’s Project Guardian and the Regulated Settlement Network with 40 financial institutions, regulators, and central banks and a financial infrastructure have achieved the same unifying all the fragmented segments and amplifying the demand in the process.
3. Expand Investor Base:
Right now, the investor base of traditional bonds is very small. This is happening because investors have to lock in a lot of funds to buy, with starting prices hovering at around a minimum $5000. Institutions are forced to do that because if they issue low entry tokens, they will have to bear additional burden of maintenance like KYC/AML verification, coupon payment processing, tax documents, annual reports, disclosure, and so on and so forth for managing all those transactions.
But through tokenized bonds, they can abstract away all the complexities, instead setting up a smart contract that can deal with all these issues. As a result, it is possible to even issue low-value entry bonds, enabling greater retail participation.
Risks of Tokenized Bond Issuance and Zeeve for Compliant Infrastructure
But tokenization comes with certain degree of risks that you must be prepared for;
But when you have a technology partner like Zeeve with a SOC2 and ISO-aligned operating posture, you can deal with all these issues. So, no matter whether you want to build across from public, private, to hybrid, multi stack and ZK-enabled systems, Zeeve can help you with all of that.
In addition to this, Zeeve also provides regulatory assurance through its Privacy Layer. With the track record of handling 20+ production chains processing 2B+ transactions monthly, we can help you not just launch but scale your tokenized bond! Schedule a call today if you are looking for a reliable technology partner that can help you innovate while staying compliant!
