What are Tokenized Bonds?
Last Update: March 8th, 2022
In general terms, a bond is a fixed-interest financial instrument representing a debt that an investor extends to a borrower. The instrument shows the details of the instruments and the payment schedule. Tokenized bonds are representations of ownership via cryptocurrency tokens in a blockchain, where terms are automated with smart contracts. The tokenization process turns data into characters that have no meaning if breached. Tokenized bonds can be transferred, stored, or registered in a blockchain.
How does blockchain tokenization of bonds work?
Bond tokenization represents the ownership of a bond instrument represented by a token hosted on a blockchain. A blockchain issued bond can be automated and governed by terms in a smart contract. Blockchain databases store the data of bond transactions to enhance security and transparency. In this case, a blockchain represents a digital ledger of timestamped and immutable records that grows as new data is added. Blockchains are hosted in multiple nodes in a network and they use decentralization and cryptography to validate transactions. The ledgers are open and transparent, and the smart contracts execute the terms of the blockchain-issued bonds, in place of the conventional documentation process.
Creating & Issuing Blockchain Bonds
A blockchain bond is issued in a tokenized form, within the digital ledger. Orders that comprise bids and bonds from investors, are then recorded in the DLT in immutable forms. A distributed ledger can be operated in a public or private network that hosts digital assets. The issuer of the blockchain bond then develops a term sheet that is incorporated into the smart contracts. The issuer can then add investors to bid on the blockchain issued bond, based on the Know-Your-Customer metrics. The tokens in question are used to value the issued bond. Although blockchain issued bonds are at their initial development phase, it is viewed as a potential industry disruptor.
Besides this, blockchain issued bonds are created with programmable codes, and they are settled almost in real-time. Transaction reconciliation is simplified, as all the nodes in the network have a copy. Coupon payments can be sent to the wallets of the investors. Investors can trade their bonds over the counter or in a decentralized exchange. The custody and bond servicing in the traditional issuance is eliminated in the blockchain issued bonds. The creation and issuance of blockchain bonds still face regulatory hurdles. Many jurisdictions are yet to allow blockchain issued bonds. Regulatory systems are slow to implement technology-enabled policies. As a result, significant investment is needed in the sector to enhance the issuance of smart bonds.
Blockchain Bonds vs. Traditional Bonds
Traditional bonds have a lengthy issuance process compared to blockchain bonds. Conventional bonds also use multiple intermediaries, where the information asymmetry can lead to inefficiencies. The lack of standardization in the traditional bond markets leads to inefficient securities pricing. On the contrary, the decentralized nature of the blockchain bonds eliminates the need for intermediaries, giving the bondholder more savings. While the traditional bonds are owned and regulated by specific entities, the blockchain bonds have a variety of digital assets in a decentralized database for freedom of choice. The lengthy settlement processes in the traditional bond market leads to settlement risks and more costs.
A Bitcoin bond is a bond instrument that is tokenized and issued on a blockchain. The blockchain issued bond is automated within a network. Bitcoin bonds are a relatively new concept that is still under review by institutions. The standard for digital bonds should be that every party is involved in the bond issuance process. Platforms that issue Bitcoin tokenized bonds offer automated coupon management services, and the digital complaint tokens can be transacted at a low cost.
Ethereum bonds are tokenized and programmed into smart contracts. Issuers can sell them directly to investors and accept payments in cryptocurrencies. Ethereum has been used in the past to support blockchain issued bonds. The European investment bank used the Ethereum blockchain to issue a €100 million (equivalent to a $121 million) two-year bond in 2021. The World Bank has also issued a blockchain-based bond called bond-i. The Ethereum blockchain has seen a surge in decentralized applications in DeFi, and the bond market is likely to benefit from the emerging technology.