The Emergence of Tokenization

Tokenization is emerging as a transformative concept in finance. It involves representing asset classes such as equity or debt through the issuance of a "token" on a blockchain. These tokens, can represent shares of any tradeable asset, including company shares, investment funds, debt instruments, real estate, and commodities.

Commonly referred to as security tokens, they have the potential to operate within existing securities laws and regulations, opening up alternative investment opportunities. This allows for fractional ownership, increased liquidity, and access to a global pool of capital, enhancing market liquidity, breadth, and depth.

In essence, a security token is a “security in the form of a digital token.” Leveraging mature digital blockchain infrastructure, these tokens provide a solid foundation for innovative financial instruments like mini-BOTs.

Similarities to tokenization

One aspect of the mini-BOTs that becomes immediately noticeable upon further analysis is their close similarly to a new emerging concept in innovative finance; tokenization.

In a nutshell, tokenization is the representation of an asset-class, such as equity or debt, through the issuance of a “token” on a blockchain. Like a coupon redeemable for an item, a token can represent a share of any tradeable asset, such as a share of a company, investment fund, debt instrument, real estate, fungible asset such as commodities, and more. These types of “tokens” are more commonly referred to as security tokens, operating within the boundaries of existing securities laws and regulations.

This is opening the floodgates to a variety of alternative investment opportunities, enabling fractional ownership, increased liquidity, and access to a global pool of capital, providing greater market liquidity, breadth, and depth.

In essence, a security token is a “security in the form of a digital token”. This, with the aid of rapidly maturing digital blockchain infrastructure, can provide a real foundation for the issuance of mini-BOTs.

Applying tokenization in practice – the mini-BOT scenario

Issuing 1) a utility token representing a tax credit, or 2) a debt token representing a digitized short term bond, where both are represented by highly liquid and fractionalized digital “tokens”

1) Utility Tokens: The Italian government can issue new utility tokens representing future tax credits. These tokens can be used to settle debts with domestic businesses, preserving cash positions. Additionally, issuing these tokens to other stakeholders effectively acts as a tax cut, where the government reduces future tax revenues in exchange for immediate debt resolution or capital inflow to pay off debts.

2) Debt Tokens: Participating creditors can swap their debt instruments for mini-BOTs with revised terms, including maturity extensions and more favorable conditions. New participants can purchase tokens, similar to traditional debt restructuring but with fewer complications. This approach avoids legal challenges like contract-based violations and demands for full debt value, which are common in unilateral maturity extensions. This is closer to a traditional debt restructuring which has underlying economic implications.

However, this also potentially avoids a large portion of the traditional challenges that could arise in a potential restructuring. For example, unilaterally extending maturities could elicit claims from creditors alleging a contract-based violation and demanding the full value of the debt instruments.

In both cases 1 and 2, there is an opportunity to work around the current debates raging in Italy and Europe to settle impending debts, enabling Italy to work on adjusting its fiscal policy while minimizing the domestic economic impact on local creditors along with the impact on foreign entities.

Implications, Impact, and Considerations

Issuing tokens, whether as utility or debt tokens, effectively injects liquidity into the economy without altering the monetary supply. This potential solution requires careful evaluation of several factors:

  1. Offering size: The scale of the mini-BOT issuance needs thorough analysis. A small-scale issuance might not have the desired impact, whereas a large-scale issuance could lead to significant economic impact.
  2. Inflationary impact: Introducing a significant number of tokens into the economy could lead to inflationary pressures. It’s crucial to model and predict the inflationary impact to ensure economic stability.
  3. Economic growth: Tokenization can potentially spur economic growth by increasing liquidity and enabling more business transactions. However, the actual impact on GDP growth needs to be carefully assessed.
  4. Tax revenue: Utility tokens act as future tax credits, effectively deferring tax revenue. This requires a balance between immediate liquidity needs and future fiscal health. It’s important to project future tax revenues accurately to avoid budget shortfalls.
  5. Restructuring Impact: Compared to traditional restructuring methods like interest reductions or debt haircuts, tokenization aims to minimize net present value (NPV) reduction, broader economic risks, and legal challenges. Given that most national debt is held domestically, this approach seeks to minimize significant write-offs and their ripple effects on the economy.

Without calculating total economic impact, both mini-BOT scenarios have the potential to contribute towards restructuring in a manner that, compared to traditional approaches such as interest reductions or debt haircuts, would rather minimize NPV reduction, broader economic risk, and legal risk. As the vast majority of the national debt is held by domestic creditors, this also attempts to minimize the large resulting write-offs and ripple effect on the Italian economy that would occur from a traditional restructuring.

Technical considerations

Beyond the economic impact, the infrastructure requirements to support such a platform would need to be carefully considered. In order to provide liquidity, an exchange or platform is required for the token to be exchanged.

Furthermore, the platform would require standard KYC/AML/CTF requirements for user onboarding. The extent that this could be government sponsored/mandated will also determine the ability to integrate with existing eGovernment services.

Parallel currency: Claims that such tokens would be a parallel currency do not hold, as the tokens are not mandated as legal tender. There is no obligation to take them, so they are not money.

Conclusions

It is true that there are already functions in most governments to offset tax owed by taxpayers with existing mechanisms of credits, similar to how taxes owed are offset by tax refunds. Depending on the desired scale of the engagement, these mechanisms could indeed be enough to service the needs of the government at the time to cover arrears.

However, with the emergence of new digital technologies, there may be real possibilities for the issuance of tokens as a viable method for a broader restructuring of sovereign debt. If at some point government does encounter challenges and has to engage in discussions to restructure the debt, tokenization may be a viable opportunity.