This blog will discuss the potential of using blockchain and tokenizing (green) bonds for the banking industry. A green bond is similar to a normal bond, namely that it is a loan which periodically pays the owner interest. However, the proceeds of a green bond issue should solely be invested in projects that assist in mitigating climate change. The current (green) bond market is inefficient, which results in unnecessary costs (Shaikh & Zaka, 2018). The market for green bonds specifically relies heavily on centralized third parties to provide trust (Malamas, Dasaklis, Arakelian, & Chondrokoukis, 2020). To illustrate how tokenization of (green) bonds will help the banking industry, this blog is structured as follows. To start, it provides a brief refresher on blockchain and tokenization. Secondly, it explains opportunities in the current system that can be improved. Thirdly, the blog discusses how to move towards a new system.
Blockchain can be defined as a distributed ledger, meaning all participants in the network own the same, continually updated, copy of the ledger. Furthermore, blockchain requires no intermediary for safely storing, recording and sending information on a peer-to-peer network. The information on the network is encrypted such that only the rightful owners to the information are able to access it. Tokenization can be defined as a method to digitize real-world assets into digital tokens that can be freely traded. Meanwhile, all transactions that are made with these tokens are safely recorded on the blockchain. Digital tokens are highly divisible, which means ownership of an asset can be shared between investors. More importantly, it could reduce minimum investment amounts of assets (Laurent, Chollet, Burke, & Seers, 2018). In short, blockchain is the main technology, tokenization of assets is an application of blockchain technology.
To illustrate the areas of opportunity of tokenizing (green) bonds, consider the example of dividend payments and bond ownership. Currently, dividend payments are not transferred automatically. However, dividend payments are predictable events, meaning programmers can write code that will automate such processes. Secondly, tracking ownership of (green) bonds is a long and difficult process due to the reliance on intermediaries to register the records of the (green) bonds. When a bank decides to call or redeem a bond (which means to pay back the loan earlier than the maturity date), it often issues an advertisement in newspapers as the bank does not know who owns their bonds (!). If (green) bonds are tokenized, ownership can be easily recorded on the blockchain. Furthermore, the immutable property of blockchain resolves the possibility of fraudulent activities (Nakamoto, 2008), such as trading a (green) bond ‘twice’.
To move towards the new structure, banks need to develop smart contracts. Smart contracts are in essence computer programs running on top of the blockchain which are able to automatically execute tasks when pre-determined conditions are met (Malamas et al., 2020). Smart contracts will be able to automate dividend payments and simplify auditability and reporting, because issuers of (green) bonds can put all documents on the ledger (Zhang, Aranguiz, Xu, Zhang, & Xu, 2018). A limitation of tokenization is the inherent incompatibility of blockchain technologywith GDPR regulation, as the ‘right to be forgotten’ is inherently violated, as once (personal) ownership data is stored, it will permanently remain on the blockchain.
To conclude, tokenization has potential to modernize the dividend payment process and ownership recording of (green) bonds. This would reduce costs for banks as the dividend payments will be automated and the search for owners of their bonds. There are more applications for banking but implementing these would be a good start for the (green) banking industry.
Laurent, P., Chollet, T., Burke, M., & Seers, T. (2018). The tokenization of assets is disrupting the financial industry. are you ready? Inside. Triannual insights from Deloitte(19), 62–67.
Malamas, V., Dasaklis, T., Arakelian, V., & Chondrokoukis, G. (2020). A block-chain framework for increased trust in green bonds issuance. Available at SSRN 3693638.
Nakamoto, S. (2008). Bitcoin whitepaper. URL: https://bitcoin. org/bitcoin.
Shaikh, S., & Zaka, F. (2018). Blockchained sukuk-financing. In International workshop on enterprise applications, markets and services in the finance industry (pp. 66–76).
Zhang, X., Aranguiz, M., Xu, D., Zhang, X., & Xu, X. (2018). Utilizing blockchain for better enforcement of green finance law and regulations. In Transforming climate finance and green investment with blockchains (pp. 289–301). Elsevier.
