Investing for the tokenization revolution

Transcript

Test 1 2. Okay, I can use the mic. I'm pretty loud though. Do I even need the mic? Yeah, you need need the mic. Okay, they tell me I have to use the mic. Okay. Hey everybody. Come on in. Uh thanks for being here. Uh I am Zach Pandl. I run research at Grayscale Investments. If you don't know Grayscale, we are the world's largest crypto dedicated asset manager. Uh so we are based in the New York City area, Stamford, Connecticut, if you've ever been out there. Uh US-based company. And we run um a bunch of different investment funds for crypto. We got started back in 2013 with a product that a lot of people know called GBTC, the the first US uh investment vehicle for Bitcoin.

But today we run lots of different ETFs uh and private funds for accredited investors uh covering the full spectrum of things that happening in crypto. We like to say from Bitcoin to BitTensor and everything uh in between. Uh so today um I'm going to talk about uh tokenization, which is a mega trend, a buzzword, an investment theme uh in the crypto asset class. There's a lot of dimensions uh to it. Um and I just wanted to share some high-level thoughts about how we are thinking about this, uh the kind of messages that we give to institutional investors. You know, if you go to a uh like the DAS event in New York uh last week, you know, the two things that institutions are aware of are stablecoins and tokenization. They are They're excited about these ideas, but they're still trying to figure out what it means for

deploying capital. You know, what sort of products am I supposed to invest in to capture these uh themes? And so, these are some of the ideas that we share uh with them. So, just going to walk through that. Okay. Uh I think most of us know roughly what tokenization uh means. It's just applying the basic principles of public blockchain uh technology to the world of asset markets. So, on a public blockchain, it works completely different than the traditional financial system. Uh you have an account on Ethereum, I have an account on Ethereum. I want you to have some ether, I just whoosh send it straight to you like an email, and there are no financial intermediaries in between uh that transaction. If you want If we want to have a exchange a dollar in the same way, take a stable coin,

stick it on Ethereum, and I just send it straight to you with no intermediaries uh in between. So, peer-to-peer digital value exchange, to me that's really the core concept of what public blockchain technology is all about. And tokenization just means applying these ideas to the world of assets, uh the world of traditional assets, stocks, bonds, and and everything else. And this is completely different from how the financial system works uh today. When Alice wants to trade a stock uh with the Bob uh in the traditional financial system, it involves lots of intermediaries. In some kind of simplified uh sense, Alice calls the the broker, the broker calls an exchange, the exchange calls a uh clearinghouse, the clearinghouse calls a custodian, the custodian calls a transfer agent, and

after all these financial intermediaries have updated their books and records, Alice has traded a stock with uh Bob. Tokenization, the pure conceptual uh version of this is that we're replacing these intermediaries with the magic of uh smart contracts. Uh and so, Alice and Bob, they both have an account on a a blockchain like Ethereum, and Bob has maybe cash, and Alice has a stock, and whoosh they can uh exchange those two things in one uh single transaction and not have all these intermediated uh steps. So, that's what tokenization is in a a very kind of textbook sort of a sense, just the same peer-to-peer transfer of digital value. Uh that is the really the core innovation of blockchain technology, the core innovation of Ethereum applied to the

world of of assets. So, the tokenization of of capital markets has now gotten underway. This is a we call it the tokenization revolution, and I would say the revolution has gotten started. Uh we have a a lot of growth in the stock of tokenized assets over the last uh several years. You know, you are talking about almost uh nothing at the beginning of 2024 and something like a 10x uh since that time. So, a lot of growth and also increasing diversity in the type of assets that are tokenized and deployed on a blockchain.

US Treasuries, that's the biggest category. You may be familiar with BlackRock's BUIDL product. There's lots of other things like that, but that's the biggest category of tokenized assets today. We also have other types of public fixed income. Think like corporate bonds, European sovereign government bonds. Uh tokenized um public equity, tokenized stock. That's a small but a growing category. Uh we have a private alternatives, things like private credit, private equity fund uh shares. Tokenized commodities, like tokenized gold. That's been a very important category uh lately in the context of uh the debasement trade or equally you might be be able to say speculative trading in gold and other uh precious

metals uh on chain this year and in the context of uh ongoing geopolitical tensions. And then there's some other things like uh active funds, uh real estate, other types of uh tokenized assets. So, tokenization is a a mega trend. Lot of growth, increasing diversity. And the other thing that stands out to me when I look at this chart is basically no correlation to the price of Bitcoin or the price of Ether. You know, this is a a trend that has its own fundamentals. It's not really about just speculative activity in in crypto tokens. This is something that is achieving lift off in its own uh right and has a a long way to go. So, a mega trend in capital markets that has gotten started but has a very long way to go.

And just to kind of emphasize how far we have to go, you know, when you when you look at a number like 25 billion when you when you say billion, it sounds like a a very big number. But, I'd like to emphasize just how tiny these numbers actually are. So, when you kind of compare the stock of tokenized assets to the size of capital markets, you realize what what's happened today is is just a little peanut compared to real capital markets. The overall stock of tokenized assets on chain today is worth 0.01% of global equity and bond markets or one basis point. So, we have only tokenized

one basis point. So, it's just the very very beginning of this journey. This is a a story that we are going to be if you're a financial professional, this is something that's going to be around your life for 10, 20, 30 years. You know, tokenization of capital markets is going to take a very long time and it'd be a huge trend and we're only at the very beginning. We think, just to give you a sense of how much growth we could see. So, let's say we have 25 billion dollars of tokenized assets today. By 2030, I think that that could be a thousand X increase. So, from 25 billion today to 25 trillion dollars in just 5 years or so. I think that that is a plausible number. Of course, a thousand X return over 5 years, that's an

enormous rate of growth, something in the ballpark of like 300% per year. But, just think of that 25 trillion dollars, that's still less than 10% of global equity and bond markets today. So, we could see explosive growth and still have a very long a way to go. And that's how I think we should think about this. At the beginning of a long journey for capital markets that's gotten started. We're going to transform capital markets with tokenized assets, reduce the central role of financial intermediaries, get more benefits of smart contracts, but a a very long way to go.

And I think kind of emphasizing the very early stage of this uh process is important for thinking about how to compare the different projects and how to deploy capital uh for an investor in in crypto assets uh today. So, when we're looking for, okay, how do how do I make money? That's that's my uh role at Grayscale is try to find these uh uh types of trends and talk to institutional investors about where to deploy capital within crypto assets in order to capture these uh trends. And it can be tempting to think that Ethereum is the only answer uh at some level. And I'm I'm going to argue against that. But it can be tempting to think that because Ethereum is already

off to a great uh start. Ethereum is the is the leader today in tokenized assets, has about a 60% market share in just the uh layer one. I'm not counting any layer twos, but just the Ethereum layer one has about a 60% market share in tokenized uh assets. A little bit more for tokenized commodities, think about like Tether gold, uh things like that. A little bit less for tokenized uh stocks, but on the whole around a 60% uh market share. And that's comparable to Ethereum's market share for stablecoins.

So, I think that there is a kind of instinct uh to say, well, you know, Ethereum is the stablecoin chain, it's the tokenization uh chain. As these uh trends uh progress, Ethereum will capture uh that uh value. And I think to to some kind of very simplified sense, that is uh correct. But I think it may be oversimplifies like how this journey is going to play out over time. And I think there probably is more to it than just extrapolating the embryonic stage of tokenized assets today, 10, 20, 30 years into the future.

I'm not sure it's going to progress in a straight line as some people seem to to think. Instead, the team at Grayscale, my my team, the Grayscale research team, we tend to think about a tokenization roadmap or tokenization timeline. And think about how this reshaping of capital markets is going to change over the coming years. And I think the core point that, you know, we believe in, that I I think not everyone is persuaded in, but the the thesis that I'm here to debate with all of you, is probably that in the early stages of the tokenization process, you will see things that have success that look more similar to how the

financial system works today. So, the financial system today is centralized. It is permissioned. It is national. You know, national borders play an important role in how capital markets work today. And institutions play a very central role in solving some of the practical challenges in how our capital markets a system needs to work. They solve challenges around privacy, for example, and around user identity. So, our thesis is that over the shorter term, say like the next 1 to 2 years, for example, you may see a fair amount of success for tokenization efforts that hue more closely to how the financial

system works today. Now, I think most of the people that attend the EthCC, and certainly I would consider myself one of these people, believe in the vision of global decentralized finance. And I think that that is where we are going over time. That eventually we will have a tokenized capital markets that are decentralized, that are permissionless, that are truly global, and where challenges related to identity and privacy are solved with on-chain tools. And I've already been to some cool talks today that talk about some of these things. We are We are building these things.

But my my view I think, and I'm curious you know if there's a debate on this, my my view is that the technology is not totally there yet. I mean that's why you have people at conferences like this presenting their new ideas. How do we solve these challenges? How do we solve challenges around privacy? How do we solve challenges around on-chain identity? How do we speed up Ethereum? You know, there is a road map that I think is executing on these problems for the Ethereum L1. But it's a road map, okay? It's not something that is exists today. We do not have a ZK-powered Ethereum L1 today.

And in my view the tech is not fully ready, and also the financial system and the regulators and the users, the users of assets are not entirely ready today. So instead of thinking about a debate between say the Ethereum L1 and centralized chains, maybe we should think about a road map or a timeline, and thinking about the types of assets that can capture value at different points along that journey. So this is like a little conceptual image that we talk about in the in my team for thinking about how this could play out and what the investment opportunities could be over different parts of time.

And I presented this before last week's DAS conference and some of the dustup on crypto Twitter at the moment around Canton and Ethereum. Delighted to weigh in on on that debate. I think we have a different perspective than some of the things I hear on on the crypto Twitter. But if you think about this playing out as a kind of road map or a timeline, and progressing in phases over time, that unlock different layers of value over time.

Some projects are maybe more ready to go today with a less ambitious vision. And there are other projects like the Ethereum L1 that have some work to do, but have a very ambitious vision and maybe more potential upside over time from that vision. So in today's kind of early stage of of tokenization, I I believe that some of these institution-centric frameworks probably will see a fair amount of of success. And I think the Canton network is actually a very good example of a institution-centric model that can solve a lot of practical challenges.

Again, we do need privacy, we need identity, we need security, all those things need to be solved for tokenization of capital markets to progress. And so the easiest way to get that process going is just to replicate what happens in the financial system today in in tradfi, and that is done by institutions. Institutions solve those problems, maintain those things today. And that's essentially how Canton network works. It is not anything like Ethereum L1. Every institution maintains its essentially its own blockchain.

And it doesn't share any data on any kind of global state. So it is easy to maintain privacy because none of the data is shared with anybody else. It's a more limited vision than what Ethereum is is trying to achieve. But I do think that there it is a reasonable investment because in this network of networks or network of blockchains, how the Canton network works is there's a something called the global sequencer that stands between these instances and it captures transaction fees as the different instances of blockchains institution-owned blockchains speak to each other.

And those fees accrue value back to the Canton coin or the Canton network uh token. So, in my view, the Canton coin is a perfectly reasonable uh investment. It is a financial claim on cash flows, much like many other things uh in this uh asset class. It's more like an application uh layer token, you know, more similar to Aave, for example, than to Ethereum uh or Bitcoin, but a perfectly reasonable uh investment thesis. Now, I could see a kind of phase two uh of this uh journey, of this roadmap, of this timeline uh being dominated by a kind of hybrid uh system, where we have both institution-owned

blockchains and global shared state. Uh and maybe these things speaking to each other in some shape or form. Now, there's lots of different versions of that, but I think people know the Avalanche uh model, and so I use that as a kind of uh example. Avalanche takes a step further than Canton. It still has a a role for institutions. Uh Can't the Avalanche network has uh individual institution-owned sovereign blockchains. There are 400 or so of these things in the Avalanche uh network.

But it also has a shared state. There is a central uh blockchain that shares state, and where we can begin to see the process of decentralized finance play out. The Ethereum L2 ecosystem and how it relates to the L1, L2s using Ethereum L1 for data availability could also be thought of as a hybrid system, allowing institutions to maintain maximum control over their own blockchain, you know, gaining the efficiencies of using a blockchain, but not uh executing the full vision of of decentralized finance.

It's possible that we live in that kind of hybrid world uh for a fair amount of time. In the longer term, and we we don't know exactly how long these timelines are, I believe that we are going to that full global decentralized finance vision. That the world will move onto a shared global state. And one of the reasons that institutions don't like that particular idea is the intention here is to disrupt institutions, to disintermediate institutions and remove their role from the financial system. So, why why is it working with institutions. It's about replacing institutions.

And so, that's another reason why it's going to take longer to get to that vision. If you are the DTC, or you are a clearinghouse, or you are someone that works with transfer agents, you don't want to see yourself disintermediated. So, something like the Canton network where you maintain maximum control of your data, maintain ownership of your domain, is a natural thing to to partner with. You know, the Ethereum vision is to replace more and more of those institutions over time. So, it's a much more ambitious vision, and I think we still have some work to do on the road map to get there. But, I think it has much more investment upside than something like the Canton coin.

Canton coin has, I think, plenty of investment upside as a financial claim of cash flows that are created but when networks speak to each other across its global sequencer. The ether also captures those types of cash flows. It's a claim on transaction fees that take place on the layer one. But, ether is more than that. It is a decentralized digital commodity, a functional commodity in the in the operating of this network. And it is a money-like asset, like Bitcoin. In my view, that has much more investment upside than something that is just a classic financial claim on cash flows.

So, when we're talking to investors about this type of roadmap, and you know, they ask, "Okay, what what is the right way to invest for the tokenization revolution?" Well, sometimes we say, "Well, what type of investor are you?" Right? If you feel like you need something that has more immediate upside, more immediate likelihood of success, but maybe has smaller terminal gains, smaller potential gains, then potentially Canton is a appropriate allocation. I do think we will see institution-centric blockchain instances see some traction over the the coming years. And I know that's not a message that everybody likes that in Ethereum conference, but that is my personal opinion that you will see these things gain traction because they're

solving practical problems around privacy and identity, and because institutions maintain control over what they're doing. And so, they naturally want to partner with that type of system. However, if you're the type of investor that wants the more ambitious vision, that's investing for the long run, and is looking for more potential upside, but potentially more risk in the vision of global decentralized finance, then Ethereum is a much more natural investment. You know, at Grayscale, our role is to provide investors with access to the credible projects throughout the crypto asset class, and they have lots of different upsides and downsides. But in my view, both

these institution-centric models and the Ethereum L1 are valid investment thesis for the for the tokenization roadmap that we see ahead. Okay, that's what I got. Happy to debate that, take any questions. Thank you for listening. >> [applause] >> Please. Thank [clears throat] you very much. Could you bring us to your very first slide on the Alice and Bob? Thank you. Um So, the phase one about Canton or Avalanche, we are in the middle. My question would be what would be the value chain with because if I understood you replace

part of the institutions, but not all. You were mentioning the clearing house. What would be the the value chain in your vision of the short-term period? >> Yeah. Thank you. So, how how you can think about it is uh and maybe I should draw the chart like this. You know, you can think of this as like the Ethereum L1, you know, just one thing that stands in between peer-to-peer uh finance. How Canton works is each of these things, in effect, over simplifying, each of these things is a blockchain. They have their own in-house blockchain and they may or may not speak to each other. But, the idea is that they will speak to each other over something called a global sequencer. So, Can- Canton network is a mix of networks with a uh a messaging system uh between it and

that's called the global sequencer. And a clearing house and an exchange, for example, to send a message uh to each other to update their books uh simultaneously, they have to pay a transaction fee. So, the value capture is basically fees over the global sequencer that are used to burn uh the token. That's how the value accrual works for Canton coin. No please. To to continue the question, you don't believe that some um chains of the value chain will be replaced, I don't know, maybe clearing house thanks to the blockchain will take the the role of the exchange building a direct link with the broker or you think because I mean, if you just uh switch

the traditional rails with blockchain rails, but you keep the same amount of institution, Yeah. you don't have a huge value creation. This is uh my point. I agree with your point. I I don't think that uh just putting what what we're going to get uh from something like this is some efficiencies in how the financial systems work. Like think about uh individual banks, individual uh custodians, individual exchanges instead of having classic book entry record keeping, they're going to use blockchain type of infrastructure and they're going to see some efficiency gains uh from that. But, it is certainly no revolution of how the financial system works. It is just a slightly different, slightly upgraded version how the financial system works. Now, I

believe that you will see these things gain big traction. That that is my what I'm trying to express uh here. I don't think it is fundamentally changing how the financial system works. It's a much more limited vision than what Ethereum uh is trying to accomplish. But, for investors thinking about Canton, okay? I think we we try to give honest and direct uh investment advice. You know, is this thing going to go up or is this thing going to go down? Uh I believe that, you know, for better or worse, uh given the practicalities of how capital markets work and potentially a defensive posture of institutions wanting to maintain maximum control of what they're doing, I think you will see some success uh of these uh projects and some value

creation for uh tokens that are associated with them. But, it is uh not the expansive vision of global decentralized finance. What one more? Yep. You talked about a little about protocols and blockchains, but you didn't talk about services in the middle, you know? Yeah, yeah. I think they're going to be uh you know, like services trying to standardize and make your own interoperability between those protocols, and those are not going to be blockchains. Uh so, and I think concerning the the subject of your topic of your presentation, that is a huge investment opportunity, maybe even more interesting than some blockchains. Yeah, I agree with that, and I I wondered whether I should write some of those things like along the bottom. I I think,

you know, there are blockchain agnostic uh investment opportunities uh that may be even more compelling but we wanted to talk about compare contrast of these types of networks. But something like a chain link I think is a good example of a good beta expression and expression of the tokenization life cycle. Chain link works with Canton with avalanche with Ethereum obviously. So it is something is a way to build that exposure into portfolio in a way that is more agnostic to chains and then of course there's lots of private investments securitize and super state and these types of things that are service providers helping to bring this vision to life.

And thank you for the questions. I'll just say of course this is a highly simplified highly stylized way to to think about it and there's a lot of complexity a lot of things moving. It's not really going to proceed as you know one two three. But I think that this is how I would encourage people to think about it that you know there are some things that are difficult to challenges that institutional centric models like a Canton I think can solve more immediately that Ethereum in my view has a very expansive vision. I love Ethereum. I think it will achieve these things over time but we got to check a couple more items on the straw map to to fully realize it.

Okay, thank you for the questions and for listening. I'm happy to hang out and chat further about it. Thanks everybody.