LEDGERPATH

Anchoring

As Mo was arguing in the previous blog post, crypto does display quite a few of the requirements for being considered a currency. Sure, it’s still early days, and, if a currency, a rather volatile one with much left to be desired. But if cryptocurrencies brings money into the modern age, this is good.

Now while there are many use cases I can think of for crypto as a bridging asset, there’s another use case on blockchain I personally think will become even bigger, if not the number 1 use case for DLTs: Anchoring.

What is anchoring?

If you’ve not heard the term anchoring you might have heard of tokenization? The video below does a pretty good job of explaining it, using Stellar as an example.

In short, anchoring is taking some other asset, be that a commodity, fiat currency, other cryptocurrency, stocks, etc, and putting this on the blockchain.

Let’s say I have a £10 note. As an example, say we can divide this into 10 * 100 pence which we then translate into 1000 tokens. Assuming I remain a good custodian of the original £10 note I can sell these 1000 tokens for a value of £10 (minus any fees).

The buyer of the tokens would exchange them with me for something else in return, which at the point of the trade we both agree is equal in value. With that we’ve just created a stablecoin, and I can issue more of this stablecoin if people send me more money. In return for this money I give them new tokens.

Now of course I need to ensure I keep this money safe. If I go off and spend them, lose them, or otherwise can’t make good on them, then the tokens no longer map 1-to-1 to its underlying and the value of the tokens have decreased. This is a form of counterparty risk.

Huge benefits for settlement

It might not immediately be obvious why the above setup would benefit anyone. It seems we might just have introduced additional counterparty risk, so why would we do that?

There’s a huge benefit to this: Settlements.

Have you ever exchanged currency before? With the traditional banking setup this is a nightmare. It’s slow, and costly, taking several days.

On a DLT like Stellar however, it only takes 3-5 seconds to change the holder of these tokens. Imagine there exists USD tokens and GBP tokens. I’m interested in exchanging my 1000 GBP tokens (representing my £10 note) for an equal value in USD tokens.

All I need for this to happen is to find someone else willing to do the trade. Someone holding USD tokens but wanting GBP tokens will meet my demand for the opposite. And 3-5 seconds later this trade is settled, instead of several days later. In a later blog post I’ll look at how DLTs can help facilitate this trade with decentralized exchange (DEX) functionality, which includes advanced features like atomic multi-leg transactions.

We can achieve similar benefits for other assets, like commodities, stocks, bonds and so on. We tokenize them like we did for the currency, and sell the tokens on the ledger. Any holder of these tokens is free to exchange them again for other tokens, again benefitting from the near instant settlement. Working out who owned what asset at which point in time becomes a simple task of looking at the ledger history.

And if someone at some point want to take delivery of the underlying they’d sell the tokens back to the issuer, much like many derivatives in the existing financial ecosystem.

Early days

As of writing this we certainly are in the early days of anchoring and tokenization of assets. But things are happening. While stablecoins have been out there for a while, we also see real estate and bonds hitting the DLTs. As the benefits become obvious for all, it’s only fair to assume we will see more of this.



This blog post was written by Christian. He's got several years of experience working within FinTech holding a MSc in Quantitative Finance and a BSc in Computer Science and Industrial Automation.

Subscribe to our mailing list