The tokenized US treasuries market has seen massive growth in 2023.
According to crypto analytics company rwa.xyz, the value of tokenized US treasury assets that currently exist on public blockchains such as Ethereum and Polygon has grown from around $100 million at the start of 2023 to more than $650 million in August.
Moreover, increasing global interest rates and falling decentralized finance (DeFi) yields have supported the growth of tokenized US treasuries.
Time to explore what US treasuries are and why US treasuries are being tokenized.
What Are US Treasuries?
US treasuries refer to bonds, bills, and notes issued by the US government.
When you buy a US treasury, you are lending your money to the US government. You will earn interest typically every six months (called coupons) and will get back the principal amount on maturity.
US Treasuries are considered among the safest investment instrument in the market because they are backed by the full faith of the US government.
It should be noted that most US treasury instruments are marketable securities, which allow investors to sell their treasuries in the open market before it matures. This brings in market risk to US treasuries. The market value of US treasuries can change depending on external economic conditions such as interest rates and inflation.
However, if an investor buys US treasuries directly from the government and holds it to maturity, it is considered a zero-risk investment.
Types of US Treasuries
- Treasury bills (T-bills) – T-bills are short-term US treasuries that mature between 4 weeks to 52 weeks. T-bills do not pay coupons and are typically sold at a discount (with the discount being the investor’s interest ).
- Treasury notes (T-notes) – T-notes are issued with maturities between two to 10 years. T-notes pay interest every six months.
- Treasury Bonds (T-bonds) – T-bonds are long-term US treasuries maturing at 20 and 30 years. T-bonds pay interest every six months.
- Floating Rate Notes (FRN) – FRN are short-term US treasuries issued for a term of two years. They pay interest every three months. The interest rate fluctuates based on the discount rates for the 13-week T-bills.
- Treasury Inflation-Protected Securities (TIPS) – TIPS are inflation-adjusted US securities that adjust the principal and interest based on changes in the Consumer Price Index. TIPs pay interest every six months and are issued for terms of 5, 10, and 30 years.
What Are Tokenized US Treasuries?
Tokenized US treasuries are the digital representations of US treasury assets, such as bills, notes, and bonds, on a blockchain network. The US treasuries will be represented by a cryptocurrency that investors can buy, hold, sell, and redeem.
Tokenized US Treasury Debt has grown 600% since the start of the year 📈
Check out the latest @axios crypto newsletter, which covers this, and more!
Link below 👇 pic.twitter.com/8hwDJi9Ji0
— RWA.xyz (hiring!) (@rwa_xyz) August 11, 2023
Why are US Treasuries Tokenized?
- Real-world capital
The global financial system is built on top of US treasuries, making it the most important financial instrument in the world. This is due to the use of US treasuries as collateral for loans.
US Treasuries are preferred as collateral due to their reputation of being a risk-free asset. This safe-haven nature has also prompted foreign governments and multinational corporations to diversify and protect their portfolios with US treasuries.
With the tokenization of US treasuries, the crypto world will welcome a highly secured asset that can be used to grow crypto lending markets.
Moreover, the cryptocurrency market is notorious for spinning money out of thin air. A newly-minted meme coin can hit a market capitalization of millions of dollars without any real-world asset backing the project. What tokenized US securities bring into the crypto and DeFi world is cold, hard cash.
- Reach, financial inclusivity, and convenience
Public blockchains and cryptocurrencies have created an open market that anyone can access. This has prompted companies to tokenize real-world assets such as real estate, fine art, and financial products with the aim of reaching wider audiences in the crypto world.
The global nature of public blockchains will allow fund managers to reach out to investors in foreign markets. For overseas investors, getting exposure to a highly-secure US treasury asset will become easy and convenient.
For the crypto degen, tokenized US treasuries could present an alternative to stablecoins to protect against market volatility.
- Liquidity and fractionalization
Tokenization of real-world assets allows the division of an illiquid asset into thousands of digital tokens, which is known as fractionalization. Moreover, easy trading and transfers of cryptocurrencies on decentralized exchanges help improve liquidity conditions for real-world assets.
However, in the case of US Treasuries, since the process is still nascent and the regulatory roadmap still remains unclear, tokenized US Treasuries managers have taken full advantage of the DeFi markets (more on that later).
US Treasuries are yield-bearing instruments. A catalyst for the growing popularity of US treasuries is the global monetary tightening cycle that started in 2022.
The US Federal Reserve has increased interest rates at its fastest pace in 40 years. At the time of writing, the US federal funds rate stood at 5.25% to 5.5%, its highest in over 22 years.
In contrast, DeFi yields have dropped due to falling demand for debt in an ongoing bear market.
Decentralization and Open Market on Hold
Time for the important questions: How are US treasuries being tokenized? How are they being sold to the crypto-natives? Are the core crypto principles of decentralization being maintained?
- Two ledgers
According to a report by rwa.xyz, global asset manager Franklin Templeton is responsible for nearly 50% (or $294.8 million) of the total tokenized US securities market at the time of writing.
Franklin Templeton has tokenized a fund called FOBXX that invests at least 99.5% of its assets in US securities, cash, and repo agreements.
The company uses public blockchains Stellar and Polygon to process transactions and record ownership. Franklin Templeton also maintains an internal ledger of record.
A similar setup was used by traditional finance asset manager WisdomTree Investments, where the company kept the primary record of share ownership and maintained a secondary record on a public blockchain
The majority of players in the tokenized US treasuries market have prioritized regulations. Fund managers like Franklin Templeton, Arca, and Wisdom Tree are obligated to disclose the assets held in the funds, monthly statements of accounts, daily net asset value, and more.
Crypto investors will receive better protection and transparency when investing in tokenized US securities compared to stablecoins.
Meanwhile, crypto-native fund managers like Matrixdock are using the ERC-1400 token standard, which offers greater compliance, control, and recovery mechanisms.
- KYC requirements and USD payments
Regulatory concerns have pushed fund managers to offer tokenized US treasuries in a traditional manner.
Investors also cannot use cryptocurrencies or stablecoins to buy tokenized US treasury products from Franklin Templeton, Arca, and WisdomTree. Investors will also be required to fill out KYC/AML forms before making investments. Lastly, products from Franklin Templeton and Wisdom Tree require investors to download a dedicated mobile application.
There are crypto-native companies like OpenEden that allow investors to gain exposure to US treasuries via stablecoins.
- Illiquid market
At the time of writing, the tokenized US treasuries market was an illiquid one. Most tokenized US treasury products cannot be traded in a peer-to-peer manner (at the moment).
Even the crypto-natively made tokenized treasuries like OpenEden’s TBILL token were not available for peer-to-peer trading on Uniswap due to “insufficient liquidity.”
The growth of tokenized US treasuries is encouraging – although the cyberpunks may point to the loss of decentralization and open market mechanisms in the process. We should note that 2023 marks an early chapter in the introduction of US treasuries to the DeFi world.
Looking to the future, we see better regulatory clarity in the US supporting accelerated developments in this space. The surge in 2023’s tokenized US treasuries market could mark a pivotal fusion point of traditional finance and crypto markets.