Tokenisation. What changes for liquidity management?

April 22, 2024

Tokenisation in general refers to having an asset represented by a token on a distributed ledger tech (DLT) system. Very generally, the resulting tokens are either a representation of an existing asset, or so-called 'native' tokens. In the area of money market funds (MMFs) the folks at Wisdom Tree started the ball rolling in this area (see here). If you are a Liquidity Manager you will not be bothered about whether a particular token is native or not, but you will care if something being a token gives you new optionality.

5 ways a tokenised MMF might be useful for liquidity

Faster process when you want to sell

Daily settlement might be the norm, T-zero as it were. 'T-instant' might be an advantage in some circumstances. For this to work, we will need the infrastructure to connect the tokens to a widely accepted means of payment to enable DvP. In prior posts, I talked about Stablecoins. If you are willing to trade tokenised MMFs against a Stablecoin, you could do that now. Some risk, as the MMFs will be regulated and less likely to break any peg than any unregulated Stablecoin. And in my mind, I’d only want to do that trade, selling MMFs to get a Stablecoin, if I needed “cash” and the person whom I needed to give cash to would accept the Stablecoin in settlement.

Faster process when you want to do a repo to raise cash

This has the same considerations as above.

Use the MMF as collateral for margin calls

This is a really interesting use case. When something is centrally cleared via a CCP, then as a rule, variation margin (VM) calls are in cash. In the world of “uncleared margin” though, there is more flexibility. This use case is top of mind at the Investment Association. They have published a series of papers on this; click here for the most recent one.

This is worth thinking about; if you know an MMF can be used as collateral, you can invest rather than hold cash. And, if you do need to use it as collateral, you are not forced to sell, which always creates downward pressure on price. In the autumn 2022 near death experience for liability driven investment (LDI) funds in the UK, margin calls forced sales which forced prices down which forced more margin calls. If we can reduce the risk of forced, fire sales, then that is a great thing.

Overall, there is the potential for two positive impacts on investor returns here:

1. A positive impact on returns if there is less need to hold cash.
   
   
2. Another line of defence for generating liquidity without a fire sale.
   
   

If the investor managers get better returns, that is good for all of us.

Collateral upgrades

Typically this is something which is a sell-side to buy-side interaction: a broker-dealer or a hedge fund needs to swap one class of collateral for HQLA (High Quality Liquid Assets) in order to do a repo and raise cash. Traditionally that requires two “free of payment“ deliveries which means taking settlement risk; each party sends the securities in question to the other, crossing their fingers that the other party fulfills its obligation. In normal securities settlement we avoid this with DvP, (Delivery vs. Payment). Until recently, there was no mechanism to do DvD, (Delivery vs. Delivery). That has changed now; the folks at HQLAx have made this possible. Until now, their offering has focused on providing a bridge between existing securitised assets and a tokenised settlement process. Tokenised MMFs could take advantage of the same capabilities.

Tokens as a means of payment

Up until now, ordinary investors are forced to make a choice between holding investments and holding cash. They need the latter to pay bills and deal with everyday life. Web 3 and the world of tokens and wallets offers new possibilities. What about if you had a tokenised MMF and could use that as a means of payment? You would have new optionality; like a professional investor, the consumer can stay invested, earning some yield and then being able to use the MMF to pay for things. That is just what the team at Yodl Pay are enabling. Done right, we would not always need the card processors in the middle. That would increase returns for merchants.

So what? What should I do?

My overall view here is one of “be interested, be curious”. Tokenisation is going to happen and it opens up new possibilities. Get involved. To quote the great Michael Jordan: “Some people want it to happen, some wish it would happen, others make it happen”.

Now depending on what you do for a living, the where to start might differ.

Here are some ideas:

If you are a liquidity manager in an investment firm, then I suggest starting at the Investment Association’s work and at the Wisdom Tree fund.

If you are a collateral manager, I’d say the same thing and add to it that you should look at HQLAx.

If you are a retail investor, interest yourself in Wisdom Tree and YodlPay.

If you are a merchant and selling stuff to people, especially cross-border, go study YodlPay.

Thanks for reading. Please do let me know what you think of these notes. Feedback via the comments would be great.

Please feel free to get in contact via LiquidityFinder here

Olaf is a liquidity and financial services expert. He is the founder of 3C Advisory  You can message Olaf directly here.