Tokenization of Trade Assets: A Game Changer for Global Trade

The tokenization of trade assets is becoming a game changer in global trade. By converting trade assets into transferable digital Tokens, tokenization provides investors with unprecedented liquidity, divisibility, and accessibility.

Traditional financial assets are significantly affected by macro market fluctuations, while trade assets are different. Although trade is closely related to the economy and economic downturns can impact bank lending, the substantial trade financing gap still offers good opportunities for investors. Even during economic slowdowns, the financing demand from small and medium-sized enterprises remains enormous, creating ongoing investment opportunities. To some extent, trade assets can withstand global economic recessions.

Trade assets, due to their short cycles, low default rates, and high financing demands, are more suitable as the underlying assets for tokenization. Furthermore, the tokenization of trade assets can bring numerous benefits to all parties and stages involved in the complex processes of global trade, whether in terms of cross-border trade payments, financing needs, or enhancing efficiency, reducing complexity, and increasing transparency through the use of smart contracts.

A certain bank expects that by 2034, the overall demand for tokenization of real-world assets will reach $30.1 trillion, with trade assets becoming one of the top three tokenized assets, accounting for 16% of the total tokenization market over the next decade.

Drivers of Tokenization of Trade Assets

1. Small and Medium Enterprises: A Trillion Dollar Opportunity to Fill the Trade Finance Gap

Global trade is expected to grow by 55% over the next decade, reaching 32.6 trillion USD by 2030. However, there is a significant gap between the supply and demand for trade finance, particularly for small and medium-sized enterprises in developing countries. The trade finance gap has increased from 1.7 trillion USD in 2020 to 2.5 trillion USD in 2023, a rise of 47%.

The International Finance Corporation estimates that there are 65 million enterprises in developing countries (accounting for 40% of formal micro, small, and medium enterprises) with unmet financing needs. The "missing middle enterprises" or medium-sized market enterprises are a group that investors find difficult to access, particularly active in rapidly developing regions such as the Middle East, Asia, and Africa, representing a large and undeveloped market.

This investment opportunity can also withstand economic downturns. Even during periods of economic slowdown, small and medium-sized enterprises still require significant financing, creating ongoing investment opportunities. According to data, the $2.5 trillion global trade finance gap accounts for 10% of all trade exports. Considering the undisclosed gap, the potential total opportunity could reach $5 trillion.

2. Undeveloped high-yield markets for investors

Trade finance assets are attractive but underinvested. They generate strong risk-adjusted returns and have some unique characteristics:

• Allows for risk diversification. The short duration of trading assets and their ability to self-liquidate are seen as low-risk investments, with lower correlation to the stock and bond markets.
• Broad investment scope. There are various trading assets available to meet specific risk preferences of investors. Along with emerging and frontier markets such as Ghana, Côte d'Ivoire, Bangladesh, or Saudi Arabia, it caters to a wide range of investor needs.
• Low default risk and high recovery rate. Trade finance assets have an impressive performance record, with a low default rate and higher recovery rates in the event of default.

Although institutional investors are underinvested in such assets, tokenization can help address this issue.

3. Banks are incentivized to adopt tokenization

Basel IV will have a significant impact on the way banks calculate risk-weighted assets. Banks need to develop growth strategies through modernized distribution business models. By initiating distribution based on blockchain, banks can derecognize assets from their balance sheets, reduce regulatory capital to cover risks, and facilitate efficient asset initiation.

Banks can leverage tokenization by distributing trade finance instruments to capital markets and emerging digital asset markets. This "digital origin distribution" strategy can enable banks to improve return on equity, expand funding sources, and enhance net interest income.

4. Real demand drives growth

By 2024, 69% of buying companies plan to invest in tokenization assets, up from 10% in 2023. Investors plan to allocate 6% of their portfolios to tokenization assets, which is expected to rise to 9% by 2027.

However, the market supply side is still in its infancy, with the total value of real-world asset tokenization projected to be around $5 billion at the beginning of 2024. In contrast, the addressable market, including the trade finance gap, will reach $14 trillion.

A certain bank predicts that by 2034, the overall demand for tokenization of real-world assets will reach $30.1 trillion, with trade finance assets becoming one of the top three tokenized assets, accounting for 16% of the total tokenization market over the next decade.

Four Benefits of Embracing Tokenization

1. Improve market access

Tokenization opens the door for a wider group of investors. By distributing trade finance assets through digital tokens, banks can increase net interest income and optimize their capital structure, while investors, businesses, and communities can benefit from improved accessibility.

2. Simplifying Trade Complexity

Tokenization provides a platform to solve the complexities of trade. It is not only a new way to access investments but also a driver of deep financing. Token-supported deep supply chain financing can eliminate complexities and enhance the overall resilience and liquidity of the supply chain.

3. Digital Tokenization

Tokenization greatly expands the pool of investable assets. By leveraging tokenization along with the programmability of smart contracts, combined with AI automation, it can address the complexities and diversities of trade asset classes. This aids in status monitoring, minimizes human errors, enhances transparency, and supports the assessment of accounts receivable and financing amounts.

4. Reduce information asymmetry

Using blockchain to trace underlying assets helps reduce information asymmetry between issuers and investors, enhancing investor confidence. Establishing a listing framework for tokenized assets is an important step to encourage adoption and boost investor confidence.

How to Participate in the Tokenization Market

1. Adopt

Investors should start with education to build expertise. Participating in pilot programs can help build confidence in tokenized asset allocation.

2. Cooperation

Collaboration across the entire market is essential for achieving the benefits of tokenization. Banks and financial institutions can expand their reach through collaborative business models. A broader ecosystem must work together to create a supportive environment.

3. Promote

Governments and regulatory bodies play a key role in promoting responsible growth in the digital asset industry. A clear and balanced regulatory framework can foster innovation while mitigating risks. Establishing public-private partnerships with banks and other financial institutions is also crucial.

Through this collaboration, regulators can ensure that the growth of the digital asset industry benefits the economy, improves global financial integration, creates job opportunities, and maintains market integrity and investor protection.