Crisis Resilience: How Tokenization Could Empower Banks

The recent bank crisis has sparked concerns and uncertainty in the financial world. With the takeover of Credit Suisse by UBS, and the collapses of Silvergate Bank, Silicon Valley Bank, and Signature Bank. We want to share some of our views on the role tokenization may play in the future of banking.

Bank Runs: Crisis Calls for Transparency and Trust

Countless bank runs have occurred throughout financial history, as no bank can survive a situation where a large number of depositors demand repayment simultaneously. Banks mostly generate income by lending deposited funds at higher interest rates; they cannot maintain enough cash reserves to cover all deposits at once.

The Twitter-era Bank Crisis Spreads Contagiously Faster Than Ever

Swift information dissemination via social media and mobile banking accelerates the potential for bank runs. In a single day, Silicon Valley Bank’s customers withdrew $42 billion, far exceeding the largest bank run in modern U.S. history, which happened at Washington Mutual in 2008 and totaled $16.7 billion but took 10 days to transpire.

As the banking crisis continues, people are increasingly distrustful of keeping their money in banks, as illustrated by the following chart. According to DBS, in 2023, US commercial banks experienced their largest deposit drop in four decades, surpassing even the 1981 Volcker-era decline. This situation calls for banks to enhance risk management and transparency to regain depositors’ trust.

Money Moves To Money Market Funds

Depositors are shifting money to money market funds due to concerns about banks, such as Silicon Valley Bank, investing in long-term government bonds, which experienced losses when sold to meet depositor demands. Additionally, money market funds offer attractive yields, some are over 4%, significantly higher than the 0.37% FDIC-reported rate for bank deposits. Financial Times reported that money market funds have received over $286 billion in inflows during March, as depicted in the chart below. It marks the largest month of inflows since the Covid-19 crisis began.

Furthermore, money market funds can tokenize their assets to rapidly gain market share and even take it a step further by allowing tokenized funds to be used as collateral. This is precisely what J.P. Morgan and BlackRock achieved last May, settling their first transaction using tokenized money market funds as collateral, paving the way for bridging Traditional Finance (TraFi) with Decentralized Finance (DeFi).

Tokenization: Steering Institutions Towards Crisis Resilience

The internet has revolutionized the way we exchange information, but the transfer of value has remained relatively unchanged, especially in private markets. Tokenization provides the solution to allow value to be exchanged efficiently and securely, empowering banks and institutions to navigate financial crises. Let’s list a few benefits:

1. Transparency: Tokenization offers an immutable and publicly accessible record of asset ownership and movement, boosting investor confidence and accountability in banks’ portfolios and balance sheets. We saw a similar trend in cryptos post-FTX with the emergence of “proof-of-reserves” by exchanges and new services from data providers such as Chainlink.
2. Real-time rebalancing: Tokenization enables the atomic settlement of securities, granting banks greater flexibility and resilience during liquidity crises by enabling rapid asset trades.
3. Dynamic Portfolio: Tokenization allows banks to create extensive, diversified portfolios. Private assets have been overperforming public assets for years. Tokenization is transforming private markets with a shared infrastructure that enables seamless global trading of private assets. Consequently, banks can strengthen risk resilience by investing across various regions and markets.
4. 24/7 Automated Risk Management: Tokenized securities enable banks to deploy smart contracts for automating risk strategies and processes, providing continuous monitoring and automatic adjustments to portfolios when predefined conditions are met.
5. DeFi Bailouts: As blockchain-savvy investors move towards DeFi for its transparency and code-based approach, banks could potentially leverage DeFi for refinancing and assistance during crises in the future, once massive adoption is realized.

The recent bank crisis has exposed the weaknesses in traditional banking systems and the need for change. As the future of securities is tokenization, it would certainly play an important role in the future of banking crises; as we explore, the benefits and challenges will be more clear.

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