Digitisation and tokenisation are widely touted for their potential in cutting transaction costs and smoothing settlement frictions, but the technology’s real pay-off will come from deeper market liquidity and higher market participation over the long-term, according to a new report.

The study, released by the Digital Finance Cooperative Research Centre (DFCRC) whose board members include Future Fund board director Deborah Ralston, says high-turnover asset classes are set to benefit the most from tokenisation, with a $7.2 billion of annual efficiency gain expected in foreign exchange alone. 

“Lower transaction costs and reduced settlement frictions initially generate savings, but the dominant second-order effect is increased trading activity, deeper liquidity, and higher market participation, creating additional gains from trade. Reductions in cost of capital for issuers are yet another important second-order effect,” the report says.

“More liquid secondary markets reduce issuers’ cost of capital, enabling additional real investment. Efficiency gains in markets therefore extend beyond trading desks to broader economic activity.”

Tokenisation generally refers to the process of turning financial assets into digital tokens, which are recorded through blockchain and distributed ledger technology (DLT).

The report estimated that the potential economic gain in foreign exchange dwarfs other asset classes both in total dollar value and per dollar tokenised. This is observed from an increased efficiency in reducing intermediaries, transactions costs and manual back-office processes.

“The FX market’s enormous transaction volume means that even modest reductions in spreads or intermediary fees translate into large economy-wide gains,” the report says.

“Tokenised settlement assets combined with automated FX trading could generate up to $3 billion per annum in savings from correspondent banking processes and $3.4 billion per annum in transaction cost reductions.”

Elsewhere, tokenisation is also estimated to give public and private market fund investments a $2.2 billion economic uplift per annum. In the Australian context, this comes from significant potential in slimming down costs around asset servicing, manual processes in applications and redemptions, reconciliation and unit valuations, “which could be removed to a large extent by on-chain registries and transaction processing”.

“For example, unit trust applications require extensive manual KYC checks, investor information is fragmented across several systems, transfer agents and registry service providers, and redemptions often settle with significant delays due to inefficient fund accounting and unit pricing mechanisms,” the report says.

“The lack of automation in back-office processes further implies a high rate of errors or significant costs associated with quality assurance.”

Other frequently traded asset classes including public debts and public equities can expect an annual economic gain of $1.3 billion and $1 billion respectively. In public debts, the biggest efficiency improvement is likely to come from economic surplus from increased trading volume, followed by reduced middle and back-office costs and custody fees.

In public equities, the bulk of savings linked to tokenisation will come from reduced transaction costs and reduced operational costs in clearing and settlement.

With that said, the report warned that Australia is only set to capture $1 billion out of the potential $24 billion annual efficiency gain from digital finance if it continues the current regulatory trajectory.

It suggested that Australia began policies around three priorities, including deploying the foundational infrastructure such as tokenised government bonds and wholesale central bank digital currency, in a regulatory and industry sandbox.

“The data suggests these foundational components would enable the development of tokenised markets, collateralised lending, payments, and related services,” the report says.

“The economic implications of delayed adoption are compounded by the time value of money. Because financial infrastructure investments have persistent effects, delays reduce the cumulative and present value of economic benefits.

“Each year of delayed adoption represents lost productivity improvements, higher operating costs, and reduced international competitiveness.”