Intersection of Bonds and Blockchain: A look into the future of the Bond Market
Exploring the advantages of blockchain based bonds, use cases thus far and protocols innovating in DeFi
Growth and Evolution of the Bond Market
Bonds have long been a popular investment option for individuals and institutions alike. For decades, the bond market has been a fundamental pillar of the global financial system, attracting investors looking for safe and stable returns. The bond market has experienced remarkable growth with the market size reaching $128 trillion in 2020, up from $17.5 trillion in the 1990’s (Bank of International Settlements).
Behind the massive rise and interest in bonds among market participants has been the large economic growth and interconnectedness and financial innovations with new bond products. Furthermore, bonds have traditionally been considered a safe-haven investment option in times of market volatility, providing a reliable source of income for investors during economic downturns. This has further fuelled the bond market’s growth, as investors have sought to hedge against the risk of market volatility and economic uncertainty.
Source: ICMA analysis using Bloomberg Data (August 2020)
The evolution of bonds over the years has been significant and noteworthy. In the past, bonds were typically issued on paper. Paper bonds had been prevalent since the 1700s and continued well throughout the 21st century. During this time, physical exchange of the bonds between investors and issuers was commonplace.
Paper bonds were highly inefficient as there was always a risk of losing or damage, slow at transferring ownership and worst of all limiting in participation. The rise of digital technologies in the 2000’s radically changed the way bonds were issued and are transferred. Today, almost all bonds are issued and traded electronically. The bond market has become more accessible and efficient, with more individuals being able to invest in the market and businesses easily obtaining the capital thy need.
However, one problem still remains. Intermediaries such as such as banks, brokers and clearinghouses are still heavily relied on to facilitate the buying and selling of these bonds. Fortunately, the emergence of blockchain technology has been a game changer.
Blockchain allows investors to buy and sell bonds directly, which has dramatically increased transparency and efficiency. Not only that, but it also helps reduce costs associated with bond trading and reduces settlement times from days to minutes. Blockchain also presents an ideal fit for tokenisation of existing bonds on-chain and bringing trillions of dollars in value to DeFi.
Why use blockchains for Issuing and Tokenising Bonds?
The use of blockchain technology for issuing bonds offers several advantages over traditional methods. Transparency, security, automation and removal of the need for CSD’s have been some of the more noteworthy benefits for using the blockchain as a means to issue and manage bonds.
Automation and reduced settlement timing
With the power of self-executing smart contracts, bond issuers are able to automate their processes and the entire lifecycle of a bond from issuance to settlement. Automation of bond coupons is another key advantage which allows coupons to be programmed on the smart contract and automatically paid out to bondholders. Automation not only reduces costs but also ensures greater transparency and security in the bond issuance process.
Removing the need for Central Security Depository and Custodians
In traditional bond markets, CSDs play a crucial role in providing custody and clearing services. However, the use of blockchain eliminates the need for such intermediaries as bonds can be held directly on the blockchain and traded between investors, resulting in faster, more efficient, and secure transactions. This also reduces the costs associated with using CSDs and custodians.
Transparency and Security
The use of blockchain ensures that the records are immutable and tamper proof to access accurate data in real-time. Blockchains allows for better market transparency as trading flows and asset owners can easily be publicly identified on-chain. This provides a key advantage for investors and bond issuers alike.
Furthermore, tokenisation of traditional bonds on the blockchain has also been a promising approach that has been popular in recent times. Some of the key benefits of tokenising existing bonds and creating digital tokens that represent ownership of the underlying bonds are increased liquidity, transparency, efficiency and access to traditional capital markets.
Banks that have dabbled with Public Blockchains for Bond Issuances and Tokenisation
Numerous large banks worldwide have been testing and utilising public blockchains to issue bonds and tokenize financial instruments.
Societe Generale SFG issued a 5 million Euro Medium-Term Note, fixed debt security that expires in five to ten years, on Tezos in 2021. The securities were fully subscribed by Societe Generale Assurances. The issue marked a new step in the development of Societe Generale - Forge, their regulated subsidiary that offers crypto assets structuring, issuing, exchange and custody services to professional clients.
Banco Santander issued a tokenized $20 million bond using distributed ledger technology on the Ethereum blockchain. The bond will live on the blockchain until maturity with both investments and quarterly coupons tokenized as securities. The quarterly coupons at a rate of 1.98% had been tokenised and automated for the entire year until maturity. Smart contracts were also used to whitelist entities with KYC to hold tokens.
https://twitter.com/_JohnWhelan/status/1172281787453706241
The European Investment Bank (EIB) issued a EUR 100m 2-year bond using public blockchain (Ethereum) in collaboration with Goldman Sachs, Santander and Societe Generale as joint lead managers for it. The payment of issuing monies from the underwriters to the EIB has been represented on the blockchain in the form of CBDC. Society Generale’s Forge subsidiary provided the issuer, lead manager and investors end-to-end services to issue and manage the digital securities on the blockchain. Since then, EIB has released a 100 Euro bond on a private blockchain and recently issued its first ever digital bond in pound sterling on a private blockchain under HSBC’s Orion platform.
UBS issued $50 million of tokenized debt securities to high-net-worth individuals and family offices in Hong Kong and Singapore. The private placement of the six-month US-denominated instruments marks the first time that uncertificated securities on a blockchain have been constituted under English and Swiss law, and tokenized on Ethereum-based blockchain.
BNP Paribas structured and tokenised a project finance bond on the Ethereum blockchain where the proceeds were used to fund solar energy projects. The bank cited a key benefit of tokenisation as enabling smaller renewable energy projects to raise funds and allow investment of smaller amounts. The bond investor was BNP Paribas Asset Management and so the bond was converted into a traditional bond, without it being retained on the blockchain as tokens.
ABN AMRO released a digital bond for a Midcorp client on the public blockchain. The bonds were issued to a select group of investors and 450,000 Euro was raised on behalf of one of the banks commercial client. The entire process of preparing, placing and documenting the bond was digital and ownership was recorded on the blockchain through tokens that investors acquired after paying for the bond.
DeFi Protocols Innovating in Issuance and tokenisation of Bonds
Obligate
Obligate is a platform that enables companies to issue on-chain bonds and commercial papers to obtain funding from a diverse range of investors. The platform is able to provide these traditional offerings with the same regulatory certainty at a fraction of the cost and time. Obligate uses smart contracts and tokenization in the place of intermediaries to reduce costs associated with bond issuances by 80% and reduce the time needed for issuance to hours.
The Obligate platform allows for bond issuances through operators and issuers. The operator determines the off-chain terms and allocations, with issuers confirming their correctness through on-chain signatures which deploys the bond. Investors fund their allocated orders into escrow, and once completed, funds and bonds are exchanged between issuer and investor.
Ondo Finance
Ondo Finance is a DeFi platform that offers tokenised funds to invest in bonds and US treasuries, bringing institutional-grade finance on-chain, for everyone. Investors can browse through a list of available funds, their expected yields and risks. Once the investor invests in one of the funds by depositing stablecoins, tokens representing the share of the fund will be deposited to the investor’s wallets. Ondo finance offerings include high yield corporate bond fund, short term US government bonds fund, and US money market funds. Ondo’s funds invests exclusively in multi-billion dollar, highly liquid, ETFs managed by the world's preeminent bond managers.
Swarm
Swarm is a platform that brings unique tokenisation and trading solutions to the world of traditional finance. The platform works with real-world asset owners to tokenise collateral and to build trading infrastructure. Swarm became the first organisation to offer regulatory compliant tokenized US Treasury bills and stocks. The asset backed tokens are available on polygon for retail and institutional investors. The platforms does not take custody of the tokens that are controlled by code and the tokens can be added to liquidity pools to earn yield or kept within investors wallets.
OpenEden
OpenEden is a protocol that brings real world assets to DeFi to unlock trillions of dollars in value. The protocol launched its OpenEden T-Bill vault, an on-chain pool that allows stablecoin holders to earn real world yield from the US Treasury Bills. It is the first smart contract vault that is managed by a regulatory financial institution and gives participants access to the US Treasury Billis 24/7. Majority of the pool is invested directly into short-dated US Treasury Bills off-chain, with a small portion that lives on-chain to facilitate withdrawals.
Conclusion
Developments from the largest banks are indicative of an increasing trend towards embracing blockchain technology for debt securities that promise improved efficiency and transparency while reducing costs significantly. Going forward, we expect to see more offerings relating to bonds and tokenisation by traditional institutions as they look to capitalize on the benefits of blockchain technology.
Meanwhile, numerous DeFi protocols are actively building innovative solutions to issue and tokenise bonds in the market. The potential to revolutionise the bond market is immense and we remain confident that the DeFi sector will continue to generate new ideas to tap into this trillion-dollar industry.
If you are building innovative DeFi applications, we would like to talk to you. Feel free to reach out to us at hello@risingcap.co.
About Rising Capital
Rising Capital is a Singapore head-quartered Digital Assets Management firm focused on early stage blockchain investments (Rising Captial Fund) and venture building studio (Rising Studios) in South & South East Asia. Since 2013, the team has built, operated and sold several crypto ventures before setting up ‘Rising’ to capture significant return asymmetries by picking and investing in brilliant founders, while keeping a majority of investments in liquid assets.
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