“Tokenization might be one of the largest commercial opportunities in history.”
Shaun Martinak
Today, less than 0.25% of total global assets are represented on blockchain infrastructure.
However, with financial powerhouses like BlackRock starting to put entire funds on chain, and as critical pieces of institutional infrastructure become marketable, we can anticipate a significant increase in this percentage in the near future.
One company leading the charge is Coinbase with their asset management division.
Last year, Coinbase unveiled Project Diamond, an innovative platform designed to enable institutional investors to issue and manage digitally native assets within a regulated framework.
At TOKENFUTURE, Coinbase Asset Management will provide an in-depth exploration of Project Diamond, alongside discussions on the topic of onchain trading of tokenized assets. However, with the platform's launch on the horizon, Shaun Martinak, the engineering lead behind Project Diamond, graciously offered an hour of his time to share his insights with me ahead of the event.
I found Shaun’s perspective on the future of financial markets, the status quo of institutional adoption and his work on Project Diamond so valuable, that I thought that I should share the entirety of our conversation.
By the way: This interview marks the beginning of a series of conversations with the foremost leaders in tokenization. To stay in the know, follow us on LinkedIn.
So without further ado, please enjoy my interview with Shaun.
Sizing the market opportunity of tokenization
How do you see the opportunity space for tokenizing assets?
Frankly, I believe it might be one of the largest commercial opportunities in history.
If we take a look at the past, we can see that internet-native technology has already disrupted and improved many other industry verticals, from media and communications to commerce. But given their regulatory integration, financial markets have been largely insulated from a lot of that change.
Now, through tokenization, the financial system is also able to transition to a new, internet-native infrastructure.
This will impact every financial institution, enabling them to leverage modern digital tools and property rights on the internet. It kicks off a next phase of opportunity, and competition.
Is this transformation limited to certain asset types or do you foresee a future where every asset will be traded on blockchain rails?
I think it applies to absolutely everything. We have introduced internet-native property rights and the means to enforce them. Those rights are the foundation of a functioning economy.
Ultimately, every major player in the traditional banking and financial services sector will transition away from the old technology stack their systems are built upon - simply because blockchain-based digital systems are faster, cheaper, and better for these purposes.
But that doesn't mean the technology stack and applications will be uniform across all asset classes. For instance, we might have heavily permissioned environments for certain types of assets or activities - alongside very open venues for others.
Status quo of institutional adoption
Where do we stand in the adoption life cycle of tokenized assets?
We're still early.
Until now, the adoption of tokenized assets, primarily tokenized US treasury bills, was driven by the demand of crypto-native investors to gain exposure to the risk-free rate.
In contrast, institutions naturally adopt new technology more slowly.
For institutional players, the shift towards a new infrastructure comes with operational complexity - something they are only willing to accept if necessary. That necessity comes from competition – the ability to take market share, or the need to protect it.
But because their systems right now work quite well, and the concrete improvements that are possible by incorporating tokenized assets haven't been proven at a meaningful scale yet, we're kind of frozen in the adoption cycle.
What we need to “break the ice” is a first mover - someone that demonstrates and capitalizes on the benefits provided by this new tech stack - to push the rest of the industry down the same path. Competitive dynamics will turn experimental technology into table stakes.
Today, the clearest benefits are in the movement of tokenized assets. The ability to transfer and settle them quickly for collateral operations, and to fractionalize them and distribute them in new and useful ways. Both are enabled by the inherent properties of tokenized property rights and the blockchain networks they live on.
Projecting forward, the impact of these technologies in their better, faster, cheaper state - where they become core infrastructure - is an expansion of market activity to many orders of magnitude larger than what it is today.
When you talk to your clients, is tokenization still a hard sell?
It's gotten a lot easier in the last six months, that's for sure.
Besides the enthusiasm we experienced in the digital assets markets recently, the big change was that we've had some market leaders really engage with the technology in a committed way - and as I've previously mentioned, what it often takes in the institutional landscape is someone to go first. Lasting change comes from the wave that follows.
In the conversations I’m having today, it feels like a recent and widely accepted fact that tokenization will have a lasting impact on the makeup of global markets. The question is timeline.
This is a stark contrast to the conversations I had 12 months ago. Back then, I was still getting a lot of strong opinions that the technology would remain irrelevant.
So, the narrative has changed 180 degrees. That’s worth drawing attention to. This is why for many companies the question today revolves around the "when" and "how" to engage with tokenization, given their respective starting points and corporate cultures.
What are the biggest obstacles these institutions are still facing?
I think it's operationalizing.
There is a lot of complexity inside institutions, especially when integrating new systems into existing ones. Building a reliable understanding of the risks and requirements, like regulatory reporting and annual audit cycles, takes repetition. Institutions haven't had the chance to gain this kind of experience yet.
So, first, they have to go from zero to one by doing something live, then, as they repeat the process, they become increasingly comfortable that it can integrate into their broader operational process.
In a lot of ways the products are only now becoming commercially ready to take institutional users on that journey. For example, the blockchain networks themselves, custodial infrastructure, reporting, interfaces, etc.
Ultimately, compared to previous technological innovations in the financial sector, the integration of blockchains takes more time. They are an innovation at the deepest layer of the technology stack.
The fintech innovation we've seen over the last 20 years has been from the middle of the technological stack to the surface layer, where the new interfaces made everything easier, faster and thereby more operational friendly. But they were unable to address the embedded inefficiencies of the rails.
On the other hand, the integration of blockchains occurs at the base layer, property rights and their handling on the internet, causing major shifts in the way we build and operate businesses. Right now, our task is to harness this potential in a way that syncs with the evolution of market participants, underscoring my earlier point that we're still very early in the adoption lifecycle.
Project Diamond
Let’s talk about Project Diamond. We saw the announcement a couple of months ago. Could you please tell on a high-level first what Diamond is about?
Absolutely!
In essence, Project Diamond let’s users create digitally native assets in a regulated format and manage them through their lifecycle. It’s a platform built to provide the tools to upgrade current business models with blockchain infrastructure, and to unlock new business models with this technology.
A reasonable analogue is what Apple's App Store looked like in its earliest days. Project Diamond is a platform. Back then, Apple had to build the first few applications themselves to showcase the capabilities provided by the company's hardware and software. The App Store was a standards layer that allowed both to work together and a home to invite in providers to build their own apps.
In our case, we want to showcase the capabilities provided by smart contracts in a regulated format and prove the value of onchain native financial tooling compared to the traditional way of doing things.
By demonstrating that important processes can be executed in a faster, more secure, and cheaper way, we can highlight the efficiency gains and, consequently, opportunities for margin expansion.
The ultimate goal is to create a modular platform, meaning that many other service providers and tooling should be onboarded over time. This creates a network effect.
Will Diamond be focusing on issuing these assets or will you also offer secondary trading capabilities in the beginning?
The platform begins with the primary issuance and management of digitally native assets. Our focus is on providing the necessary infrastructure and tools to create and operate these instruments throughout their lifecycle.
Over time we will bring in secondary trading capabilities. We have some exciting work happening in the background there.
What are the first types of assets that are going to be issued on Diamond?
Initially, we will issue short-term discount notes, primarily because they are the simplest form of fixed income instruments and allow users to build experience through repetition. These instruments often have maturity dates of a few days to a month.
Users will be able to lend and borrow based on these instruments within a fully KYC-compliant environment with regulatory clarity.
This way, they can gain the necessary experience of creating and managing credit in an internet-native way - a process that is fragmented, and often clunky, today.
Which user groups are you going to target?
Project Diamond will be used by a diverse set of market participants, ranging from larger financial service providers to small and medium sized enterprises. Businesses of all types need to borrow and lend.
It’s also useful to separate B2C and B2B use cases.
On the one side, you will have those players using the platform to lend or borrow directly through our frontend - this is the B2C case. In order to create the best possible user experience, the interactions are fully account abstracted, meaning that users only manage USDC in their wallets without an additional gas token.
On the other hand, the first users are already thinking about B2B capabilities and how they can integrate this platform natively into their businesses, thereby upgrading their own business models. That will require direct connectivity at the code level, through APIs.
For example, enterprises might want to enable lending and borrowing within their own user-facing applications. Down the road, those use cases will be possible by integrating the platform natively into that enterprise's existing systems.
What do you think about the distinction between digital-native assets and RWAs or “digital twins”?
I think those are really important distinctions to understand.
The creation of digital twins represents a very useful first step towards the end goal of broad tokenization. Digital twins are created when we take already existing assets and represent them digitally, in the form of tokens, on blockchain rails.
By doing this, more efficient forms of transfer, settlement, and an ability to fractionalize are unleashed.
The main issue is that you need to manage two operational layers now, both on- and offchain.
This, of course, creates additional costs and does not capture the full efficiency gains. It also preserves some of the operational limitations of the current system.
The ultimate goal of tokenization is to create fully digital-native assets, which unlocks the full set of efficiency improvements. Fully digital-native in this context simply means that the asset's entire lifecycle takes place on a blockchain, from creation to final maturity.
It's obvious that, at least for the foreseeable future, digitally native representations of all real-world assets, for example a specific warehouse in Germany, or construction equipment in the US midwest, will not be feasible. But it may be extremely valuable to represent them onchain and use them as collateral.
This is where the use of digital twins can play a powerful, long-term role.
You've built Diamond using Coinbase-developed Layer-2 blockchain Base. What motivated this decision? Alternatively, why did you opt not to use a permissioned blockchain, similar to J.P. Morgan's approach?"
To really achieve internet scale network effects, we need a global public base layer. I think it's extremely important.
While private environments may suffice for current business models, I believe that public networks' interoperability will unlock the next generation of business models. Especially because open and permissionless networks tap into the creativity of so many talented people, and it's extremely difficult to compete with that in a closed environment.
Permissioning and regulatory clarity is critical for institutions, but we still can harness the power of public networks as our base layer and design our own compliant systems on top as we and our users see fit.
And what do you think about the privacy implications here?
I think in the long run, there's a lot of technology development to come, and there are already clear ideas about how to solve some of these problems by connecting private transactions to public records in a way that doesn't disclose all of the details.
We have already gained some practical experience with this, by conducting a so-called blind dutch auction for the primary issuance of instruments.
Without getting too deep into the technical details, we moved the entire auction system - basically the place, where the bids are made - offchain. After the auction the instruments are issued directly into a digitally native format on a public blockchain. In order to make sure that everything was executed in a fair way, we make use of zero-knowledge-proofs.
Using this system, we can provide institutional clients with the things they value most: privacy and cash efficiency, while maintaining all gains from public blockchain rails.
When are you going to launch Diamond and how will you roll it out?
We’re planning to launch over the next few months.
Currently we're finalizing our regulatory status, entity setup, and all the nuts and bolts of operationally going live.
But it's important to point out that there will be some initial limitations in place.
Within the Abu Dhabi Global Market (“ADGM") RegLab, the development environment inside which our platform is expected to launch, we expect to have a limited list of users and a maximum amount of capital or debt outstanding on the platform.
We will demonstrate continuous commercial operation and grow user activity - but at a managed size and scale that will step up through time in conjunction with ADGM’s rules.
At the end of that RegLab process we expect to have the clarity to run a truly open, global business. It’s very exciting.
Are you also actively exploring tokenization within your organization?
On June 18th we host an exclusive event around tokenization tailored towards institutional investors, capital allocators and banks in Frankfurt am Main.
Learn more on our website or feel free to reach out to max@blockstories.de.