Ever since humans first began to trade assets of any kind, the need arose to record those trades to keep an account of what was owed, to whom, and to record tax payments, even measure the wealth of kingdoms. Civilisations are built on ledgers.

In Mesopotamia, merchants used clay tablets to record transactions. Papyrus scrolls were used in Egypt. In China, bamboo strips were used and later replaced with silk and paper. In India birch bark, palm leaves and copper plates. Ancient Romans used wax tablets, papyrus scrolls, and parchment.

Early ledgers were secured in temples or palaces of the ruling elite and stamped with the seal of the monarch or king, in order to establish trust in those records.

During the Middle Ages, the double-entry accounting system was developed by Italian mathematician Luca Pacioli. It used two columns to record financial transactions. One to record debits, or assets going out, and another to record credits, or assets coming in. This allowed for more accurate record-keeping, and helped prevent fraud and errors in financial statements.

Financial instruments such as coins, notes, and contracts that represent a claim to a financial asset or cash flow, have also existed for centuries alongside ledgers.

During the Middle Ages, instruments such as bills of exchange were developed for merchants to trade goods and services over long distances without having to physically transport cash. In the 17th and 18th centuries, the development of joint-stock companies led to the creation of stocks and bonds as ways to raise capital for business ventures.

However, it was in the 20th century that financial instruments began to take on their modern form with the growth of financial markets and the rise of modern finance. This saw the development of new financial instruments such as derivatives, futures contracts, and options, which have since become increasingly complex and sophisticated.

Securitization was first developed in the 1970s by a group of investment bankers at Salomon Brothers, a now-defunct investment bank. The first asset-backed security (ABS) was issued in 1970 by the Government National Mortgage Association (GNMA), a U.S. government agency, to securitize mortgages. The first mortgage-backed security (MBS) was issued in 1968.

Despite innovations in ledgers and financial instruments, there is one thing that fundamentally has not changed from the time of clay tablets up until today - the need to reconcile payments with ownership of assets.

Reconciliation means figuring out how two ledgers relate to each other. For example, if a company sells shares of stock to an investor, the shares must be reconciled with the money paid for them. Two ledgers are being reconciled here to ensure accuracy and prevent discrepancies:

• The ledger of payments (bank transactions) and

• The ledger of ownership of company shares

Ledgers have to be audited and approved to ensure someone did not make a mistake. Even when the books are well maintained and audited, it can become very difficult to figure out what the underlying collateral or asset for a financial instrument actually is. Pulling up paper or even digital records from database silos across multiple organisations is expensive and time consuming. This is why ratings agencies have a role to play. However, you do need to trust the rating agencies, trust that the people working there have the right information and haven’t made a mistake.

For the first time ever since humans started off on clay tablets and bark, it is now possible to have a single ledger for payments and to record asset ownership and eliminate reconciliation completely.

Thinking from first principles, a financial instrument are “real or virtual documents representing a legal agreement involving any kind of monetary value”. This means they can exist exclusively in digital form, or could be converted from paper to digital.

https://www.investopedia.com/terms/f/financialinstrument.asp

Money, can also be digitised. In fact, most money already exists purely in digital form in the database of your bank, and associated with account numbers. Except these databases do not really communicate well with each other.

Blockchain technology allows for a shared, tamper-proof ledger that can be accessed and verified by all participants in a transaction.

Stablecoins, (digital currencies backed by traditional assets such as fiat currency) and CBDCs, (digital versions of fiat currency issued by central banks) can provide a stable unit of account for the exchange of assets on the blockchain.

Asset backed and Mortgage backed Securities can be “tokenized” (issued digitally) on the same ledger that stablecoins operate on. And smart contracts can be used to automate the execution of trades, reducing the need for intermediaries and streamlining the process.

Since the blockchain is the shared common ledger that stablecoins (unit of payment) and tokenised financial instruments exist on, there are instantly several efficiency gains that can be had:

• Reduced effort and associated costs involved in the issuance of tokenized instruments (asset or mortgage backed securities)

• Automated transactions through the use of stablecoins as unit of payment

• Automated payouts via smart contracts (dividends, interest etc)

• Improved transparency on collateral backing ABS/MBS

• Improved liquidity due to instant settlement

Over the past year, advances in cryptography have made it possible to conduct private transactions on public blockchains and share read only information with relevant counterparties.

The scale of the opportunity is massive. A recent WEF report dissects the numbers by market cap as follows:

• Equity markets: $95 trillion

• Debt markets: $106 trillion

• Mortgage backed securities: $10 trillion

• Derivatives: $560 trillion

• Asset management/fund administration: $89 trillion.

Without needing to make predictions, it is safe to say that we are on the verge of a revolution in capital markets and how they operate.

Over the coming weeks, I will be doing a deep dive into the benefits of tokenizing securities. We will also look at issues related to tokenizing ABS and MBS, the risks involved and how they could be mitigated.

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