The tokenization of securitized debt has long been described as one of the more practical use cases for blockchain technology. Blockchain’s ability to fractionalize assets and to settle transactions via its open ledger nearly instantly addresses major pain points of securitization: high buy-in thresholds that exclude some investors as well as long settlement times via traditional methods. Given China’s push to include blockchain in its broader economy, China Construction Bank’s recent play via Fusang’s digital exchange in Malaysia to issue a US$3 billion bond via the Ethereum blockchain could be seen as a logical play — but Beijing quickly put a stop to it this week and the offering was withdrawn.
Why would a company issue a bond on the blockchain?
Interest rates are at historic lows, so banks and other companies have a huge incentive to raise capital via debt offerings to finance their operations. For large companies this is a cheap and easy way to raise cash without having to dilute current shareholders equity. For investors, bonds from large and well-known companies are considered to be an ultra-safe investment and form the backbone of many portfolios.
The downside to this is that many of the best-rated bonds have a high threshold for a minimum buy-in. If one can’t afford the US$50,000 to $100,000 minimum purchase, one can’t have exposure to this investment vehicle. Hence the need for fractionalization via tokens.
China Construction Bank is the fourth largest bank in the world by market cap and is considered to be quite stable by the ratings’ agencies. The bank itself has a global presence, and is a major player in financing projects throughout Asia and especially in Belt and Road Initiative countries.
For retail investors in emerging Southeast Asia, being able to add this to their portfolio would be a huge counterbalance to some of the riskier assets they hold. Given the region’s low buying power, retail investors might be interested in a US$1,000 investment versus $100,000 — which is potentially impossible without the ability to hold a fraction debt offering. Given the emerging interest in digital assets, tokenized stable assets or commodities, the bond tokens can also be marketed to cryptocurrency traders looking to diversify their portfolios.
With bond offerings comes the need to settle deals. Bonds can be traded on secondary markets, and to ensure settlement risk is minimal, there’s a long process of clearing and settlement. But the blockchain negates the need for elaborate clearing and settlement structures, such as insurance that makes sure nobody loses out in case things don’t go through smoothly. Like any token or issuance on the blockchain, China Construction Bank’s bond would have all the transactions taking place via an open, distributed ledger making settlement of its sale instantaneous.
The head of research at OKLink, a China-based startup specializing in remittance settlement, was quoted in the Chinese financial press explaining that this could be a significant change for the institutional bond issuance industry as smart contracts can save a lot of time and labor on the underwriting process.
So what exactly is the problem here?
Tokenized bond offerings bypass capital controls
China has strict capital controls to prevent an outflow of its currency, the RMB. As the market invents new ways to bypass these restrictions, China squashes them. It’s a cat and mouse game.
A tokenized bond offering like this would not only open the market to small investors. It would also be an efficient intermediary for moving capital out of China. A trader could buy China Construction Bank’s bond token with RMB, then sell it for ethereum or USD. If there is demand for the asset, it would be liquid in any currency.
The People’s Bank of China (PBOC) is aware of the power of blockchain and cryptocurrency to disintermediate its control over the country’s money supply. Recently, the bank made a point of passing new regulation that specifies “no group or individual may produce or sell tokens, coupons and digital tokens to replace renminbi or be used as renminbi substitutions circulating in the market.” Effectively, any way to make a synthetic substitution for the RMB for settlement is now forbidden.
Given new reports that China Construction Bank’s relationship to the bond offering is at best tenuous, it’s likely that the ethereum component to the plan wasn’t run by its regulatory affairs office in China and rather added by Fusang, the Malaysia-based exchange, at the last minute. Tokenized bond offerings do have potential, as they have gone off without a hitch in Germany, but when concern about capital controls is thrown into the mix and the target market is offshore, things can get complicated in a strict regulatory environment like China.