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Inverse-Tokenization: Re-Routing & Re-Rooting Value

By Ben Caselin

Compared to Bitcoin, security tokens (STOs) are hardly controversial. We know the merit of these instruments lies in their ability to render illiquid assets liquid, lower barriers of entry, open up new avenues to raise capital, secure ownership and enhance transparency. Furthermore, most STOs fall within the bounds of regulatory language and capacity, and as such pose less of a problem to traditional participants in finance. 

But the growth in Bitcoin as a native digital asset and STOs are not separate developments, especially when we take Central Bank Digital Currencies (CBDCs) into the mix. In what is at least an intriguing thought experiment and a play on semantics, and at best a serious prospect, in this article, I’d like to introduce the concept of “Inverse Tokenization” as a possible future roadmap for digital assets.

Ben Caselin is Head of Research and Strategy at AAX

Re-Routing Value: Transitioning To Bitcoin 

While the earliest discussions with Satoshi Nakamoto already hinted at Bitcoin as Gold 2.0, this narrative only really began to gain traction over the past two years. Fund manager Grayscale had already proven to be successful in pitching this idea to Millennials with their #dropgold campaign, but it was specifically in the aftermath of the March 2020 market crash that the narrative escalated to the mainstream. 

MicroStrategy’s complete and, for all intended purposes, permanent conversion of the company’s treasury to Bitcoin has set off a chain reaction in corporate America and global finance: from Tesla and Square to Ark Invest and PayPal (we all know the story). The point is that fiat reserves are increasingly seen as a liability at risk of devaluing at too fast a rate, and, rather than gold, corporations are warming up to Bitcoin. 

Bitcoin is hard money, the narrative goes. Fine art, collectables, perhaps some ancient relic, can be rare or scarce. Gold, real estate, diamonds, land, pearls – none of these can realistically make claims to absolute scarcity. Bitcoin, however, has a fixed supply of 21 million and an inflexible issuing rate that programmatically decreases in output over time. Its scarcity is rooted in mathematics, and it is therefore perfectly scarce. Other cryptocurrencies can implement similar or even better scarcity models; however, as a first-mover with strong network fundamentals and proven resiliency throughout significant reputational, regulatory and technical crises, and arguably due to its anonymized origins, Bitcoin stands unchallenged and resolute. 

Mid- to long-term investors might look to Bitcoin’s Sharpe Ratio over five years at least and would perhaps find this indicator sufficiently compelling (specifically, have a look at the ratio change for traditional assets as opposed to Bitcoin in 2020Q1). For such fundamental analysis, the work by Bitcoin On-Chain Analyst Willy Woo could be instructive. 

Bitcoin Risk-Adjusted Returns vs Other Assets

Source: https://charts.woobull.com/bitcoin-risk-adjusted-return/
* Risk-adjusted returns are calculated using Sharpe Ratio over a 4 yr HODL period.

However, in this emerging narrative, we don’t ‘buy Bitcoin’ or ‘invest’, but we ‘transition’ into Bitcoin as a new way of storing value in the long term and re-organizing global wealth. Michael Saylor’s explanation is quite clear when he says that rather than looking at the price of Bitcoin, we should just look at Bitcoin as a bank in cyberspace, and its market cap simply tells us how much money is in the bank. 

Bitcoin, or “Vault space”, in this virtual bank is scarce, so the more money people place in Bitcoin, the higher the price goes. And since the supply of fiat currency is practically infinite, and Bitcoin’s network is the most accessible bank that has ever existed, its price appreciation over time is not surprising – and indeed, mathematically, has no maximum

In this narrative, we don’t think of Bitcoin as a currency yet. It is literally a global ledger and, hypothetically, if the world’s entire population were to put its wealth into Bitcoin, we would then have a highly comprehensive monetary system that offers integrity and unprecedented levels of transparency as to where capital is concentrated and how it moves. In this scenario, Bitcoin – as the global wealth ledger – would eventually shed much of its volatility and would likely be the quoted currency in global trade. Bitcoin maximalists refer to this as the “Bitcoin Standard” – or, in meme terms, we might think of a giant PacMan that eats its way through gold, bonds, and so forth, growing to monstrous proportions in the process.

This brings us to CBDCs and the prospect of Inverse Tokenization. 

Re-Rooting Value: A Return to Sound Money

Talk around CBDCs have made quite a few headlines over the past two years and we could spend time analyzing them, but I want to cut straight to the chase and say that their value proposition is wildly overstated.

Surely, CBDCs would make the legacy system more efficient and would give national economies new avenues to distribute capital, provide stimulus, tax, monitor and, essentially, control. Judging from what we’ve seen in 2020, I think it’s safe to assume this is an unattractive proposition, at least when it comes to storing value and relinquishing such control. In the end, CBDCs, as currently conceptualized, are basically stablecoins pegged to fiat and thus subject to the exact same inflationary pressures. However, that is not to say there is no future for government-issued money in the form of a good old-fashioned (digital) coupon. 

In a recent article, I wrote about PlanB’s famous Stock-To-Flow Model, which provides a stunningly accurate price projection for Bitcoin, and the prospect of the masses frontrunning the model, setting in motion what Dan Held has called the Bitcoin Super Cycle. So far, despite corporate America moving in on Bitcoin, the price of Bitcoin has remained tethered to the model, but there is a case to be made for the process to see acceleration. It should be noted, however, that in PlanB’s revised model (S2FX), time is not a central factor – in his new model, price projections are based on Bitcoin’s transitional growth into a financial asset and the extent to which it is able to absorb global wealth. 

For this to occur, however, we cannot dismiss the relevance of sovereign wealth. Scouring social media, we can see some are keen to point out that ‘Central Banks will never accept Bitcoin’ or ‘CBDCs will dwarf Biy KK Default Kitpublishclosedclosed default-kitKK6https://thetokenizer.io/?elementor_library=default-kitelementor_librarycally), and 3) just as Central Banks might hold gold, they can hold Bitcoin. 

Bitcoin is decentralized, and when a critical mass votes with capital, it is less about ‘accepting’ and more about adapting. 

How many Central Banks does it take to change a lightbulb? One might ask. It doesn’t matter – the sun is shining.

The issue at play is not so much that the government cannot be in on the money business, so to speak. But for government money to be of lasting interest to a global, increasingly informed population, it’s possible that we will eventually see CBDCs backed by solid stores of value, such as Bitcoin or perhaps a basket of (tokenized) assets. Such a move could propel the State into the Bitcoin mining industry, potentially giving rise to new types of partnerships between the State and an energy sector looking to diversify. With CBDCs constructed as such, the government could then still keep a degree of oversight and control with respect to their national digitized currency, but the confidence in that currency would come from the collateral that sustains it. 

The Case for Inverse Tokenization

When we think of tokenization, we tend to think of rendering tangible assets digital by capturing their value on the blockchain. Perhaps this is because it’s difficult to imagine things could go much further than that. 

Willy Woo’s recent observation that Bitcoin is today where the Internet was in 1997 in terms of user adoption, but that Bitcoin usage is increasing at a faster rate and is likely to hit 1bn users in the next four years (on par with the Internet in 2005) then we can get a sense of the potential magnitude of this transformation. 

Source: @woonomic

If we do see more corporations – especially in emerging markets – transition to Bitcoin, and if we see a continuation of high net worth individuals, asset managers, funds and everyday folk move into Bitcoin, it is not too much a stretch of the mind to imagine Central Banks starting to hold Bitcoin in reserve. 

More than this being the outcome of a decision that some central authority makes on Bitcoin, it’s much more likely that uptake will be driven by speculation and later FOMO at a macro level. Even as early as 2009, Satoshi Nakamoto pointed to such crowd dynamics as being of importance when he wrote that Bitcoin “has the potential for a positive feedback loop; as users increase, the value goes up, which could attract more users to take advantage of the increasing value.”

And if the market dictates a preference for hard money, rooting CBDCs or newly configured national currencies in the Bitcoin network makes sense. This would close the loop full circle, place digital assets at the core, and raise what could be called an Inverse Tokenized Economy. 

About the author 
Ben Caselin is Head of Research and Strategy at AAX, the first cryptocurrency exchange to be powered by the London Stock Exchange Group’s LSEG Technology. @BenCaselin. AAX.COM

Image by David Zydd from Pixabay

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