Real World Assets On Blockchain: Study of ABS in China

After monetary and payments use, the next most promising application of blockchain technology is for the digitalization of securities and other real-world assets.

In January this year, the Hong Kong Institute for Monetary and Financial Research published a study on the application of blockchain for issuing and governing a special class of securities: ABS

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Asset-backed security (ABS) is a type of financial investment that is collateralized by an underlying pool of assets—usually ones that generate a cash flow from debt, such as loans, leases, credit card balances, or receivables. It takes the form of a bond or note, paying income at a fixed rate for a set amount of time, until maturity. ABS markets are well developed in countries such as the United States where it reaches a capitalization of more than USD1.5 trillion.

The researchers analyzed around 5,000 ABS deals or 14,000 tranches launched between 2015 and 2020 in China, a country that issued its first blockchain-based ABS in 2017. By comparing the pricing of blockchain-based ABSs with regular ones, they sought to prove that the technology makes the process more efficient. Additionally, they examined if there were certain asset classes or markets that have even greater potential in terms of blockchain use.

The study findings showed that blockchain adoption improves ABS pricing significantly. On average, blockchain improved ABS pricing (in terms of lowering the yield spread) by 0.18% (39 bps) in primary trading and 0.10% (25 bps) in secondary trading, compared to non-blockchain ABS.

Moreover, the researchers concluded that the blockchain is equally effective across different institutional arrangements and asset classes.

One interesting social mechanism that the researchers touched upon during their work, was the “embeddedness” or familiarity among interacting parties in the deal. As the researchers note, embeddedness plays an important role in many well-established financial or economic decisions and commercial banks even make lending decisions partly based upon their 'embeddedness' with the borrowers. The study revealed, however, that blockchain does not add any benefit in such a relationship, compared to a 'non-familiar' arrangement.

The benefits of using blockchain technology for the underwriting of securities and, in particular, for specific classes such as ABS, have been explored since 2016. However, actual use cases are limited around the world.

The first experiment for a blockchain-based ABS in the U.S. was done by the behemoth investment management company Vanguard in June 2020. The company partnered with blockchain solution developer Symbiont, although there has been no news on the continuation of that project since then.

In April this year, U.S.-based financial blockchain firm Figure issued blockchain-based ABS in mortgage lending markets together with Jefferies, JP Morgan and Goldman Sachs.