Digital markets and tokenizations represent a potential avenue of growth for the rapidly evolving private credit market. Tokenization, in particular, is poised to address some of the underlying challenges inherent in private credit, while enhancing efficiency and enabling broader investor participation, a new report by S&P Global says.

The report, released in October 2024, explores how tokenization could unlock new opportunities in private credit by enabling fractional ownership on blockchain platforms, mitigating liquidity risks and addressing operational inefficiencies that deter many investors.

Private credit refers to a non-banking type of loan typically offered to companies but also individuals. In the private credit market, investors make loans to entities or individuals who may have trouble accessing credit from banks or the public markets. Because of the heightened risk, investors typically collect higher interest rates on private credit than they would earn on bonds or other debt investments.

Despite these prospects, many investors are still hesitate to participate because of inherent challenges related to private credit. A year-end 2023 survey by Coalition Greenwich found that a majority (70%) of the wealth and asset managers would have allocated more to private credit investments if it weren’t for liquidity risks and/or high management fees. Additionally, a substantial share (38%) of survey respondents cited concerns about transparency.

These issues are where tokenization offers transformative potential. Tokenization enables easier trading of fractionalized assets on digital marketplaces, making private credit more accessible by improving liquidity. Furthermore, the use of smart contracts reduce back-office costs and improve operational workflows. Finally, shared ledgers enabled by the use of blockchain technology enhance transparency and thus trust through real-time immutable records of records of ownership and transaction history.

Strong growth potential

Though still in its early stages, the tokenized private credit market is growing rapidly. According to S&P Global, there is currently about US$500 million of tokenized private credit globally, but that market has surged by 66% over the past 18 months.

With the broader private credit market currently standing at about US$1.7 trillion in investment globally, there remains significant room for growth, signaling a positive outlook for the market in the years to come.

Diving into the current state of the tokenized private credit market, the report notes that there are currently two main ways in which private credit is being tokenized: first, by tokenizing existing private credit funds like Hamilton Lane’s SCOPE fund, which includes corporate loans; or by creating tokenized debt directly on decentralized lending platforms.

Currently, decentralized platforms make up for the bunch of the tokenized private credit market. Centrifuge, for example, is a specialized blockchain designed for individuals and businesses to borrow against traditional financial assets from decentralized finance (DeFi)-based lenders. The platform had US$289 million of active loans outstanding as of July 26, 2024, focused on consumer asset backed securities (ABS), real-estate bridging loans, and trade finance.

London-based digital finance company Greengage has taken a different route, focusing instead on small and medium-sized enterprise (SME) financing. The company announced in July a partnership with Coinbase to issue tokenized private credit to provide e-money account services to SMEs.

Asset tokenization gains momentum

Asset tokenization, which refers to the process of digitalizing ownership rights to physical or intangible assets, is gaining traction across the financial services sector. By leveraging blockchain technology and smart contracts, tokenization allows financial institutions to improve efficiency through programmable, composable financial instruments. It also allows for increased liquidity through fractionalization, and unlocks new revenue streams with innovative financial products.

Formerly known as Onyx, Kinexys is the permissioned blockchain of banking giant JP Morgan. The platform allows users to trade tokenized assets like US Treasuries and mortgage-backed securities, and has exceeded US$1.5 trillion in notional value, processing an average of more than US$2 billion daily in transaction volume.

Similarly, Goldman Sachs launched in January 2023 its Digital Assets Platform in partnership with blockchain software provider Digital Asset. Using Digital Asset’s purpose-built Canton Network blockchain, Goldman Sachs’ platform facilitates the issuance, registration, settlement, and custody of various tokenized assets.

While the adoption of tokenization remains nascent, the tokenized assets market is gaining momentum. Roland Berger estimates that the tokenized assets market size reached US$400 billion in 2023. By 2030, asset tokenization is projected to grow to become a market worth at least US$10 billion, representing a 40-fold increase in the value of tokenized assets between 2022 and 2030.

Featured image credit: edited from freepik