Last year Israel’s Ministry of Finance collaborated with the Tel Aviv Stock Exchange (TASE) to run a proof of concept for the issuance of a DLT-based government bond as a security token. Today it published a detailed report on the tokenization work.
As a quick recap, on 31 May 2023, the trial involved issuing the bond to a dozen banks as primary dealers. These included the major local banks and global brands such as Barclays, BNP Paribas, Deutsche Bank, Goldman Sachs and JP Morgan.
One of the cited benefits of blockchain is efficiency. The bond market has been a popular focus area because it is less developed than equity markets, and issuance involves considerable manual back and forth. Additionally, a lot of secondary trading happens over the counter, including for government bonds. However, that’s not the case in Israel, where TASE accounts for 70-80% of trading.
Israel’s take on tokenization benefits
The first cited tokenization benefit was transparency because all market participants have the same visibility and can track the issuance. Secondly, TASE sees improved accessibility because it’s easier to onboard investors, potentially expanding the investor base, which could improve liquidity. For TASE, efficiency gains from automation only made it into the third spot on the list of benefits despite being the most often cited one for bonds. It envisages time savings as enabling faster access to capital and quicker liquidity for investors.
Other benefits include risk reduction, enhanced security and atomic settlement. On the whole the report was upbeat, focusing on benefits and skipping over challenges. Hence atomic settlement in which the payment and security transfer happen simultaneously was positioned as eliminating counterparty risks. That’s certainly the case, but others also point to the higher demands for cash that atomic settlement requires. That said, atomic settlement can be simultaneous without being instant. So it can be scheduled a few hours or days in the future with certainty of timing, and still achieve reduced counterparty risk.
Finally, TASE sees benefits in Web3 integration as fostering an environment for “future advancements in the financial industry.”
Upgradeable smart contracts
The paper delves into some high level technical issues. For example, blockchains are known for their immutability, but that applies to smart contracts. If there’s a bug in the code then the smart contract needs to be updated. For a while this issue has been dealt with by using proxies.
Proxies work conceptually similarly to domain names, where www.ledgerinsights.com points to an IP address of a web server. If we move the hosting provider, we update the domain name record to point to the new server. A proxy acts like the domain name and points to a particular smart contract version. If you need to change the smart contract, update the proxy to point to the new one.
There are some challenges to this. For example, the smart contract security token contains a list of token owner wallet addresses. If you upgrade the smart contract, the new one doesn’t have that list. Hence, the proxy also has storage where you can store the wallet owners.
Meanwhile, the paper didn’t share details about potential next steps. However, TASE said that new projects are already in progress. That could related to its plans to allow brokers to provide crypto services to clients.
