Cryptocurrency in $2 Trillion Covered Bond Market

A bond market as old as capitalism itself has emerged as the latest proving ground for cryptocurrencies.

A unit of Societe Generale SA sold 100 million euros (US$112 million) of covered bonds—debt backed by mortgages—in the form of digital tokens, with the French bank as the only buyer. The idea of last month’s pilot issue conceived by what the bank called an internal startup was to test how the technology behind virtual currencies can be used to cut costs and speed up settlement for the securities.

While traditional finance firms have been reluctant to embrace the futuristic currency, evangelists expect the use of security tokens—virtual representations of assets like real estate and stocks—to boom. They could grow into a $24 trillion asset class in the next decade, according to Finoa, a digital-asset firm in Berlin.

“The proliferation of tokenization within finance will occur, but don’t expect to see it go mainstream anytime soon,’’ said Romal Almazo, who leads the crypto and blockchain practice at Capco, a financial-technology consultancy. “This market will take years to properly mature and evolve.’’

SocGen declined to discuss the transaction. In a statement last month, the bank said its security token “explores a more efficient process for bond issuance.’’ It was registered on the Ethereum blockchain, a public ledger, and earned the highest credit rating from Moody’s Investors Service and Fitch Ratings. The settlement process for corporate bonds usually takes up to two business dates after the execution date.

Covered bonds first appeared as a method of debt financing for Prussian aristocrats and churches in 1769, seven years before Adam Smith published “The Wealth of Nations.” There has never been a single default in the market, which now amounts to more than 2 trillion euros.

The bonds could be a test case for security tokens, since the issuers are regulated financial entities and policymakers follow the market closely. Still, the benefits of tokenization for covered bond issuers could be limited, according to Richard Kemmish, the former head of covered bond origination at Credit Suisse Group AG.

“I don’t want to come across as a grumpy old luddite, but I’ve got to ask whether we are really ready for this,’’ said Kemmish. “One of the things that SocGen seem to have emphasized is improving settlement and clearing, but I’m not really sure how much of a problem or expense they are actually avoiding.’’

To skeptics, the new tokens and the way they’re sold—so-called security token offerings, or STOs—are little more than a desperate attempt to inflate the crypto bubble that burst spectacularly in 2018. A meaningful marketplace for such contracts doesn’t yet exist.

Security tokens are not just a new way of packaging debt. Crypto entrepreneurs are trying to convert everything from trophy assets to diamonds into tokens. Proponents say tokenization will allow investors to access markets currently beyond their reach, create liquidity, and introduce a regulated method for raising money via digital assets.

“Everything is going to be tokenized,’’ said Graham Rodford, CEO and co-founder of Archax Ltd., a security token trading venue that has asked the U.K. Financial Conduct Authority to regulate it. “But it’s not just about allowing previously illiquid assets to be traded, like shares in a private equity fund. It will also bring great efficiencies to existing traditional markets.’’

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