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A terracotta soldier figurine emerging from a digital tablet. The soldier looks digitized at it's base but becomes a solid form at it's top.

Were progressing toward the next era of the internet in fits and starts. Web3 is said to offer the potential of a new, decentralized internet, controlled by participants via blockchains rather than profit-motivated corporations. But progress hasnt been linear: one major setback has been the meltdown of the cryptocurrency market in 2022, triggered by multiple cryptocurrency failures and high-profile cases of fraud. Regulators are paying increased attention to Web3 players, and public curiosity is peaking.

Robert Byrne is a senior partner in McKinseys Bay Area office, and Prashanth Reddy is a senior partner in the New Jersey office.

But Web3 is about much more than crypto. Blockchain, smart contracts, and digital assetsthe latter created via a process called tokenizationstand to change the way we exchange ideas, information, and money. For organizations and early adopters, there is significant value on the table.

Lets get specific: tokenization is the process of issuing a digital representation of an asset on a (typically private) blockchain. These assets can include physical assets like real estate or art, financial assets like equities or bonds, nontangible assets like intellectual property, or even identity and data. Tokenization can create several types of tokens. Stablecoins, a type of cryptocurrency pegged to real-world money designed to be fungible, or replicable, are one example. Another type of token is an NFTa nonfungible token, or a token that cant be replicatedwhich is a digital proof of ownership people can buy and sell.

Tokenization is potentially a big deal. Industry experts have forecast up to $5 trillionin tokenized digital-securities trade volume by 2030.

Theres been hype around digital-asset tokenization for years, since its introduction back in 2017. But despite the big predictions, it hasnt yet caught on in a meaningful way. We are seeing slow movement: US-based fintech infrastructure firm Broadridge now facilitatesmore than $1 trillion monthly on its distributed ledger platform.

In this article, well drill down into how tokenization works and what it might mean for the future.

Learn more about McKinseys Financial Services Practice.

Before we dig deeper into tokenization, lets get some basics defined. As weve seen, Web3 is a new type of internet, built primarily on three types of technology:

As well see, these technologies come together to support a variety of breakthroughs related to tokenization.

Some industry leaders believe tokenization stands to transformthe structure of financial services and capital markets by letting asset holders reap the benefits of blockchain, including 24/7 operations and data availability. Blockchain also offers faster transaction settlement and a higher degree of automation (via embedded code that only gets activated if certain conditions are met).

While yet to be tested at scale, tokenizations potential benefits include the following:

Learn more about McKinseysFinancial Services Practice.

There are four typical steps involved in asset tokenization:

Maybe. Financial services players are already beginning to tokenize cash. At present, approximately $120 billion of tokenized cash is now in circulation in the form of fully reserved stablecoins. As noted above, stablecoins are a type of cryptocurrency pegged to a physical currency (or commodity or other financial instrument) with the goal of maintaining value over time.

Financial services players may be starting to play with tokenizingtheirs is the biggest use case to datebut its not yet happening on a scale that could be considered a tipping point.

That said, there are a few reasons that tokenizing might take off. For one thing, the higher interest rates of the current cyclewhile cause for complaint for manyare improving the economics for some tokenization use cases, in particular those dealing with short-term liquidity. (When interest rates are high, the difference between a one-hour and 24-hour transaction can equal a lot of money.)

Whats more, since tokenization debuted five years ago, many financial services companies have significantly grown their digital asset teams and capabilities. These teams are experimenting more and continually expanding their capabilities. As digital asset teams mature, we may see tokenization increasingly used in financial transactions.

Learn more about McKinseysFinancial Services Practice, and check out Web3-related job opportunities if youre interested in working at McKinsey.

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What is tokenization? - McKinsey