There is a strange schizophrenia in the governance of debt capital markets in India. Policymakers and regulators keep stating that they would like the depth and liquidity of Indian bonds markets to improve. Yet, when it comes to regulations and conventions of the bond markets, almost every effort is made to keep the small investors out!
Ticket size and liquidity
Most Indian bonds have a face value of Rs 10 lakh. A few have it lower at Rs 1 lakh or Rs 10,000, but may still have larger trading lot sizes. Government bonds are typically available at even larger face value and trading lots. Any search for smaller ticket sizes leads to a discussion about “odd lots” – which imply lower yield than the standard lots and lower liquidity while selling.
A related issue is the lack of liquidity. There is hardly any trading on the retail debt market segment of either NSE or BSE. Compare this with the US markets and the contrast is eye-opening. The bond market is larger than the stock market in the US – both in market capitalization and trading volume. In India, the bond market is a tiny fraction of stock markets – especially in trading volume.
On the surface, these two issues seem to be two different problems. However, a strong possibility is that they are linked. The large ticket sizes and exclusion of small investors may be partly responsible for the lack of liquidity. Consider Indian stock markets – most shares have prices below Rs 1,000. It is not hard for a small investor to start out small. It is also not very difficult for a mid-sized investor to partly exit a position.
When it comes to bonds, one can only build a diversified portfolio with something like Rs 1 crore and above. Not exactly the foundation of a thriving and deep market!
Can tokenization on a blockchain solve the issue?
Asset tokenization on blockchain refers to the process of converting typical assets such as bonds into crypto-tokens available on a blockchain. Given the unique advantage of blockchain in the form of complete transparency and immutability of transactions, tokenization is an obvious solution to the above problems of bond markets.
A token creator has to own the government bonds and lock them up in a suitably chosen demat account – the contents of which can be made public. The token creator then creates tokens on the blockchain with this ownership backing it. The tokens on the blockchain are essentially fractional units of the underlying bonds – with all economic benefits and risks passed on to the token owners from the token creator.
Such tokens can be created at values as small as Rs 100 per unit. This solves the problem of ticket size. Can tokenization also help overcome the problem of liquidity?
Peer to peer transactions in tokenized bonds
Normally, one needs a centralized exchange because one doesn’t know or trust the counterparty of a transaction. For example, if I am selling my bonds to Ms. Sharma without knowing her well, I cannot be sure that I will receive my payment as expected. Hence both I and Ms. Sharma meet on the centralized exchange, which acts as a counterparty to both of us. Given the processes of the exchange, there is little risk to the exchange itself and given the exchange’s size and reputation, both I and Mrs. Sharma live with the credit risk of the exchange (which is still not zero). This whole transaction can take up to two days (T+2 settlement) and some costs.
Cut to the tokenized bonds on blockchain. Transactions can be real-time and without a centralized third party. Given the technology of blockchain, one does not need an intermediary. A suitably designed transaction either goes through or fails entirely – meaning either I will have the money and Ms. Sharma the bonds or I will continue to hold the bonds and Ms. Sharma her money. It will never be half-done – one of us having both and the other nothing. The worst that can happen is that no transaction is completed at all.
This opens up the transaction universe significantly. Investors can directly exchange bonds amongst themselves. Several technology-based apps can also facilitate the transactions. There is no need to stay reliant on one monolithic big exchange, waiting for encouraging rules.
Where to?
Asset tokenization is a promising new domain for the investing world. Specifically, for bonds in India, tokenization can bring about significantly more access and liquidity to small investors.
If investors can buy and sell government debt, PFC, REC, SBI and other bonds at Rs 100, it would be better for the debt markets in India in general. Hopefully the regulations will remain neutral or conductive to such innovations!
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