TL;DR: Tokenization can make ownership and transfers easier to track, but collateral creates another problem. Lenders need to know not only who owns an asset but whether somebody else already has a claim on it. As tokenized assets become more widely used as collateral, pledges, liens, releases, and other encumbrances will need to become part of the asset’s live digital state. Shared, scalable ledgers could make those claims easier for different institutions to verify.
Key takeaways:
- Tokenization can provide a shared record of ownership and transfers, but ownership does not reveal every claim attached to an asset.
- Double-pledging occurs when the same underlying asset is used to secure more than one obligation without the relevant lenders being aware.
- Tokenized collateral needs to record encumbrances such as pledges, releases, priority, and permitted use.
- Fragmented ledgers make this harder because different systems may hold different records relating to the same underlying asset.
- A shared, scalable ledger could give lenders a common record of an asset’s current state and the claims attached to it.
Bitcoin was designed to solve the double-spending problem.
Since digital information is easy to duplicate and copy, a successful digital cash system needed a way to ensure the same unit hadn’t already been spent elsewhere. Bitcoin solved this by maintaining a shared chronological record of transactions, which anyone can independently verify.
Tokenized collateral creates a similar problem, though not exactly the same one.
To illustrate, imagine a company owns a $1 million tokenized bond and pledges it to Bank A as collateral for a loan. It then approaches Bank B looking for another loan and attempts to use the same underlying asset as collateral again.
Bank B needs to know whether the company still owns the bond and whether Bank A has a claim on it.
In other words, tokenized finance needs to keep track of more than ownership – it also needs to keep track of encumbrance.
Double-spending and double-pledging are similar but different problems
Double-spending concerns whether the same digital asset can be transferred twice. A shared ledger can establish the transaction history and prevent conflicting versions of that history from being accepted.
Collateral is more complicated because ownership and economic claims can exist at the same time. Company A can own the bond, but Bank A can have a claim on it. Collateral can also be released, substituted, pledged again, or rehypothecated by the receiving institution if the agreement allows it.
This means the current state of a tokenized asset may need to confirm much more than who currently owns it. It may be necessary to confirm whether or not it’s already pledged, who has a claim over it, what the value of the secured obligation is, whether one lender has priority over another, and other facts.
The International Monetary Fund (IMF) has highlighted how tokenized lending can embed collateral triggers and covenant enforcement directly into programmable infrastructure, while tokenized securities can be used as collateral in near real time.
Depository Trust & Clearing Corporation (DTCC) is already experimenting with this idea. Its Collateral AppChain supports tokenized assets being pledged and rehypothecated, provided reuse is permitted under the relevant collateral agreement.
This means tokenized finance needs more than just programmable ownership—it also needs programmable encumbrance.
Faster collateral makes its state more important
One of the main advantages of tokenization is that collateral can move faster.
While traditional collateral management can involve custodians, clearing houses, banks, separate databases, and reconciliation between multiple parties, tokenized infrastructure can move eligible assets in near real time and make them available around the clock.
Imagine a tokenized asset is unencumbered at 09:00, pledged at 09:01, substituted at 09:04, and released later that day. If collateral can move in near real time, lenders need an equally current view of the claims attached to it.
Reuse adds another layer. Rehypothecation, where a financial institution reuses collateral it has received, already exists in traditional finance, so it’s not a new problem. Tokenization could make automation easier, but that makes it even more important to know whether reuse is permitted and where it has been subsequently pledged.
The IMF has warned that smart contracts could allow for automated rehypothecation. The potential dangers of increased leverage and the resulting financial instability are obvious unless adequate controls are in place.
In a nutshell, the more mobile collateral becomes, the more important a reliable record of its current state becomes.
One asset can end up with records across several systems
The problem becomes harder when tokenized assets exist across multiple systems and fragmented infrastructure.
Imagine the same bond is represented in a custodian’s database, tokenized on one blockchain, used via a collateral platform on another network, and subject to a legal agreement elsewhere.
Each system may have an accurate record of what happened inside it, but no individual system necessarily has a complete overview of every claim attached to the underlying asset. The asset itself can be singular, but the records describing claims against it may not be.
This is similar to the interoperability problem facing tokenized assets in general. Moving or representing an asset across different networks creates a requirement for those networks, or a separate system, to maintain a consistent view of its state.
Collateral raises the stakes because it includes not only ownership but also the rights of lenders and other counterparties.
A shared ledger is one potential solution. A pledge could result in a change in an asset’s state, followed later by another transaction when the collateral is legitimately released or reused. Different lenders could then reference the same record rather than separate versions of events.
This doesn’t mean putting every agreement or piece of information on a public blockchain. Cryptographic proofs, signatures, and references can establish changes in state while sensitive or private information stays in private databases.
A scalable public blockchain could serve as a neutral, immutable verification layer beneath various collateral applications, enabling large numbers of claims, releases, and state changes to be recorded at extremely low cost.
Of course, scalable public blockchains can’t solve every problem. It’s still possible for someone to sign a separate off-chain agreement pledging the same asset. Off-chain matters will still require traditional legal systems and enforcement to resolve. However, one shared ledger solves many problems inside the tokenized financial system itself.
Tokenization started with representing assets digitally. The next challenges involve how they move, how different networks interact, and how the cash leg settles alongside them.
The double-spending problem required a shared record of transfers. The double-pledging problem requires a shared record of encumbrance.
FAQs:
What is double-pledging collateral?
Double-pledging occurs when the same underlying asset is pledged to support more than one obligation without the relevant lenders having an accurate view of competing claims against it.
Is double-pledging the same as double-spending?
No. Double-spending involves attempts to transfer the same asset more than once. Double-pledging involves multiple financial claims being created against the same underlying asset. The two problems are related in that both require participants to agree on an asset’s current state.
What is an encumbrance?
An encumbrance is a claim, lien, pledge, or other restriction attached to an asset. An owner may still legally own an asset even if another party holds rights to its collateral.
Can tokenized collateral be rehypothecated?
Yes, if the agreement and applicable legal framework permit it. Rehypothecation means a party receiving collateral reuses it in another transaction. Tokenized infrastructure could make this process easier to automate and track.
How could blockchain help prevent double-pledging?
A shared public blockchain can record pledges, releases, permitted reuse, and other changes to an asset’s state, providing different parties with a verifiable record. However, blockchain can’t automatically detect undisclosed off-chain claims unless the legal and financial systems creating them are connected to the digital record.
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Gavin Lucas
Gavin Lucas is a writer at CoinGeek covering blockchain, digital assets, payments, fintech, iGaming and emerging technology. He has more than a decade of experience in digital publishing, SEO and online media, with particular expertise in blockchain technology, online gambling, digital currencies, and payments. His work has included industry reporting, analysis and interviews across blockchain and iGaming, alongside independent digital publishing projects in the UK.
