Difficulties in enabling on-chain payments and the lack of a functioning on-chain secondary market have limited issuers' and investors' interest in digital bonds. Recent innovations related to public blockchains and wholesale central bank digital currencies (wCBDCs) could overcome these challenges and boost adoption.
Chart 1
What's Happening
Innovation in digital bonds is accelerating. Over the past 18 months, we rated 14 digital bonds that totaled about $1.6 billion and were issued by sovereigns, multilateral lending institutions, local and regional governments, corporations, and financial institutions. These bonds were mostly issued on private blockchains, with bond payments made off-chain and via traditional payment rails. That said, we recently rated digital bonds that were issued on public blockchains or were part of the Swiss National Bank's pilot scheme and relied on on-chain payments via a wCBDC.
Why It Matters
Innovation is necessary to unlock the key benefits of digital bonds. Digital bonds issuances have already benefited from a streamlined issuance processes that were supported by intermediaries' platforms. However, the two features that make them particularly attractive to investors have not materialized yet:
- Enhanced collateralization and trading capabilities: Digitalization can make it quicker for investors to use bonds as collateral, for example by improving efficiencies in intraday liquidity management and enabling investors to trade bonds 24/7, rather than only during market hours. However, this requires an active and liquid on-chain secondary market, which does not exist yet.
- Accelerated settlement: Near-instant delivery versus payment can reduce exposure to counterparty risk but requires on-chain payments, which are still at an early stage.
An on-chain secondary market remains a work in progress. So far, most digital bonds have been issued on private blockchains via platforms from traditional intermediaries, including HSBC Orion and Onyx by J.P Morgan. In a few cases, digital bonds were listed and stored on digital exchanges, such as Six Digital Exchange or D7 by Deutsche Börse. They are effectively issued in a so-called walled garden--a secondary market that is limited to investors who are members of the platform or go through intermediaries that are members.
Bond payments remain mostly off-chain. Most digital bonds continue to rely on off-chain payments and traditional rails for settlement and repayment. However, the Swiss National Bank's pilot scheme for digital bond issuances demonstrated one possibility to enable on-chain payments. Issuers used a wCBDC to pay intermediaries, which consisted of Swiss banks that acted as the interface between investors and issuers.
What Comes Next
Interoperability challenges will continue to limit the growth of an on-chain secondary market over the short term. Investors need to access the blockchains on which the bonds are issued, and institutions need to connect their legacy systems to these blockchains. Different options are emerging to address these challenges, including the use of:
- Private permissioned blockchains that are shared among partner institutions;
- Public blockchains; and
- Cross-chain communication technologies that enable different private and public blockchains to interact while mitigating security risks.
Regulatory clarity on stablecoins will boost the adoption of on-chain payments. Emerging regulatory frameworks in key jurisdictions will support the use of compliant stablecoins for bond payments and increase investors' appetite for digital bonds.
Related Research
- KfW's First Distributed Ledger-Based Bond Rated 'AAA', Marking Issuer's Next Step On Digitalization Path, May 24, 2024
- Your Three Minutes In Digital Assets: New Rules Could Boost U.S. Stablecoin Adoption, April 23, 2024
- Digital Assets: Will Technological And Regulatory Developments Unleash Institutional Blockchain Adoption?, Dec. 4, 2023
- Societe Generale's Proposed First Digital Green Bond Rated 'A', Nov. 30, 2023
- Utility at a cost: Assessing the risks of blockchain oracles, Nov. 17, 2023
- How DeFi's Operational Risks Could Influence Credit Quality, June 7, 2023
- S&P Global Research Insights – Digital Assets
This report does not constitute a rating action.
| Primary Credit Analyst: | Mohamed Damak, Dubai + 97143727153; mohamed.damak@spglobal.com |
| Secondary Contact: | Andrew O'Neill, CFA, London + 44 20 7176 3578; andrew.oneill@spglobal.com |
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