The key difference between a 'tokenized deposit' and a 'deposit token'

The crypto world has a well-deserved reputation for being loose with vocabulary. To most people, the word "token" traditionally means a small representation of low value (laundromat token, a token of my appreciation), but in the context of crypto, we use it to mean an intangible representation of possibly considerable on-chain value. "Mining" commonly connotes the extraction of geological resources from the earth, but we use it to describe protocol maintenance. Not all blockchains have blocks.

And then there's "tokenized," which is often misapplied to a range of concepts.

One of those is deposits. By now, you have probably heard finance industry professionals talk about the potential of tokenized deposits to turbocharge bank services.

The term refers to an on-chain representation of funds held in a bank account — there may or may not be actual tokens involved. The process can vary between institutions, but generally involves a client choosing to move part of their traditional account balance to their on-chain account managed by the same institution. This can then be transferred to any other on-chain account within that institution's network, to be converted back into dollars as the traditional ledger is adjusted in the background. It's essentially a transfer of funds between accounts within the same bank, only with extra steps and some gains in speed, programmability and hours of availability.

What's more, the term "tokenized deposit" is often used interchangeably with "deposit token" even though they mean different things and carry very different implications for the evolution of banking.

This is worth unpacking, given that both are on the roadmap for a range of U.S. institutions and in production at a few, with the aim of competing with stablecoins while improving the in-bank payments experience.  

To start with, what is a "deposit?" The Federal Reserve defines deposits as "funds that customers place with a bank and that the bank is obligated to repay on demand." This links the money to a contract between the depositor and the financial institution. Put differently, a deposit is not just money, it is also an obligation. How do you tokenize that?

Of course, on-chain tokens can represent obligations as well as value and these can be transferred, just like bonds can be traded. But a deposit contract is not necessarily fungible, whereas the funds should be.

Nevertheless, let's establish that a "tokenized deposit" represents both a value and an obligation. The term "tokenized" describes the on-chain form of the deposit, without changing its nature.

Although, drilling deeper, tokenization does change the nature of a bank deposit in one key aspect. Bank deposits are covered by FDIC insurance up to a certain amount. Tokenized versions, at least for now, are not.

What about a "deposit token?" The order of the words is crucial here: "Token" is the noun, with "deposit" describing what backs the token, much like the terms "gold token" or "real estate token."

You can see how this would be less binding. A deposit token is an on-chain representation of money held in a bank account. It does not have to also represent a contract, as it is not technically a deposit, it is a token that happens to be backed by deposited funds.

The process would be similar: A client asks for a certain amount of deposit tokens; the bank deducts the amount from the client's account and mints the corresponding number of tokens which are then deposited in the client's on-chain address. But these are no longer deposits in the legal sense.

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This opens up the possibility that a deposit token could leave the originating network, much like a check from one bank can be cashed at another. This does not mean free movement — banks are responsible for complying with know your customer and anti-money laundering, so transfer would be limited to approved addresses.

And there would need to be some standardization of formats as well as a legal framework agreed on by banks. Would accrued interest move with the token? If so, this could give deposit tokens a chance of competing with the greater flexibility and yield possibilities of stablecoins.

So, tokenized deposits and deposit tokens embody different concepts, and yet many commentators and even entities still confuse the two. There are welcome exceptions: JPMorgan, for instance, clearly labels its JPMD token that went live last week on public layer-2 blockchain Base as a "deposit token," while its Kinexys Digital Payments network offers "blockchain deposit accounts" that enable the on-chain transfer of value between JPMorgan clients, akin to tokenized deposits.

The distinction is relevant for much more than just semantics and technical specifications. It will help shape our understanding of where the industry is heading.

Tokenized deposits are an on-chain representation of a banking relationship.

Deposit tokens are an on-chain representation of commercial bank money.

The former concept has limited scope and debatable utility. Its key advantages — speed of transfer, 24/7 access, programmability — could be achieved using traditional databases as the current friction is due to market structure issues rather than technology. And the freedom of movement plus the potential connectivity with other networks and applications are not needed within a walled garden. The case for using blockchain for value transfer becomes apparent, however, when considering collaborations between financial entities, such as the partnership announced last week between JPMorgan and Singapore's DBS to explore "tokenized deposit" interoperability.

Deposit tokens, on the other hand, could end up being a foundational building block for a new type of banking, with bank tokens hopping between authorized addresses and on-chain services. They would not be able to participate in fully open applications on public networks, but they could still enable access to on-chain lending or other yield protocols. This, and innovations yet to come, would improve the utility of commercial bank money while cementing the role of banks as finance moves to new rails.

In sum, tokenized deposits represent the digitalization of banking relationships. Useful, perhaps, but not exactly ground-breaking. Deposit tokens are closer to an evolution in money movement. And it's time we clearly distinguished between the two.