What is asset tokenization?
The emergence of Bitcoin opened up a new world of opportunities to revolutionize how investments and assets are issued, managed, and transacted. The technology behind the world's first cryptocurrency, blockchain, is one type of distributed ledger technology that holds the floodgates to multiple means of investment.
Blockchain will tend to the financial landscape and enable an asset to be easily broken down into smaller units, representing ownership, encouraging the democratization of investment in historically illiquid assets and bring about fairer markets. Whether it be paintings, digital media platforms, real-estate property, company shares, or collectibles, everything can be tokenized on a distributed ledger. This leads us to the question: What is asset tokenization?
Asset tokenization explained
Asset tokenization is the process by which an issuer creates digital tokens on a distributed ledger or blockchain, which represent either digital or physical assets. Blockchain guarantees that once you buy tokens representing an asset, no single authority can erase or change your ownership — your ownership of that asset remains entirely immutable.
— Let's dive into an example —
Suppose you have a property worth $500,000 in New York, NY. Asset tokenization could convert ownership of this property into 500,000 tokens — each one representing a tiny percentage (0.0002%) of the property. Let's say you need to borrow $50,000; it wouldn’t make sense to sell your property, because you need somewhere to live, but you still need the money. So instead, you issue tokens on a public distributed ledger like Hedera Hashgraph which allows people to freely buy and sell on different exchanges. When someone buys a token, they buy 0.0002% of the ownership in the asset. 500,000 tokens to become 100% owner of the property. Since distributed ledger technologies are immutable, no one can erase the ownership of the investor who has bought the tokens, or in this matter, shares of a property.
If we zoom in on how tokens are built, it becomes apparent that two kinds of cryptographic tokens exist: fungible and non-fungible.
Types of tokenized assets
Fungible asset tokenization
A fungible asset has two main characteristics:
Interchangeable: Each unit of the tokenized asset has the same market value and validity — for example, Bitcoin: All units of 1 $BTC are exactly the same. They hold the same market value, and are interchangeable. It doesn't matter from whom a $BTC was purchased, since all BTC units have the same functionality and are part of the same network. You can swap one-fourth of a $BTC for anyone else's one-fourth of a $BTC, with confidence that your $BTC’s one-fourth holds the same value, despite being one-fourth of different coins.
Divisible: A fungible cryptocurrency can be divided into as many decimal places which were configured during its issuance. Each unit will have the same value and validity.
Non-fungible asset tokenization
A non-fungible token is:
- Non-interchangeable: NFTs can't be replaced with tokens of the same type because each token represents a unique value.
- Non-divisible: NFTs are not typically divisible, although F-NFTs do offer fractional ownership of NFTs, such as in the case of expensive fine art or commercial real-estate.
- Unique: Each token differs from another token of the same type and has unique information and attributes.
What can be tokenized?
The possibilities are endless as tokenization allows for both fractional ownership and proof-of-ownership. From traditional assets like venture capital funds, bonds, commodities, and real-estate properties to exotic assets like sports teams, race horses, artwork, and celebrities, companies worldwide use blockchain technology to tokenize almost anything. However, we have grouped them into four main categories:
Asset: An asset is any item of value that someone can transform into cash. It’s further divided into two classes: personal and business. Personal assets can include cashand property. Business assets include assets that are present on the balance sheet.
Equity: Equity (shares) can be tokenized; however, the assets remain in the digital form of security tokens stored online in a wallet. Investors can typically buy shares on a stock exchange.
Funds: An investment fund is a type of asset that investors can tokenize — these tokens represent an investors' share of the fund. Each investor is provided tokens which represent their share of the fund.
Services: A business can offer goods or services as a way to raise funds or conduct business. Investors can use tokens to purchase goods or services provided by the supplier.
Benefits of asset tokenization from an asset owner’s perspective
Let’s use the example of an individual requiring $50,000 taken out of a condo valued at $500,000. This individual may have tokenized their condo into 500,000 security tokens, each worth 0.0002%. They might sell 50,000 tokens, instead of selling the entire property and losing its utility as a livable space, thus ensuring a more liquid asset.
Assets that can't be liquidated often have an unestablished market price. In this case, asset owners typically provide buyers with incentives like illiquidity discounts, which reduce the asset's price. Tokenization of assets would increase an asset's liquidity, as it facilitates fractional ownership, which eliminates illiquidity discounts. Moreover, selling small fractions of ownership enables owners to charge a fair market price.
Reduced management costs
If you transfer ownership of an asset today, it requires lawyers acting as intermediaries to handle the paperwork and create trust between you and a buyer — this results in extra time and cost. If you choose to tokenize the very same asset and utilize a decentralized platform or marketplace it’ll automate many parts of this process, saving time and cost.
Benefits of asset tokenization from an investor’s perspective
Considering the example above of a tokenized property, it’s now possible for retail investors to invest smaller amounts of money in a property. Investors have a chance to diversify their portfolio by investing, for example, a sum of $10,000 — this wasn’t historically possible without a lot of paperwork, which costs money and takes extra time. Investors benefit from the increased liquidity of assets through tokenization.
Shorter lock-up periods
Lock-up periods restrict investors from selling their assets. Sometimes this is due to the asset being large and illiquid. Tokenization of assets has the potential to shorten the lock-period, due to investors being able to sell their tokens easily in a liquid market. Investors, in this scenario, no longer have to wait for years to take profits or losses.
Since the underlying technology behind asset tokenization, blockchain, is immutable, owners are unable to change an assets' history to make it appear more attractive. This allows investors to see the history of a holding and make more informed decisions.
With ownership and decentralized identity (DID) details kept on the blockchain, a buyers' private-public key pair forms a digital signature ensuring it’s really them — this can be used for things like KYC / AML verification. Additionally, there are DID identifiers decided upon by standards organization, such as w3c, ensuring acceptance across many different networks and platforms.
The future of asset tokenization
Tokenization is poised to transform asset management as we know it today. It democratizes access to markets while ensuring fairness and security. The only obstacle today being legal boundaries — to what extent this hurdle stands in the way depends on the type of asset you want to tokenize. A network for exchanging Basketball cards will have small hurdles compared to a platform of expensive paintings.
Creating a legal bridge between assets and distributed ledger technology needs legal professionals to solve tax-related and cross-jurisdictional issues. Nevertheless, new solutions will come into the market, which will iron out these concerns in the years to come.