Tokenization & Defi
9 months ago
Selling real assets can be complex and time-consuming. Asset tokenization on a blockchain gives buyers and sellers the best of both worlds – solid asset value and easy trading.
Blockchain technology is strongly associated with cryptocurrencies, yet Bitcoin, Ethereum & Co. are just the beginning. The digitally documented and transparent smart contracts that blockchain technology enables are increasingly allowing more efficient and cost-effective transactions in a wide array of sectors. Smart contracts use algorithms to issue licenses verifying terms and conditions without third-party involvement. Interestingly, this new digital technology is now poised to revolutionize business in some of the oldest areas of the old, old economy: tokenization on a blockchain to enable the sale and purchase of assets like fine art, precious metals, gems, antique cars and real estate.
Tokenization: The underlying concept
A blockchain-based digital system termed tokenization is the key to this revolution in asset trading. The concept is to issue digital tokens representing units of ownership, which are recorded on a blockchain. A token then serves as an accounting unit proving ownership and providing transparency throughout all transactions. The term tokenization refers to the process of issuing tokens for asset accounting and trading.
Tokenization on a blockchain enables investors to liquefy real-world assets, while retaining their solidity as investments. As it vastly widens the group of potential buyers, eliminates the need for third-party brokers, accelerates the business process and reduces transaction costs, it has the potential to enhance the attractiveness of investment in real-world assets. This in turn could increase the market value of the assets involved.
Benefits of tokenization
In fact, tokenization has positive effects for all stakeholders. The token owner has a legal title to a given asset, and can transfer ownership to another party such as a buyer without paperwork – simply by transferring the token. Businesses use a blockchain-based ledger or registry, making operations faster and more efficient. In a sense, a blockchain-based ledger is comparable to a conventional centralized accounting system or paper registry. One difference, however, is that a blockchain-based ledger – a tokenization platform – ensures the integrity of the entire transaction and offers data-processing properties like availability, non-repudiation and authenticity.
Blockchain-based tokens can be utilized to liquefy virtually any real-world asset, including commodities as well as intangible assets like brand equity or copyrights. To tokenize an asset, the owner creates a tradable token and puts the asset into a legally binding trust. The tokens are purchased by investors, who then collectively own the asset. This legally binding token-holders’ agreement is encrypted and distributed equally, rendering it impossible to lose or change without permission of all shareholders, which in turn helps cement trust and security among all stakeholders.
As platforms for tokenizing real-world assets emerge, new marketplaces can be expected to open up and make access to liquidity virtually endless. Private wealth managers and high net investors will have a world of new opportunities for placing capital. Accordingly, the World Economic Forum has projected that 10% of the world’s GDP will be shifted into crypto assets within a decade – a staggering US$ 10tn stored in digital tokens.
Initial tokenization successes
While tokens have entered the spheres of loyalty programs and gaming, tokenization of real-world assets is still in its infancy. That said, we have already seen the first successful tokenized transactions, for example, in real estate.
Real estate is by nature difficult to subdivide and physically transfer to buyers or investors. Conventional paper transactions are slow, complicated and expensive, a problem that is made even worse when parties are located in different jurisdictions. But if the title deed to a property is recorded on a blockchain and digital tokens created to represent shares in the physical asset, all this changes. For a commercial property valued at US$ 100m, for instance, 100 million US$ 1 tokens could be issued. Based on smart contracts recorded in a blockchain-based ledger, payment for – and ownership of – tokenized real estate can be transferred instantaneously. Depending on the market value of the property, these tokens would increase or decline in value.
In a recent example, the New York-based investment firm Elevated Returns sold an ownership stake in the St. Regis Aspen Resort, a prestigious luxury resort located in the Rocky Mountains. The tokenized real estate offering, Aspen Digital, netted US$ 18m.
The figure represents a small proportion of the asset’s value. A trophy property with spectacular views of the Rocky Mountains, the St. Regis Aspen includes a 179-room luxury hotel, four restaurants, a spa, private residences and 29,000 square feet (2,694 square meters) of indoor and outdoor space for conferences and banquets. But the point is not the size of the share in ownership the transaction encompassed, but the fact that investors who otherwise would not have had access to such an asset were enabled to participate. The SEC-registered operator Templum Markets was responsible for the initial offering and secondary trading of the digital tokens, via its Alternative Trading System (ATS).
Hurdles to overcome
As attractive as the concept is and as great as the promised benefits to asset owners and investors are, a number of obstacles remain to be overcome before tokenization can unfold its full potential. Above all, regulatory clarity and alignment are needed to allow worldwide trading. Additional unresolved questions include how the secondary token market will function. That is, how token owners will cash out without having to rely on other tier-one investors.
A further aspect to be clarified is how an issuer should place tokens on an exchange and how a user should withdraw them. And of course there is the issue of liability – especially where the secondary market is concerned: if you have a problem with a token you just bought, where do you go with your complaint? Other questions to be answered include the reporting requirements for issuing companies and how to verify ownership of physical assets. The latter point is relatively easy to resolve in the case of real estate, where title deeds document legal ownership, but trickier where movable assets like gold are involved.
A key role for tokenization
Despite these obstacles, tokenization has the potential to revolutionize trade in illiquid assets. Tokens combine the best of both worlds, being as readily tradable as cryptocurrencies, yet having real-world assets behind them. The concept reduces barriers for new investors, thanks to its cross-border efficiency and the option of fractional ownership of a real-world asset. Tokenization also enables increased portfolio diversification and spreads risk, with investors co-owning multiple assets at once.
But perhaps the greatest promise of tokenization is the possibilities it opens up for the unbanked. If smallholder farmers were able to tokenize their crops, for example, they would have instant and easy access to liquidity and a readily tradable asset they could borrow against. People who have been traditionally forced to borrow at exorbitant loan-shark interest rates would be in a position to participate in decentralized finance (DeFi) – a concept you can read about in our articles “Can DeFi defy traditional finance? An introduction” and “DeFi applications: What they can – and can’t – accomplish.” This may sound too good to be true, but in fact players like the blockchain-based commodities trading platform Binkabi are making it reality. Similar systems are also in place for livestock, including Sentinel Chain.
It may not happen overnight, but tokenization could turn out to be a cornerstone of the next big thing in finance: decentralization and democratization.
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