We are living in a digital era where most of the assets are digitized to bring innovation to the world. The blockchain is making it possible to move towards the digitization of a physical asset due to its transparent, auditable, immutable and distributed nature.
It takes only a few minutes to buy clothes or airline tickets, but when it comes to buying stocks or getting a mortgage, transactions are more time-consuming. Transferring or selling assets like real estate, gold, carbon credits or fine arts is difficult and often compel sellers and buyers to deal with a lot of paperwork and lengthy process.
Moving physical assets to digital tokens on a distributed ledger can unlock the value of real-world assets and make it possible to exchange them in real time.
Converting a physical asset into the tradeable digital asset blockchain platform offers a higher degree of liquidity and reduces the entry barriers for private investors in asset classes dominated by high net worth individuals and institutional investors.
In this article, we shall explain why and how blockchain can transform everything from investment to trading with asset digitization.
But let’s first understand what a digital asset is and how it works.
What is Digital Asset?
Digital Asset is defined as a digitized right of ownership of an asset. Also, it can be termed as the content owned by an individual in the digital form. But here, we are defining the digital asset as a store of value.
Digital Assets can be categorized as follows:
- Digital Currencies with a limited audit. For example, central bank digital currency, PayPal’s digital USD or any digital wallet with some amount. The auditing limitation implies that digital currency users cannot be assured to the authenticity of the process as they have to trust parties who manage them.
- Digital tokens are more transparent and offer auditability to allow users to trace back the immutable transactions whenever required.
Why digitize real-world assets?
The world is full of valuable assets: real estate, carbon credits, stocks, oil, precious metals (gold, silver or platinum) and so on. It is challenging to physically transfer or subclassify the assets, restricting the sellers and buyers to paper trading which represents some or all of the asset. However, paper and complex legal agreements are clumsy making it difficult to move or track the assets.
Understanding the complexity associated with paperwork, commodity exchanges have introduced electronic transactions and standardized agreements. But the overhead of such systems is massive and users have to rely on trusted parties. Therefore, major financial companies and startups around the world are planning to move to the next phase of the evolution: tokenized or digitized assets.
Let’s understand how can a digital token represent a physical asset with an example.
Imagine Alice is a gold wholesaler who has $20 million of gold. Since it requires careful inspection and a lot of security to ensure that the fake gold is not introduced in the supply chain, it becomes difficult to transfer gold to buyers. On the other side, Jane would like to invest a few thousand dollars in gold but does not want to receive them physically.
Jane wants to diversify her gold position by owning small pieces of different types of gold. Alice now needs an easy way to subclassify his gold stock to sell fractional fragments of it to Jane and other people. The ability to provide fractional ownership and make everyone happy could become possible with the blockchain tokens representing a physical asset.
Here are the types of assets that can be put and created on the blockchain:
- Intangible Assets
An intangible asset lacks physical nature and exists due to the operation of law. Examples of intangible assets are patents, brand names, copyrights, carbon credits, trademarks, etc.
Since they lack the physical substance, it is possible to combine them easily with blockchain based solutions. The challenge is to ensure that the blockchain model of asset transfer maps with the legal model of transfer.
There could be differences according to the jurisdictions of different countries. But it is simpler to tokenize such assets than physical objects as there would be fewer concerns regarding shipment and storage.
- Fungible Assets
A fungible asset is an asset which can be exchanged for another similar asset of equal value. The best examples of fungible assets are commodities.
For instance, a barrel of oil is equivalent to another barrel of oil and an ounce of gold is equal to another ounce of gold. A physical resource usually backs fungible assets- gold is stored in a warehouse, oil is kept in a pipeline.
As fungible assets are often traded in bulk form, delivery cannot be instantaneous. For example, the shipment of thousands of barrels of oil is quite bulkier. Transferring ownership of the asset from one user to another might involve a lot of transportation expense or a lengthy paper trail.
Therefore, a tokenized or digitized asset can reduce complexities by utilizing smart contracts. Digitized assets would not involve any intermediaries like exchange agents, government checks, warehouse administrators or port officials.
Barrels of oil uniquely identified on the blockchain can be moved from buyer to seller in a hassle-free way. Since the trading is recorded on the blockchain, a verifiable and tamper-proof receipt is created.
- Non-fungible Assets
Non-fungible Assets are the assets that cannot be replaced with other assets of the same type. Examples of non-fungible assets are real estate and art.
For example, there is only one real painting, Mona Lisa which can be sold or brought as a unit. The unique Mona Lisa painting is not similar to that of millions of digital copies or print of Mona Lisa. So, tokenizing/digitizing a piece of art introduces digital ownership or signature which cannot be altered.
How Digital Asset Blockchain Platform could work?
While creating the digital assets on the blockchain, the first step is to choose the blockchain platform and smart contract environment. There are many blockchain platforms like TrustToken, Alpha Point and Fraction/al that allow digitization of assets on the blockchain.
A digitized asset is created and its value is set equivalent to the physical asset backing it. For example, if you want to digitize the gold asset, the cost of digital gold on blockchain would be fixed at the price of gold in a specific market.
The value of the digital asset to be launched on the blockchain is fixed in the immutable smart contracts. The number of tokens minted by the company should be backed by the equal amount of physical asset holdings.
Regular audits should be performed to confirm if the organization has the physical asset holdings to support the launched digital assets/tokens.
Digital assets supported by the physical goods can also be defined as regulatory asset backed tokens which only allow accredited investors to get digital ownership of assets.
Every investor who wants to own the fractions of the assets has to undergo KYC/AML checks to become eligible. Once the KYC/AML validation is completed successfully, investors can be onboarded to the Digital Asset Blockchain Platform and can own a specific amount of holdings they invested in.
Asset backed tokens are usually tradeable and redeemable that make them more liquid than physical assets. Investors can redeem or sell digital assets whenever they want.
When investors initiate the transfer of digital assets to the organization or another investor, the tokens are first transferred to the escrow account. Once the specific conditions are met and the investor’s KYC/AML status is validated, the transfer request is approved and funds are transferred successfully.
No involvement of intermediaries, fewer complexities, ability to transfer or exchange illiquid goods, fractional ownership and decreased transactional frictions are some of the primary reasons that have led to the digitization of physical assets on the blockchain.
Benefits offered by the Digital Asset Blockchain Platform:
- No Regional Barriers
An investor from any corner of the world can invest in the digital assets without leaving their territory, with the speed, security and ease of exchange or transfer provided by the blockchain network.
- No Middlemen
Trade can be made seamlessly without the involvement of third-party brokers or a centralized authority which can often slow down the process and make it more expensive and inefficient.
- Increased liquidity
Digitized assets can improve the liquidity of real-world assets by enabling fractional ownership and making the transfer from one entity to another possible without the legal complications.
- Reduced transaction costs
Transaction cost for digitized assets is less as a result of the removal of intermediaries/middlemen, reduced fees in transactions on blockchain and reduction in counterparty risk. Intermediaries involved in the financial system charges fees associated with transactions.
Compliance can be added to the smart contracts of the digital assets on the blockchain which manage how or when the token can be legally traded.
- Asset interoperability
Asset interoperability is one of the intriguing benefits of digitized assets but needs the development around regulation, governance and technology.
Regulatory environments can vary in many countries. However, the standards on Ethereum like ERC-721 and ERC-20 state the ability of standardized interfaces to interact with different types of value.
Imagine you have bought tokens backed by the gold assets and value of each token is equivalent to the price of 2grams of gold. It could become possible to redeem the purchased tokens against the physical gold or fiat.
If you want to redeem tokens for fiat, then the amount equivalent to the tokens in your wallet can be transferred to your linked wallet once you sell the tokens.
Similarly, physical gold could be transferred to your desired location with some shipping charges. In this way, investors can easily exchange the digital tokens for the real-world assets in the possession.
We have created a workforce of blockchain experts who can assist you in building the digital asset blockchain platform supporting the physical assets. If you want to digitize an asset on the blockchain, contact us and discuss your requirements.