Asset Tokenization – Real Assets on the Blockchain
Table of Content
- An Example explaining Asset Tokenization
- Here are some of the reasons why the market is shifting to tokenization
- What can be tokenized?
- Benefits of Asset Tokenization
- Here are some of the challenges that obstruct the adoption of asset tokenization
- What should be considered to participate in the token economy?
The way we invest in assets could change with the emergence of tokenization. Whether it’s a real estate property, painting, precious metal and company shares, everything is being tokenized on the blockchain. Asset tokenization refers to the process of converting real assets into digital assets. Let us explain the process with an example.
An Example explaining Asset Tokenization
Let’s forget smart contracts and blockchain for a while. Suppose you want to invest in a real estate property, but you have only $5000 for early investment. You may wish to start with small and raise investment moderately. For instance, you
want to invest a few thousand every two or three months. It might seem an awkward thing to do in the real estate industry. People have not been able to buy four or five square meters in an apartment.
Now, reverse the situation. You have an apartment, and you quickly need some money. The value of your apartment is $200,000, but you only need $30,000. Do you know how you can use that property to get the money you need?
Here tokenization comes into the picture. Tokenization is also defined as the method to convert ownership rights in an asset into a digital token. Your apartment worth $200,000 can be converted into 200,000 tokens, where each token is equal to 0.0005% share of the apartment. Then, tokens are issued on any blockchain platform that can support smart contracts, for example, Ethereum. When a user buys one token, it means they buy 0.0005% of the asset’s ownership. If someone buys 80,000 tokens, they own 40% of the asset. If they buy all 200,000 tokens, they become 100% owner of that property.
Blockchain is an immutable public ledger that ensures once you purchase tokens, you cannot delete the ownership, whether it is registered on the government-run registry or not. It is now clear why blockchain is implemented in such services. So, we took an asset, tokenized it and built its digital representation on the blockchain.
Due to the capability of tokenization to offer increased liquidity, reduced costs and faster settlement, it continues to achieve momentum and investments are being made across different industries. Let’s discuss why the market is shifting towards tokenization in a more detailed way.
Here are some of the reasons why the market is shifting to tokenization
- No territorial barriers
An investor can invest in a property located in any part of the world without visiting there physically. Investment becomes secure, fast and easy with asset tokenization on the blockchain.
- Elimination of middlemen
Trading of assets usually takes days to months to achieve a settlement. It involves external entities to validate the documentation of transactions and investor’s eligibility, which adds extra costs to the process. But, tokenization removes the need for intermediaries with blockchain’s ability to provide immutability and transparency.
- Fractional Ownership
When assets are digitized, they become highly divisible. Thus, investors can invest in small percentages of tokenized assets. For example, you can buy only a 10% share of a tokenized real estate property. It dramatically removes the barriers for billions of investors to enter the market.
- Improved liquidity
Bringing the investment process on the blockchain provides a low-friction environment. Asset tokenization enables the automated transfer of ownership while ensuring compliance. With reduced complexity and costs, tokenized assets present the possibility to invest with fiat money and P2P trading on regulated exchanges, which can improve liquidity.
- Quick and cheaper transactions
Since the transaction and transfer of tokens are done with smart contracts, the exchange process is automated. Automation can reduce the burden associated with buying and selling, with no intermediaries required. As a result, it fastens the deal execution with lower transaction fees.
- Broader Investor Base
Traditionally, the trading of real-world assets has a restriction on the level of fractionalization. But asset tokenization eliminates the limitation by making it possible to sell or buy tokens representing fractions of ownership. It results in a broader investor base participating in the investment process. Tokenization would open opportunities for a new set of investors and allow them to diversify their investment portfolio into assets that they could not afford previously.
From the above reasons, it is concluded that tokenization will stay here for many coming years and present a wide array of opportunities to a broad asset class.
Now, we shall list some of the asset classes which can be tokenized and made available for small and large investors.
What can be tokenized?
From exotic assets like artwork, sports teams and racehorses to traditional assets like bonds, real estate, venture capital funds and commodities, almost every asset class can be tokenized.
- Real Estate
Real Estate tokenization allows fractional ownership, which opens the doors for high capital and increased market participation. Tokenized real estate assets provide an opportunity to expand real estate investment markets.
Tokenization of commodities can offer new market opportunities across the sourcing of commodities and trading lifecycle. Converting physical assets into tradable digital assets offers improved liquidity and lesser barriers to entry in asset classes led by institutional investors individuals.
- Private equity shares
Currently, information about shareholders and shares of small-to-medium size companies is recorded on papers or spreadsheets. Each party manages records in its database, creating siloes which is inefficient and prone to errors. Tokenization of equity shares allows companies to interact with shareholders by providing information on a single shared and immutable ledger. Shareholders will have ownership transparency and authenticity to run trades on the secondary market.
- Physical Goods
Illiquid assets, including artwork, wine, ownership interests in private companies, partnership shares and more, can be tokenized to offer provenance, lending and price discovery through the blockchain’s transparency.
Now, let’s discuss how assets tokenized on the blockchain will benefit the user and the issuer.
Benefits of Asset Tokenization
Today, a large percentage of the global population cannot access high-value investments. Powered by blockchain technology, new capital formation techniques present an introduction to capital mobility and international capital markets.
Tokenized assets can be accessed globally, 24/7, from anywhere in the world.
Once anyone buys, the token ownership gets removed. However, it can be transferred from one person to another if the owner sells it to someone else. In case of any disputes, conflicts can be solved quickly by looking at immutable records of ownership.
As each record is maintained on a shared and immutable ledger, no one can claim to own assets fraudulently. Transparency within the ecosystem will ensure everyone to have a clear view of the updated ledger of ownership records.
Tokenized assets remove the involvement of intermediaries that often restrict investment accessibility. Eliminating intermediaries from the system will reduce high fees and bring clarity.
- Easy to invest
As tokenized assets provide greater liquidity with fractional ownership possibility, asset tokenization removes minimum investments.
Though the tokenization of assets represents new opportunities for the asset trading market, many challenges restrict the adoption of this emerging technique.
Here are some of the challenges that obstruct the adoption of asset tokenization
We need to overcome some challenges to widen the scope of tokenization and token economy. The rising interest has made the government authorities and brokers very attentive to asset tokenization.
- Uncertainty in code of conduct
The lack of code of conduct and common standards for developing and managing the tokenized assets compels financial entities to review the business architecture and exposes investors to unwanted practices. Using formal frameworks will ensure trust among all market participants. Using formal frameworks will ensure trust among all market participants.
- Uncertainty in regulations
The lack of regulations within jurisdictions and the borderless nature of nascent blockchain technology presents a challenge for investors and institutions to hold tokenized assets confidently. Regulators, local and global policymakers should coordinate to state the legal framework, including all aspects of digital asset management.
Besides the above challenges, some companies are assisting in solving compliance-related issues. For example, Harbor aims to embed compliance at the token level. They check whether the trade is compliant or not by considering who the buyer and seller are and where the trade takes place. If the trade is found to be compliant, the trade becomes possible on any token exchange.
Proper KYC and regulatory compliances in place can help make the adoption of asset tokenization for every industry easier. EU’s ESMA and US SEC have made progress and comments in the field of tokenization. Countries like Malta and Switzerland have also planned to build a room for marketplaces for tokenized assets. A clear picture of the regulatory framework is crucial for the safe development of the token economy.
Beyond regulations, people might have a concern about how tokens will remain linked to real-world assets. For instance, you own tokens representing a fraction of 100 g gold bars kept at a custodian bank and 5 bars are stolen from that bank. What happens to your tokens and other token holders is that the token’s value is reduced if they are not proven to be linked to tangible assets.
Therefore, asset tokenization requires proper structuring to make progress and become mainstream for businesses around the world.
However, we have tried to address the above issues and explained what needs to be considered part of the token economy.
What should be considered to participate in the token economy?
The token economy embodies a significant shift from extensive centralized agents to the individual. Cryptology replaces intermediaries with blockchain network members executing complex algorithms to verify the integrity of the ledger. Financial institutions should know how they will adapt to the token economy.
Following are some of the factors that need to be considered to participate in the token economy:
- Business Model
Financial institutions have to choose what needs to be done in the value chain. For example, they can choose to advise issuers on the token structuring or serve as a safe keeper of tokenized assets. Leveraging the expertise of custodian banks, they create lifecycle event transactions on the distributed ledger. In an advanced model, they implement lifecycle processing in smart contracts and host them on the public blockchain network. On the other end, they could also provide services to manage customer accounts in tokens or act as central distributors providing access to transact on token exchanges or diverse tokenization platforms.
Since the digital payments reached billions of dollars in 2017, cybercriminals targeted tokens increasingly. Though distributed ledgers offer a high degree of cybersecurity, the ecosystem contains some weak points at its edges that need to be secured efficiently. One of the weak points is the management of private keys and wallets because anyone can steal private keys to control wallets and steal money. So, financial institutions should consider implementing security measures and providing a way to store keys and wallets securely.
- Platform Integration
Financial institutions will implement various operating models based on the business model they want to include. Depending on the operating models’ components, they have to decide the type of blockchain platforms to work. Selecting the right platform will depend on the regulations to be followed, types of products or services offered to the clients, and other platform factors. They also need to consider an infrastructure that provides economic and technical solutions to their business models while thinking about its impact on downstream systems. If a new platform cannot integrate with legacy systems, financial institutes might have to deal with a partial re-platforming of information systems.
As regulatory and legislative frameworks can differ from jurisdiction to jurisdiction, financial institutions should ensure tokens are compliant both in the investor’s and issuer’s jurisdictions.
Anti-money laundering and KYC (Know your customer) are at the center of any financial institution’s obligations. Institutions. In the token economy, where business interactions are irreversible and expeditious, methods to comply with regulations need to be adapted. Institutions should not reconstruct the wheel but collaborate with new entities like KYC utilities, tech startups, or blockchain software vendors to apply new operational measures and prove that they remain compliant in the digital space.
We expect that the emergence of asset tokenization will bring new actors, new services and new roles to the market. It will present unique opportunities to the traditional players to meet the new demands of the token economy.
We have been thoroughly researching the blockchain and its use cases since its emergence in the market. Therefore, we understand what it takes to tokenize a real asset without any constraints. Consult our blockchain experts and convert your real asset into a digital token.
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