Tokenization. Why it matters .. a lot!
Ms. Smith, a woman from the middle class in London, wants to invest in real estate because it is projected that property prices would continue to climb in the city. This would be quite difficult for her with conventional financial products because of the typical relatively high initial capital investment. Tokenization and fractionalization -the partition of an asset class into parts smaller than the whole- present Ms. Smith with an opportunity. But how is it even conceivable? Welcome to the world of tokenization.
At its core, tokenization is the process of replacing a physical asset (such as credit card data, real estate, commodities, fine art, classic cars, precious metals, and so on) with its digital equivalent (token). Tokenization is not a new concept; it has been used successfully for over two decades. For example, tokenization was first used by TrustCommerce in 2001 as a means of replacing sensitive data (credit card data) with a digital equivalent - a token. This increased the security of payments and transactions and protected them from data leakage and/or hacking attacks.
Tokenization, in connection to blockchain technology, is the process of transforming something of value into a digital token usable on a blockchain application. Fractionalisation, on the other hand, makes it possible to divide an asset among several owners. Each owner holds a visible stake in the asset and is registered on the blockchain. To exchange or trade that asset, all owners must reach a consensus, however, such a consensus is not required to trade individual shares.
Going back to Ms. Smith’s metaphor, she could use tokenization to invest in an apartment. For instance, For example, if she wants to invest in a £200,000 studio apartment, the owner of the apartment can tokenize it into a total of 20,000 tokens, with each token representing 0.001% of the apartment’s value. Additionally, he can use a smart contract to guarantee, for instance, that the apartment will be sold within five years or when the market value is at least 40% higher, whichever comes first. With each token worth £10 only, it is evident that Ms. Smith can now invest in London real estate regardless of her income level. Unlike traditional ownership rights, however, the apartment tokens would be merely an investment, and she would be unable to use or live in the apartment.
The Power of Tokenization
The above scenario highlights one aspect of the power of tokenization. In review, tokenization could provide:
Greater accessibility: Investors are increasingly looking for alternative assets to diversify their portfolios. Real estate, luxury goods, and precious metals are examples of asset classes that can be used to mitigate the risk of inflation or economic instability. However, the majority of these assets are illiquid by definition. The term ‘illiquidity’ refers to the difficulty of buying or selling these assets in a short period and without the use of intermediaries. This illiquidity occurs as a result of market supply and demand imbalances. Evidently, Tokenization can provide additional opportunities for solving the liquidity problem through fractional ownership.
Higher efficiency: The tokenization, as mentioned earlier, can utilize smart contracts to replace traditional financial roles lowering expenses for both investors and issuers. Furthermore, when compared to traditional financial infrastructure, any asset can now move almost instantly on the blockchain.
Safety: Due to the way blockchain technology operates, when a token that uniquely identifies an asset is created, an immutable registry entry in the form of a unique code that cannot be stolen or hacked is created.
Convenience: In contrast to the vast majority of transactions that require the physical presence of the parties to be completed, tokenization coupled with smart contracts allows anyone to sell and buy assets anywhere and at any time.
The Tokenization Market
The tokenization market is booming at the moment showing a significant impact on the global economy as a whole. The global tokenization market is projected to grow from $1.9 billion in 2020 to $4.8 billion by 2025, at an average annual growth rate of 19.5% over the forecast period (Markets & Markets). This could be attributed due to the market’s constant push to improve customer service quality, the need for simple and straightforward compliance algorithms, and the widely recognised benefits of Blockchain technology (which almost eliminates the risk of fraud and data theft).
The Barriers/Challenges to Adopt Tokenization
There are two major challenges that limit the wider adoption of tokenization as follows::
The first challenge to the wider adoption of the concept of tokenization is the lack of consistent regulation across the tokenization spectrum. Evidently, there is a need for a global taxonomy (i.e., the definition of token) and regulatory framework (i.e., roles and procedures in the digital asset value chain) to overcome such a barrier. In addition, the legal aspect still has a long way to go before it can be relied upon to resolve any emerging issues. It is important to note that when we talk about “tokenization” of assets, we are referring to a complex legal environment in which a “Token,” as a digital representation of a right, requires complete legal equivalence between it and the represented right. These issues, combined with the borderless nature of blockchain, impede widespread tokenization adoption.
The second challenge is the lack of robust foundations for the tokenized economy. Hence, it is essential to establish solid foundations for tokenization by using a comprehensive and reliable digital asset management platform to manage digital assets. This platform must offer comparable levels of performance to conventional asset systems while also offering institutional-level and premium-grade safety against physical and cybercrimes.
The evolution of tokenization is undeniable and it is evident that tokenization will play a crucial role in the digital economy, redefining some aspects of innovation and entrepreneurship, on the basis of a more decentralised economic model, less bureaucracy, and greater user participation. Since its inception in 2001, tokenization has come a long way. Today, when combined with blockchain technology, it is poised to usher in a new era in the evolution of the digital world’s investment opportunities. One thing is certain: tokenization is just beginning to gain momentum and explore its potential applications.