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Concepts: Tokenization

Gunnar Jaerv
Gunnar Jaerv 1 April 2020

Tokenization Asset tokenization is the process of creating tokens that stand in for a specific fraction of the value of an asset.

For instance, if you owned a building worth a million dollars, you could tokenize it, creating a million tokens. Each token would be worth one-millionth of the value of the building.

That’s not the same as having those tokens be worth one dollar: they’re worth a millionth of a building, and the value of that building might change.

They’re also not worth a millionth of the company that owns the building: they aren’t shares or securities, because they represent a share of direct asset ownership. They don’t represent a share of a business that expects to make a profit and have its share value rise, and they don’t represent a share of expected future profits either.

Why tokenize assets?

The business case for tokenization is most compelling when the asset’s value is high and stable, and the asset is nonfungible, difficult to divide, and immobile.

For instance, there’s little point in tokenizing an asset worth just a few hundred dollars; it’s more efficient simply to sell the asset whole, and the potential market is large: many people can afford to spend a few hundred dollars. Even an asset worth several hundred thousand dollars can attract a much larger market if it can easily be shipped from one location to another.

An asset like a Picasso painting or an apartment block is a better candidate.

You can’t cut the painting in half and sell the two halves to two different people, each paying half the full value of the work. By dividing it, you destroy it. But the potential market for a painting worth millions is small.

An apartment block might be worth millions too, and its potential market is small. Yes, you could sell the apartments singly, though this can be complex legally; but what happens if each apartment is worth several million dollars? Again, the potential market is relatively small.

Finally there’s the opportunity to sell partial ownership of assets: if you’re the owner of a $100,000 asset, and you want to realize 10% of that value, there are few options open to you, all costly, unwieldy, and slow. By tokenizing the value of the asset, you can sell a proportion of it for immediate requirements.

There’s a market of investors who could invest smaller sums, or who wish to spread their investments across multiple assets and asset classes (rather than buy one Picasso and hope for the best). And there’s a large and growing number of asset owners who own assets they’re struggling to sell or monetize. Tokenization serves both these populations.

Which assets can be tokenized?

In theory any asset can be tokenized. However, as outlined above, there are clear reasons to tokenize particular types of assets, including:

  • Real estate tokenization permits fractional, distributed ownership of assets.
  • Converting commodities into digital tokens improves liquidity and lowers barriers to entry.
  • Tokenization of private equity shares improves communication between the company and its shareholders and makes its financial information more secure.
  • Tokenizing illiquid assets like artworks and ownership interests in private companies can offer provenance, lending, price discovery, and access to new markets.

How does tokenization work?

Tokenization requires the creation of discrete tokens that can be freely traded and moved, stored and exchanged, and that can’t be counterfeited or double-spent. While it’s possible to argue that everything from a ledger to a currency to a share certificate is a form of tokenization, the kind of tokenization we’re talking about relies on the same mechanisms used to create cryptocurrencies, and asset tokens are a kind of digital asset.

Asset tokenization isn’t the same thing as data tokenization, which is the process of replacing easily-readable data with unique, recognizeable symbols that represent it while concealing its meaning from unauthorized access.

How do tokens work?

Asset tokens are based on the blockchain, but the tokens themselves can be traded off their native blockchain in the same way as other digital assets such as Bitcoin. Thus there is a secondary market in asset tokens after their initial sale. Their reliance on blockchain means they cannot be double-spent or counterfeited, and can be traded freely and securely.

Tokens can be freely traded across exchanges, including for both digital assets and fiat currencies and their proxies. Thus, the value of the assets they represent can change depending on trading of the tokens.

Disclaimer:

Disclaimer: This publication is general in nature and is not intended to constitute any professional advice or an offer or solicitation to buy or sell any financial or investment products. You should seek separate professional advice before taking any action in relation to the matters dealt with in this publication. Please note our full disclaimer here.

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