Applications of Asset Tokenization Are Multiplying: From Real Estate to Fund Raising

What Is Asset Tokenization?

Asset tokenization is the process of representing real-world assets as digital tokens on a blockchain. The digital tokens represent the ownership and legal rights of the real-world asset.

Tangible (real estate, art, wine) or intangible (copyrights, patents) real-world assets can be tokenized. The process of asset tokenization enables secure, transparent trading, transfer, and storage of real-world assets without the need for an intermediary or a third party. As digital tokens exist on the blockchain, the trading, transfer, and storage of these tokens are automated with the use of smart contracts.

Tokenization of assets is especially beneficial for illiquid real-world assets such as real estate. The power of fractionalization of assets enables the ownership right of a commercial building or a holiday resort to be divided into hundreds of digital tokens. These digital tokens can then be transferred and traded in a peer-to-peer manner over the blockchain seamlessly and instantaneously.

Properties of Tokenized Real-World Assets

Smart contracts: Real-world assets are tokenized using smart contracts. These are coded with instructions and are executed automatically when the conditions are met. The use of smart contracts promotes decentralization and removes the need for a third party to carry out operations.

Fractionalized: Real-world assets can be divided into hundreds of digital tokens on the blockchain. The fractionalization of real-world assets promotes liquidity and financial inclusivity. For example, the investment barrier for a commercial building worth $1 million is greatly reduced when it is divided into 1 million digital tokens worth $1 each.

Liquid: The tokenization of assets makes them more liquid by facilitating easy asset trading and transfers all in one place. Digital tokens can be exchanged freely and instantaneously in a peer-to-peer manner without the need for an intermediary financial institution.

Transparency: Real-world assets are tokenized to exist as digital tokens on a blockchain. A key feature of blockchains is transparency. Users can access all transactions occurring on a blockchain network, trace the origins and review the whole history of a tokenized asset and verify ownership. 

Real-time tracking: The transparent nature of blockchains allows tokenized assets to be tracked in real-time, which helps prevent fraudulent use. Central banks across the world are issuing tokenized forms of fiat currencies called central bank digital currency (CBDC) which can be tracked in real-time.

A single layer of data: Blockchain technology prevents fragmentation of data points by providing a single layer of data. This allows multiple parties to collaborate and share data about the assets more efficiently.

Financial inclusivity: Digital tokens can be issued by anyone. Individuals, small and medium-sized businesses, private companies, and NGOs do not need the approval of any financial institution to issue tokens on a public blockchain like Ethereum (though if they are securities, they would need to be registered with the Securities and Exchange Commission in the U.S.). On the buyer’s side, fractionalization of assets helps promote financial inclusivity by lowering the barrier to investment.

Decentralized distribution: The distribution of digital tokens can be easily facilitated without the help or approval of third parties. Issuers can list their tokens on public decentralized exchanges (DEXs) or conduct a token sale.

Non-fungibility: Digital tokens can be issued as non-fungible tokens (NFTs). NFTs are one-of-a-kind tokens that cannot be replicated or replaced. NFTs are different from fungible tokens. An example of a fungible token is the ETH token; all ETH tokens in the world have the same properties and can replace each other.

Real-World Applications of Asset Tokenization

1. Central Bank Digital Currencies (CBDCs)

It is difficult to comprehend the difference between CBDCs and a digital form of fiat currency that you see on your mobile phone or your bank’s website. The main difference between the two is that CBDCs are issued on a blockchain network.

Since CBDCs are issued on the blockchain, the entire history of a token can be tracked from its origin to its most recent transaction. Account balances of CBDC-holding addresses can also be tracked in real time.

Numerous governments, including the U.S., UK, EU, Japan, and India, are researching ways to implement CBDCs. China is the frontrunner in the CBDC race and has trialed the “digital yuan CBDC” in several provinces.

While the use of CBDC is expected to help clamp down on corruption and fraudulent activity, CBDC is a double-edged sword that may result in privacy breaches and intensified government surveillance.

2. Fundraising – Security Token Offerings

The power of blockchain tokens allows projects, small and medium-sized enterprises (SMEs), companies, and individuals to bypass traditional fundraising options such as venture capital, angel investments, and initial public offering (IPO). The rise of smart contracts blockchain Ethereum has allowed numerous crypto projects to raise funds directly from the public via initial coin offerings (ICO).

However, with regulators such as the US SEC taking legal action against ICOs and labeling them “unregistered securities,” the landscape of fundraising via blockchain tokens has entered a risky stage.

Enter security token offerings (STO). STOs aim to bridge the gap between the high-regulated and slow IPO fundraising process and the questionably legitimate but quick and easy ICO process.

STOs can be conducted by startups, SMEs, private equity firms, and large companies. STOs do not require a financial institution to broker the fundraising process. Digital tokens are issued as securities directly by the issuer and can be bought by the public using fiat or cryptocurrencies.

The STO will follow a regulated process, and the issuer will have to issue an STO prospectus, receive approval from the market regulator (the SEC in the U.S.) and comply with regulatory filings, just like a publicly-listed company.

STOs are quite similar to regular cryptocurrencies. The main difference is that there isn’t a threat of the SEC (or an equivalent regulatory body) classifying your token as an unregistered security, potentially bringing massive fines and total destruction to the token.

3. Real Estate

Blockchain technology is infusing the real estate market faster than most other industries, and the main focus at this intersection is asset tokenization. Here is an example of how blockchain tokenization of real-world assets is taking place in the real estate sector.

According to the OECD, the first tokenization of real estate in France took place in June 2019 with the tokenization of a luxury property using the Ethereum blockchain. After completing the valuation process, the property was divided into thousands of digital tokens on the blockchain. The minimum entry ticket of investment was set at EUR6.5.

The ownership rights, a one-year vesting period for initial token holders, conditions of purchase and sale, and voting rights were all coded on the blockchain. Documents exchanged during a traditional property sale, such as notarial deeds, certificates of ownership, and identification data of buyers and sellers, were encrypted on the blockchain.

There are now a handful of popular platforms that sell tokenized real estate. These tokens often earn interest from rent and are a fast-growing sector in the cryptocurrency world.

4. Precious Metals

The world has already seen the tokenization of popular metals such as gold in the form of tokens such as tether gold and PAX gold. These tokens track the market value of gold and are backed by one fine troy ounce of gold.

While the gold market is a highly liquid one due to the presence of financial instruments such as exchange-traded funds (ETFs), futures, and options, the market of other lesser-known precious metals such as palladium and platinum is not as liquid.

Tokenization of these metals can boost market liquidity, while the use of smart contracts can promote secure and instantaneous settlement of trades.

5. Supply Chains

Blockchain tokenization has the potential to increase transparency and automation in supply chains. Digital representations of real-world assets along the supply chain can be used to verify ownership and prove the authenticity of the end product.

The tokenization of assets in supply chains of the diamond industry is a great example. A customer can verify the origin of a diamond and check whether the diamond was mined in a responsibly-managed and licensed mine. They can also check whether the diamond is a second-hand sale on the blockchain. 

The transparency provided by tokenized assets will also help companies double down on their environmental, social, and governance (ESG) initiatives by vetting their supply chain.

6. Art 

High-value art is a very illiquid market. However, with blockchain technology, highly-valued 1 of 1 painting can be represented on the blockchain by hundreds or thousands of tokens. This will allow a broader group of investors to own a piece of legendary paintings. The investors can sell their digital tokens on the market when needed. 

The art world is famous for how exclusive it is because of the extremely low liquidity and insanely high prices of the most popular art. The liquidity of art is often so low that exorbitantly wealthy collectors manipulate the supply of art by certain artists and types of paintings to enrich themselves. The tokenization of art has already lowered the barriers to art in a positive way, and the industry is only growing.

7. Carbon Credit Market

Polluting companies are awarded a certain amount of carbon credits or carbon offsets.  These credits allow companies to emit a specified amount of carbon dioxide or greenhouse gases.

When a company releases fewer emissions than the credits they were awarded, it can sell those credits to other businesses, giving them an incentive to cut down on emissions. For example, Tesla makes billions of dollars by selling its carbon credits to other automakers.

These carbon credits can be tokenized and sold, transferred or retired on the blockchain in a transparent manner. Tokenization of carbon credits creates a more liquid market which will allow companies to access carbon offsets more easily and will allow climate action projects to raise funds more efficiently.

8. Bonds or Debt

Several financial institutions and banks have tokenized bonds on public blockchains like Ethereum. These tokenized bonds are issued, cleared, settled, and registered on a blockchain.

The tokenization of bonds is expected to reduce reliance on intermediaries and brokers, increase transparency, reduce costs, remove geographical boundaries, and open bond markets to more investors.

9. Intangible Assets

Blockchain tokenization offers a new way to protect intangible assets such as copyrights, trademarks, and patents which are typically stored in paper or digital form. 

Owners can protect their intangible assets by leveraging the transparent and immutable properties of the blockchain. Once tokenized, a copyright or patent will be tamper-proof, traceable, and verifiable in real time on the blockchain. A copyright or a patent can also be tokenized into an NFT to protect its authenticity.

How to Tokenize an Asset?

We will take the example of tokenizing a real-world asset on a public EVM-compatible blockchain.

1. Select a real-world asset to tokenize. This could be equity, art, wine, or cars;
2. Select a token standard. For example, an Ethereum ERC-20 token is used for fungible tokens, while ERC-721 is used to create NFTs;
3. Select a blockchain to issue the tokens on. This could be Ethereum or an L2 rollup like Optmisim or Arbitrium;
4. Select a third party to verify real-world assets and check for regulatory compliances;
5. Review and audit smart contracts;
6. Issue tokens.

Some platforms will do the hard part for you if you aren’t interested in tokenizing the asset yourself.

The Bottom Line: Asset Tokenization is Nascent But Growing Rapidly

The tokenization of real-world assets is still in the experimental stage. Properties of blockchain transparency and immutability are attractive propositions, but users tend to get cold feet after learning about the hacks and thefts rampant in the cryptocurrency industry. Moreover, technical difficulties that users encounter continue to be a big hindrance to mainstream adoption.

We will have to keep an eye on developments in the broader cryptocurrency and blockchain sector to see if the tokenization of real-world assets will see its full potential.