What Are the Asset-Backed Cryptocurrencies (ABCs)?
Cryptocurrencies have evolved beyond digital coins with volatile speculative value. One of the many types of crypto assets that have emerged in recent years and has potential in a range of applications is asset-backed tokens.
These tokens represent a bridge between traditional assets and blockchain technology, combining the security and transparency of distributed ledgers with tangible, real-world assets.
Asset-backed cryptocurrency tokens (ABCs) are a form of digital token that derives value from tangible or physical assets and represents their ownership on a blockchain.
Conventional cryptocurrencies such as Bitcoin or Ethereum are purely digital assets that are valued based on market demand and supply dynamics, whereas asset-backed tokens are linked to real-world assets such as fiat currencies, real estate, fine art or commodities.
This backing provides the tokens with a measure of stability and trust, as their intrinsic value is tied directly to the worth of the assets they represent. As the value of the underlying asset changes, so does the token’s value.
Asset-backed tokens are an innovative use of blockchain technology that can give the holder the right to own the underlying asset. This means they can be used to transfer ownership digitally without physically moving the asset or requiring physical paperwork. Instead, contracts and other ownership information can be stored on-chain.
While there are debates as to whether cryptocurrencies like Bitcoin and Ripple are currencies, securities or other types of assets, ABCs tend to be classified as securities by financial regulators.
Tokenized assets can be used as a store of value and traded between peers at low cost, without the need for third-party intermediaries like financial institutions.
How Does an Asset-Backed Cryptocurrency Work?
Asset tokenization involves converting the ownership rights to a real-world asset into digital tokens stored on a blockchain using smart contracts. This enables fractional ownership of assets, as each token can represent a share rather than whole.
The following steps should be taken to issue an asset-backed token:
- Asset Validation: Trusted third-party auditors or institutions thoroughly validate the existence and value of the underlying asset.
- On-Chain Minting: Upon successful validation, the asset-backed tokens are minted or created on-chain.
- Exchange and Transfer: The minted tokens can be easily exchanged, transferred, or traded on blockchain-based platforms like regular cryptocurrencies.
Asset-backed tokens that have redemption value allow holders to exchange their digital tokens for the underlying asset, such as fiat currency, gold, or real estate. Each transaction is contained in a transparent, verifiable and immutable record on the blockchain platform.
Types of Asset-Backed Crypto Tokens
Asset-backed tokens can be pegged to various types of assets, including:
- Fiat Currencies: Some stablecoins, like Tether (USDT) and USD Coin (USDC), are asset-backed cryptocurrencies as they are backed by traditional fiat currencies, such as the US dollar as collateral. Each stablecoin token is pegged at a 1:1 ratio to the underlying currency and can be redeemed at any time. Stablecoins aim to provide the stability of traditional currencies while benefiting from the speed and global operation of digital currencies. Stablecoins are widely used for remittances and as a hedge against currency volatility.
- Commodities: Asset-backed tokens can be linked to the value of commodities such as oil, natural gas, precious metals like gold and silver, or agricultural products. These tokens give investors exposure to commodity markets without having to physically own the assets, and act as a store of value or hedge against inflation.
- Real Estate: Tokenized real estate enables the digital transfer and fractional ownership of properties. Tokens can provide liquidity and accessibility to real estate investments, allowing investors to buy tokens representing a fraction of a property.
- Art and Collectibles: Fine art, collectibles, and other high-value assets can become more accessible through tokenization that allows them to be fractionalized and easily traded. Multiple investors can own a piece of a valuable artwork or collectible and trade their share.
- Equity and Debt Tokens: Asset-backed tokens can represent virtual ownership in a company, similar to traditional stocks, bonds or other debt instruments. This provides a digital alternative to traditional investments and can simplify the process of raising capital.
What is the Purpose of an Asset-Backed Cryptocurrency?
The main purpose of asset-backed crypto tokens is to provide stability and reduce the volatility often associated with cryptocurrencies like Bitcoin.
By pegging the value to real-world assets, these tokens aim to combine the advantages of blockchain technology with more predictable and secure investment options.
Asset-backed crypto tokens can also create new liquidity in markets such as fine art and antiques, opening up ownership to global digital markets and attracting digital-savvy investors regardless of location who may not have engaged with traditional auction processes.
Tokenization also facilitates easier and faster transfers of asset ownership.
The Role of Smart Contracts in Asset-Backed Cryptocurrencies
Smart contracts play a pivotal role in the functioning of asset-backed cryptocurrencies. These self-executing contracts reside on the blockchain and govern the issuance, transfer, and redemption of asset-backed tokens. They can incorporate governance rules, ensuring that any regulatory or compliance requirements are met. This automation increases efficiency, ensures transparency and reduces the need for intermediaries.
Once the terms and conditions of a smart contract are coded into the blockchain, the contract executes based on predefined triggers and actions. All of the contract terms and information about the asset are recorded on-chain, so they are accessible to all participants in real time.
This aims to create trust in asset-backed tokens, as anyone can independently verify the details of transactions and ownership.
Smart contracts also enable near-instant settlement as the code executes automatically when the predefined conditions are met. This contrasts with traditional asset transfers, which can be time-consuming and involve multiple intermediaries and extensive paperwork.
Tokens that generate income, such as from equity or debt assets, can use smart contracts to automate payment distributions, making the process more efficient.
Smart contracts can also be designed to interoperate with other smart contracts and decentralized applications (dApps). This enables asset-backed tokens to integrate seamlessly into various blockchain systems.
What are the Advantages of Asset-Backed Cryptocurrency?
Asset-backed cryptocurrencies aim to bring together the benefits of digital tokens, such as fast transaction speeds and accessibility, with the value of tangible assets.
The advantages include:
|Pegging tokens to assets aims to provide more stability and less price volatility than speculative cryptocurrencies, as their value is determined by tangible or physical assets with real-world value.
Asset-backed tokens can provide a stable store of value for individuals affected by inflated or devalued currencies or stock market volatility. This makes them more suitable for everyday transactions than cryptocurrencies.
|Lower Transaction Costs
|Smart contract automation reduces the need for intermediaries such as brokers and custodians, and manual systems that require the processing of paperwork. This can reduce transaction costs.
|Tokenization can create new opportunities for investors and bring a broader investor base to businesses and individuals who can create new debt or equity instruments.
Additionally, fractional ownership makes it easier to buy and sell smaller shares of high-value assets on blockchain exchanges, providing more flexibility in trading. Tokens can be traded 24/7 on blockchains in peer-to-peer transaction or on exchanges, further increasing liquidity.
|Transparency and Security
|Blockchain protocols store the details of each transaction and ownership transfer on an immutable, tamper-proof decentralized ledger. The underlying assets that back tokens can be publicly audited, fostering trust and accountability.
|Lower Counterparty Risk
|Smart contracts automate processes, including the transfer of funds, reducing the number of intermediaries and ensuring that all parties fulfill their obligations—limiting the potential for fraud or default.
|Asset-backed tokens can increase financial inclusion around the world, as anyone with a smartphone and Internet access can access and invest in digital assets.
The global reach of blockchains networks also facilitates fast and cost-effective cross-border transactions and remittances. Individual investors, not just the wealthy, can buy real-world business assets without having to physically store or exchange them.
|Asset-backed tokens make it easier for investors to diversify their portfolios with exposure to different types of assets, potentially reducing their investment risk and maximizing returns.
Examples of Asset-Backed Cryptocurrencies
Stablecoins are the most common form of asset-backed cryptocurrencies.
- Tether (USDT)
This is a stablecoin that claims to be backed at a ratio of 1:1 by the US dollar. This means it holds an equivalent value in US dollars in its reserves for each USDT token issued. The company behind Tether publishes information about the value of its reserves on its website to provide transparency.
Similarly, USDC is a US dollar stablecoin issued by financial technology firm Circle, which states that it is 100% backed by highly liquid cash and cash-equivalent assets and is always redeemable at a rate of 1:1 for US dollars.
The majority of the USDC reserve is invested in the Circle Reserve Fund, which is a government money market fund registered with the Securities and Exchange Commission (SEC). USDC has gained popularity because of its compliance with regulatory standards and its use in decentralized finance (DeFi) applications.
- PAX Gold (PAXG)
An example of a commodity-backed crypto token is PAX Gold (PAXG), issued by Paxos. Each token represents ownership of one fine troy ounce of a London Good Delivery gold bar stored in a secure London vault.
This tokenization of gold allows individuals to own and trade the precious metal in small denominations without having to deal with the physical storage of the metal. Paxos publishes monthly reserve reports on its digital assets to provide transparency.
Here is the top 10 asset-backed tokens list as of 19 January, 2024.
Are Asset-Backed Cryptocurrencies Centralized?
The level of centralization of asset-backed tokens can vary depending on the issuer. While blockchain technology ensures the transaction process is decentralized, the management and custody of tokens – as well as the underlying assets – can be centralized.
Some issuers use centralized governance models, while others might allow smart contracts to govern the asset-backing process. For example, the Tether stablecoin is issued and backed by the centralized company Tether, and the USDC stablecoin is managed by Circle.
Asset-backed cryptocurrencies represent an evolution in the use of blockchain technology and the concept of cryptocurrencies, aiming to provide a more stable and secure alternative.
They create new opportunities for ownership and investment in various tangible assets, with the potential to increase liquidity and expand financial inclusion. As blockchain technology continues to advance, the integration of real-world assets into the digital realm is set to reshape the financial industry.