The tokenization of assets has been a hotly debated topic in the crypto industry over the last two years. Everything is up for tokenization, from stocks to real estate and even art objects. We tried to figure out whether this is a new way of making money or a step toward revolutionary changes in the market.
What Is Tokenization?
Tokenization is the transfer of rights to a traditional asset into a token on the blockchain. Such a token is backed by a real asset and tied to its value. It is assumed that this digital twin has the advantages of the blockchain (low transaction cost, security, transparency, speed, no intermediaries) while maintaining the characteristics of a classical asset. This should attract investors who are scared of the lack of control of ICOs.
Theoretically, any asset can be tokenized (liquid or not): stocks, debt instruments, derivatives, real estate, precious metals, art, or tenure rights. Most talk is about the tokenization of securities when blockchain technology is used instead of electronic records.
In fact, tokenization is securitization (financing assets through issuing securities), but on the blockchain. It should be cheaper and simpler than traditional means but achieving the same effect.
Tokens and stablecoins linked to fiat currency (Tether), precious metals (MyGold, Digix, Orebits), gold (Goldmint, Vaultoro), shares of large companies based on a marketplace (Blackmoon, Templum), real estate (Atlant), oil ( Petro), music, and art (SingularDTV).
Special platforms also allow users to tokenize assets. For example, Polymath, BankEx, Harbor, Smartlands, Trusttoken, Securitize, Swarm.Fund, OpenFinance Network, Atomic Capital, and the LAToken and Openfinance crypto exchanges. But the main problem of such projects is that there are more of them than cases of their use.
In May 2018, the blockchain arm of the investment company Morgan Creek Capital announced the conversion of the company’s paper shares into digital token assets. The Overstock tokenized assets exchange is also about to issue tZERO portfolio company tokens that will meet SEC requirements. The holders of these tokens will be able to receive quarterly dividends from tZERO profits.
In January, the licensed DX.Exchange was launched, allowing traders to buy tokenized shares of NASDAQ-listed companies and tokens on conventional ETFs.
What Are the Benefits of Tokenized Assets for the Financial Market?
The use of cryptocurrency in the real economy. To buy assets, users do not need to convert cryptocurrencies into fiat money.
The transition of trading capital into crypto assets. Suppose an investor works with oil, and perhaps it will be easier for them to do this by trading in oil tokens, which means introducing working capital into a stable cryptocurrency.
Increased liquidity. The tokenization of illiquid assets turns them into liquid ones (for example, real estate and art objects, where a transaction cycle may take several years).
Transparency. Thanks to the blockchain, the regulator will see any transaction, and smart contracts will be able to determine the pattern of revenue distribution or dividend payments and reveal the identity of the buyer or the time of sale.
Trade without intermediaries. Blockchain can remove brokers, depositories, and banks from the trading structure. Having bought such a token, the investor no longer depends on the stock exchange, depository, or regulator, and at any moment can sell it. But free sale can be limited by creating a platform for accredited investors, and the main thing is that a broker-dealer is no longer needed.
Reduced commissions. The fewer intermediaries, the lower the fees.
Quick execution of the transaction. If there are no intermediaries, then all transactions take place through smart contracts, and traders receive the most timely information.
Free market, expanding the base of investors. Without strict regulation and standards, an investor can enter the market with any (even small) capital and enter into transactions with any person from any country in any market.
The possibility of partial purchase of an asset. Expensive assets (for example, real estate) can be tokenized and divided into any number of inexpensive tokens available to any investor.
But Is the Market Ready for Tokenized Assets?
The status of tokenized assets is not legally established; they are not reflected in the legislation at all. All that the organizers of tokenizing companies propose is to rely on entries on the blockchain and, at most, smart contracts. As long as they are not prescribed by the law, all tokenized assets will remain ordinary tokens, and the law does not protect the rights of the investors.
Tokenization requires new regulation, which would allocate such tokens to a special class of assets and fix investors’ rights. In the meantime, the organizers (and regulators) either try to apply existing norms to them with respect to traditional financial instruments (then it is not at all clear why they are needed if everything works fine) or simply release them at their own peril and risk.
Tokenization of shares is not always justified. Low-liquid assets (for example, real estate and works of art) seem to be more suitable for tokenization than securities, as the asset becomes more liquid due to the fragmentation of rights to it.
But the release of a token to a public share seems only a way of dispersing the value of the asset and making money on it. It seems that buying tokens tied to stocks (or other assets) makes sense only if the investor does not want to leave the cryptocurrency market, but wants to reduce risks and invest in traditional low-volatile assets.
The issuers do not guarantee anything: profit, return on investment, or liquidity of tokenized assets. Moreover, most tokenized assets do not have any documentary evidence of collateral, and the platforms tokenize the shares of companies without the consent of the shareholders.
Eliminating intermediaries and financial organizations from transactions can be considered beneficial for the crypto community, but for an investor looking for guarantees, this is rather a minus than a plus. After all, part of the responsibility is levied on the buyers and sellers who cannot guarantee anything.
Tokenized assets have no established market. Tokenized assets can be brought to the market cheaply and transparently, but who knows how they will behave? The issuer cannot give any guarantees that the secondary market will develop or provide holders with the liquidity of investments. It is not necessary that such assets will grow speculatively, for example, as this did not happen with Bitcoin futures.
No infrastructure. Large-scale tokenization would require no less massive changes in the market infrastructure. For the system to work, users need to recreate the entire infrastructure: role management (users and administrators), asset lifecycle management (issuance, taking out of circulation, etc.), security, integrate remote identification and access systems, integrate payment systems, commission management, limits, develop exchange modules, integration with other exchanges, applications, etc. Smart contracts would be added, and there would be the possibility of a transparent audit in real-time with access to the results for all the parties involved, as well as guaranteed data synchronization between bidders, fast transactions in a few seconds, and the ability to pair any software with any trading platform. It is necessary to consider the procedure for registering such assets and their certification and licensing of blockchain platforms.
Many crypto exchanges are not very interested in creating such an infrastructure and making additional commitments on KYC/AML, as commissions from the sale of coins bring in more money.
It is not clear how tokenization will occur in real life. Most projects do not have a calculated (or transparent) business model, such as the amount of commissions, liability, and the number of assets purchased. Open questions: who owns the rights to such assets (do users need a permission of issuers of original assets), how to pay taxes on them, who will manage a tokenized asset with a large number of owners (for example, real estate)? Existing tokenization projects deviate from direct answers to these questions.
The Possibility of a “Bubble”
One should bear in mind that the uncontrolled, unlimited access of any person (unqualified investor) to the market brings not only the democratization of the market but also threatens another “bubble.” With a free unregulated market, the “quality of investors” is sharply reduced since there is an influx of small, unhedged, and insolvent retail investors. This usually leads not to an increase in liquidity, but to a decrease in the value of the asset. Such a bubble of low-quality liquidity, if inflated, will soon burst after all since investors have no discipline.
Businesses are interested in tokenization not because it is profitable and convenient for small retail investors. And not because the existing trading system cannot cope with its tasks. Against the backdrop of a protracted crypto market crisis and lower margins, tokenization for businesses is an opportunity to disperse the liquidity of a new asset and manage to make money on it until it falls.
Tokens Are Waiting for Their Assets
Tokens have advantages over traditional securities. Thanks to the blockchain token, no intermediaries are needed, such as depositories and exchanges. Due to its decentralized nature, as a derivative financial instrument, the token is even more secure. All this prompts major market players to look closely at the blockchain and test the technology.
But the development of tokenization is hampered by difficulties with regulation, infrastructure limitations, distrust of market participants, problems with the creation and registration of such assets, their management, and licensing of issuer platforms.
Despite all the difficulties, it seems that the market is almost ready for tokenized assets. There are no principal obstacles to tokenization; it is only necessary to adapt the financial sector and legislation. In the meantime, tokens are waiting for their assets, which will make them a full-fledged and legal financial instrument.