By Jason English, VP Protocol Marketing, Sweetbridge
Tokenization is one aspect of a rapidly-evolving movement toward more fluid and decentralized forms of value exchange. This movement started with Bitcoin and Ethereum, and has continued with the enabling blockchain technologies that support newer digital currencies.
Tokenization is the process of assigning a token as a unit of value for the specific asset it represents. In the blockchain and cryptocurrency spaces, this means assigning a digital token to represent an asset so it can be used as a medium for value exchange in a network.
Is tokenization a new concept, and how would I explain it to my grandparents?
Maybe our elders aren’t so unfamiliar with it after all.
In a sense, the U.S. dollar is an analog, generic, traditional asset token: It is considered legal tender for all public and private debts, and it is backed in the full faith and trust of the government. It stopped being backed in gold or silver reserves a few decades ago, and like other fiat currencies, it represents a unit of value people agree upon. If you were to tokenize that on a blockchain, it would be worth, oh, about a dollar.
As recently as 1950, there were thousands of functioning forms of tokenized currency in the United States alone. Individual banks could issue parallel banknotes. Industrial and agricultural trading companies would write their own “scrip” to streamline transactions with suppliers and buyers. Local and state governments, retailers, and property brokers offered alternate forms of currency for trade, often because the supply of actual government-issued currency was quite scarce or illiquid.
Even now, we are familiar with using utility tokens to pay for things like car washes, laundromats, and arcades. We can use or share airline loyalty points, gamble with casino chips, and trade in various gift cards. In this sense, tokenization doesn’t seem so new.
Why is tokenization suddenly becoming interesting again?
Right now, much of the hype around tokens is largely due to a phenomenon called the Initial Coin Offering, or ICO in which new cryptocurrencies are issued to the world as “coins” or tokens, and bought as an alternative source of crowdsourced funding. Using this method, companies or projects can raise millions of dollars in capital outside of conventional VC investment routes. It is no wonder that in the last three years, we have gone from a handful of known cryptocurrencies to more than 4,000.
Looking at some of the potentially outsized valuations and rapid growth rate in this space, one can hardly blame opportunistic buyers and founders wanting to catch the next big thing. But let’s set the speculation aside and focus on the value tokenization can provide for the assets it represents and the networks it supports.
Serious blockchain project founders, engineers, and analysts are not talking about tokens in terms of prices and market valuations. They are advancing tokens as a new way of exchanging economic value to build decentralized networks and get real work done.
What tokens can represent
In his blog, tech investor Nick Tomaino tightly summarizes the models that are currently in play in the decentralized space, breaking down tokens into four categories: traditional asset tokens, usage tokens, work tokens, and hybrid tokens.
- Traditional asset tokens are the cryptographic representations of standard fiat assets; a good example would be Tether (USDT), a cryptocurrency asset backed by the U.S. dollar held in Tether reserves.
- Usage tokens, like Bitcoin, provide access to a digital service; in the case of Bitcoin, users are granted access to a virtual payments network.
- Work tokens, meanwhile, offer users the right to contribute work to a decentralized organization. A popular instance of this type of token is Maker, which serves as the backstop in a collateralized debt system.
- Finally, hybrid tokens, a mix of usage and work coins, can be used for multiple purposes; one example of this is Ethereum tokens backed by the Proof-of-Stake algorithm, a system in which the creator of the next block is determined in a pseudo-random way, with a user’s chances depending on the amount of wealth in their account.
That might seem rather demystifying. In conventional terms, we all understand the idea of assigning a value to an asset, whether it is a dollar, product, or house. We pay for usage of a wireless service, or Netflix, or a gym membership. We get the idea of paying to work: You might rent an office in a location close to customers, pay an ownership share to join a legal or medical firm, or get a commercial license to drive a truck or fly a plane. And for a hybrid model, you could pay dues to a professional organization or union to both obtain work and take advantage of shared services and data.
The big shift is that tokenization on blockchains and decentralized networks can now create a massive increase in the ease of value exchange across all of these dimensions. Trades can be fairer, transactions can happen faster, and costs can be lower. In supply chain industry terms, tokenization provides units of value exchange that can shrink cost and time at every stage from the moment a customer places an order, to the end state when the order is delivered and all suppliers get paid for their contribution. Tokens that are purpose-built for the industries and networks they support move much faster than money, and get much more done.
When applied correctly, tokenization aligns incentives for decentralized organizations to build customer-oriented solutions in a more engaged way, thereby making winners out of all participants, rather than focusing on growth at all costs, shareholder value, or exit strategies.
Liquidity is the new king
Cash is money at best, and too often at rest. As we see our world become ever more fluid and digitally connected, cash will have a role, but will no longer reign as king. Governments are already considering this: Take for instance India’s decision to eliminate high-denomination bills in a multi-year effort to increase financial transparency and liquidity.
In Stephen McKeon's blog post on "Traditional Asset Tokenization," he hints at a coming wave of tokenization of things far beyond the realm of cryptocurrencies and financial-type transfers of value. Assets that are not easy to trade in a market are considered illiquid because buyers are not readily available, and thus they tend to trade below their actual value.
“Financial economists have attempted to measure the illiquidity discount in a variety of ways. A common rule of thumb is20–30%. This represents a huge amount of value and therein lies great promise.”
Great promise indeed. If tokenization can help us recapture liquidity not only for currencies, but by digitizing the value of all assets, time, and work in a more flexible, fair exchange, that’s exciting. And given the amount of work still ahead, I’d say tokenization may still be a toddler.