By: Glenn Woo, Managing Director, Head of APAC, Ledger, and;
Scott Thiel, Partner and Asia Head of Technology, Blockchain & Digital Assets and FinTech, DLA Piper
The fractionalized future of assets is upon us. Tokenization will help to ensure greater liquidity, better price discovery and universal accessibility of illiquid assets. This technology has the potential to disrupt several asset classes such as art, precious metals, real estate, private shares, and private debt. However, with this move towards fractionalization comes the challenge of ensuring the security of tokens.
Tokenization will allow smaller-scale investors to participate in investment opportunities without needing large amounts of capital to do so. Simultaneously, this allows asset owners to access new sources of liquidity, which has immense upside potential. For example, a vendor of a building would no longer be restricted to a market of a few potential buyers - with tokenization they could have thousands.
TOKEN CUSTODY
Asset custody is traditionally associated with entities such as central depositories, custodians and trusts. These institutions are needed to determine and safeguard the records of ownership, details, and any changes that occur to assets being held. However, blockchain technology fundamentally alters that paradigm. Those legacy institutions are instead replaced by immutable distributed ledgers.
Determining the ownership of assets on blockchains is driven not by centralized records, but rather by public and private key management. In this context, custody refers to control of, and access to, private keys and the question for any asset holder becomes: “who or what holds that information?”
What this means in practice is that for blockchain-based assets, self-custody is possible in three key forms: retail self-custody, institutional self-custody, and the newly-developed third party custody landscape.
TOKEN CUSTODY MODELS
Retail self-custody
Retail self-custody allows investors to hold their investments in secure, offline cold wallets, that they can keep in physical proximity, at minimal cost and effectively serve as their own holding solution. The downside of this model is that it has single failure points, namely the individual holding the private key and the device itself. While this model follows the dream of digital asset ideologues, many investors do not want to be their own bank, as that could potentially mean keeping the ownership of a high-value asset tied to a single USB-sized device, that if lost, would be entirely unrecoverable.
Institutional self-custody
Institutional self-custody is best suited to institutional-grade token holders who wish to minimize risk and spread potential failure points throughout a larger organization. The best solutions include multi-authorization for different users, whitelisting of specific addresses being authorized for use, and conditional flows, which prevent movement of assets outside of specified conditions. This option allows organizations to achieve high levels of transparency and control. Institutions can be their own custodians to protect their assets as they see fit and ensure the quick access to liquidity that they need.
Third-party custody
Third-party custody allows investors to choose to appoint one or a few qualified entities to act as the custodians for an entire project. Through this, both an issuer’s and investors’ tokens can be managed by a single custodian. The advantages of such adoption are that tokenholders do not need to understand the underlying blockchain technology and can just order a custodian to send, receive, trade, check their balance, all while complying with regulatory needs across multiple jurisdictions. Third parties can help settle between parties efficiently, and could also act as investment banks to create derivative products - interest-bearing accounts, lending services, and the creation of structured products, and other value-added services such as accounting, reporting, and tax filing. With these services the blockchain ecosystem as a whole can retain its inherent advantages while helping to make the management of digital assets accessible.
Today’s tokenized offerings sit at the fulcrum between the highly progressive digital asset movement and the traditional finance sector. With this edge, tokenization may be the key that unlocks the real benefits of next-generation finance.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.