The Boomer’s Guide to Investing: What the Heck Is Tokenization?
By Doron Cohen, Managing Partner & CEO of A-Labs
Everyone likes to joke at the expense of the baby boomer generation these days, but the truth is they’re far from the only ones that need a crash course on the concept of digital assets and tokenization, which has taken the financial world by storm over the past few months as traditional financial institutions globally have adopted the blockchain-powered approach to investing.
Newcomers in the budding cryptocurrency space have pushed the idea for years, but now that the big wigs are interested, well, so is everyone else. So what exactly is all that? The short answer is that it’s essentially the next generation of capital markets. Equities 2.0 if you will (Equities = Stocks for the benefit of ‘the rest of us’). This is the NASDAQ and London Stock Exchange brought into the era of the 21st century.
Until now, shares have represented only one thing: Ownership rights in a specific company. The blockchain revolution has taken this concept to the next level. Digital assets mean representing an asset, any asset (physical or non-physical), on the blockchain and enable this asset to have a value and be traded by multiple parties. You can imagine a prominent art item whose owner is listing 10% of that art item as a digital asset and enables its global trade by anyone in the world. It will have a valuation provided by the crowd, and it will benefit the investors with 10% of the profits the art owner will produce once he sold that item to the next art collector. The same concept applies to real estate, patents, talent (yes, you can take Beyonce public using digital assets), and more. Anything can be represented by digital assets - called ‘Tokens’ - and have the ability to trade and raise capital.
So the term ‘tokenization’ means taking any asset (as illiquid as it may be) and virtually encapsulating its value and existence to be represented by a digital Token that can be traded like stocks of companies.
But what’s the point of all this? But what are the advantages? Let’s break it all down into smaller segments.
It All Started in the ‘70s
Surprisingly enough, the tokenization practice did not start with cryptocurrency. The concept itself has been around since the 1970s in the financial industry as a mechanism for data security, though it was a little different from its current iteration with cryptocurrency. In the 70s, sensitive information (personal information, credit card numbers, financial statements, etc.) was replaced with tokens, which were essentially a string of digital letters and numbers that represented the client or bank member in the digital realm. It is still used in that way to protect financial information. It is also used in other areas, such as software programs (to keep login credentials secure) and hospitals (for patient records).
Tokenization in Blockchain/Cryptocurrency
So we’ve established that tokenization in the traditional sense focused on data security. How does it differ from its modern counterpart, blockchain tokenization?
Blockchain, otherwise known by it’s more official name, distributed ledger technology, is essentially an ultra-secure record-keeping technology built by algorithms. Every time an algorithm is solved, a new block is created, creating a public ledger for every transaction conducted on the chain. The information itself makes up the “blocks,” while the public database is considered the “chain.” In the case of blockchain tokenization, the blocks represent secure financial transactions. Even though the ledger is visible, the transactions themselves are mostly anonymous, as personal information is limited to digital signatures or usernames.
As we have mentioned, instead of just personal data, the types of assets that can be tokenized with blockchain include stocks, real estate, company concepts, artwork, celebrities, sports teams, racehorses, and so much more. When these assets are broken into tokens that represent a fraction of their value, they become liquid for the first time. Investing in security tokens can be comparable to purchasing shares of public companies, just on the blockchain.
Such tokenized assets differ from cryptocurrencies. Cryptocurrency is a digital or virtual currency, a payment method in essence rather than an asset. Cryptocurrency is more like a US Dollar instead of a company share. It is secured by cryptography (a secure communication technique), which makes it nearly impossible to counterfeit or double-spend the currencies. The ever-popular Bitcoin was the first blockchain-based cryptocurrency and remained the most valuable, trailed by Ethereum.
The Advantages of Tokenization
There’s a reason FinTech sees the introduction of tokenized assets as a game-changer in the financial world, as they hold numerous opportunities for investors and asset owners alike.
Along with the greater security inherent in blockchain technology that tokenization offers, it also creates a way to break down assets into shares, or pieces, so to speak, that was previously unavailable. In order to buy a super expensive painting, for example, an art collector had to be wealthy enough to actually buy the painting in its entirety. To invest in property, one would have to actually purchase the entire house in question. Tokenization empowers normal people to buy tokens representing shares of each, opening the doors to a booming market of retail investors.
In finance speak, this process makes traditionally illiquid and exotic assets very liquid. It also creates shorter lock-up periods (the period of time in which investors are prohibited from selling their tokens), which grants investors and traders greater flexibility with their investments. Thanks to the nature of blockchain technology, data security, and increased transparency are one of the biggest perks for investors, as it allows them to make more educated investment decisions and easily monitor their investments in a 24-7 market.
There is also the added perk of fair prices, with the consideration that illiquid assets do not have an established market. As such, when you factor the law of supply and demand, selling assets in fractions allows investors to charge prices that are fairer for those interested in purchasing. Perhaps one of the most enjoyable elements for asset owners is the lower cost of paper-ownership. This is due to the mostly-automated nature of such transactions, which removes the need for lawyers and their teams to handle transaction-related paperwork.
The Regulatory Challenges of Tokenization
One of the biggest disadvantages of tokenization concerns regulatory alignment. Security tokens can fall under the full scope of relevant security regulations, which vary between jurisdictions. That means many of the advantages of tokenization can be undermined if regulations prevent the free and international exchange of tokens. This is a concern that won’t last very long though because the traditional market infrastructure is adapting to the token economy, as seen in the case of INX, which is the first fully regulated trading platform for digital assets.
In many cases, there are also concerns over how tokens would remain linked to actual assets. For instance, if an individual were to own tokens that represent a fraction of 50 diamonds, but 10 of those diamonds got stolen, how would that affect the individual and the other token owners?
On a similar note, governance can be another concern, especially when it comes to tokenizing real estate. If a skyscraper is split between thousands of people, there would barely be any incentive for them to bear the costs that are associated with maintenance.
According to blockchain event platform Elev8, “While tokenization does provide similar benefits to other blockchain implementations (transparency, security, etc.), it’s not a perfect solution. Tokens are still in a legal grey area, stopping many individuals and corporations from getting involved. This legal limbo also means that quite a few scams still exist in the token industry.” Such concerns would fully need to be sorted out before any of us can expect to see a fully tokenized world.
Can the Economy Actually Become Tokenized?
It may be too bold of a statement to say that a totally tokenized economy can become a reality but it’s fair to say that it is emerging. The potential of tokenization is being widely recognized in many of the most powerful nations worldwide.
A large part of the economy is already digitized anyway, considering the usage of apps to make purchases and send money. A tokenized economy would only take things to the next level. The scalability element may take a while, but then again, the concept behind tokens is far from new. Things such as ID cards, concert tickets, loyalty program points, club memberships, dinner reservations, and more all fall within the same realm.
In its current iteration with blockchain and cryptocurrency, tokenization represents the future of financing. While it may still have a few kinks that need to be worked out, it is poised to be transformative across countless fronts.
The managing partner and CEO of A-Labs, Doron Cohen is a highly experienced entrepreneur, investor & mentor with over 20 years in executive management, corporate strategy, sales, marketing, business and M&A activities, both for private and public companies, in the Telecom, Mobile, Media, Advertising, Internet & Blockchain markets.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.