When Will We Learn There's No Point in Tokenizing Anything Without Proper Security?
By Lior Lamesh, CEO and Co-Founder of GK8
We’ve all likely received a generous financial gift from a family member at one point or another and been told to “put it to good use.” Quite often this implies investing the gift in something that will enjoy solid growth over a long period of time—perhaps in a savings account or the stock market.
The stock market has a long track record of producing steady yields, but often it’s a challenge to invest in stocks without going through an intermediary. And investing in a given equity always has its downside. Mutual funds, for example, are great for retirement plans, but don’t necessarily provide a strong passive income.
Other asset classes, such as precious metals and real estate, tend to provide less volatility with dependable and consistent growth over time. But investing in these types of “safe haven” assets is an even greater challenge without access to enough fluid capital and detailed market knowledge.
Tokenization welcomes a new investor class
Due to financial limitations and a steep learning curve, purchasing and managing any type of asset, whether high-class art, jewelry, automobiles, or real estate, has long been a hard-to-access arena for the “average Joe”—and even harder to navigate successfully. As with stocks, without the proper resources and know-how, many individuals are effectively cut off from investment opportunities that can materialize into significant growth.
For the average consumer, the once hard to access financial markets are beginning to open up, thanks in a large part to the crypto industry. Blockchain technology has introduced to the world the concept of tokenizing real-world assets, making easier and more accessible investing a reality.
We all talk about the NFT boom of 2021, but what really gave credence to the idea of tokenizing real-world assets was the security-token “boom” of 2019. During this period, putting traditional assets on the blockchain and fractionalizing them in token form was all the rage. That idea faded before the most recent bull market, which seemed to prioritize NFTs, play-2-earn gaming, and DeFi.
Blockchain-based tokenization will, undoubtedly, open up trillions of dollars worth of assets for institutional investors, and of course, retail and novel investors to finally have access to legitimate growth opportunities. To this point, Goldman Sachs is exploring ways to offer its clients a mechanism to tokenize financial instruments. In addition to effectively leveling the playing field with regards to growth investments, going forward with tokenization will likely enable easier investor registration procedures while reducing the threshold to partake in marketplaces.
Benefits of tokenized assets versus traditional assets
Critics have long argued that crypto has no real world use and lacks tangible benefits outside being a speculative asset. Tokenization, on the other hand, brings to the forefront several substantial benefits that prior to the crypto industry’s birth were non-existent. These benefits include:
Fractionalized ownership: By bringing financial transactions on-chain, traditional-growth assets can be fractionalized into tokens representing partial ownership over a physical or non-physical asset. This allows investors with more modest amounts of liquid capital to invest what they can in safe-haven assets that provide dependable yields, like real estate.
Indisputable ownership: Another benefit of tokenizing real-world assets via blockchain is that it reinforces ownership, making it indisputable because the blockchain symbolizes one source of truth. Imagine if Ukrainian citizens fleeing their homes in eastern Ukraine at the onset of Russia’s invasion earlier this year had tokenized their houses, establishing undeniable ownership over the piece of land. This would, at the very least, make recouping the value of the property much more likely once the region returns to calm. Considering blockchain isn’t dependent on any country or any tech infrastructure, it enables smooth cross-border ownership over tokenized real-world assets.
Transparency: Because of blockchain’s distributed ledger technology, all transactions and data of tokenized assets will benefit from increased transparency, including the ability to trace and review all transaction history related to a specific asset.
All this potential also has a downside: security
The era of tokenization is already upon us. There are already several large asset-tokenization platforms that provide the technological know-how for businesses looking to infuse capital through tokenizing a near-endless list of real-world assets. Companies like VNX, for example, that tokenizes precious metals, and CC Token, which provides access to tokenized carbon credits collateralized by EU futures, pave the way for new ways of investing in existing assets.
All of this sounds great: opening up access to new investment opportunities for small-time investors is noble and will contribute to an overall boost in the economy. There’s a but. Recent hacks of blockchain protocols and centralized exchanges have exposed vulnerabilities, some of which have grave implications for the token ecosystem.
A hacker who steals the private keys to a tokenization platform can hold the whole ecosystem, or marketplace, captive. As more and more digital assets get minted, dedicated hackers are finding more targets and therefore more vulnerabilities to attack. The threats are too real, and too important to overlook. Most importantly, this risk completely negates the benefits of democratizing access to growth investment opportunities and triggers a potential economic meltdown.
In order to secure all these new tokenized assets, the demand for digital asset custody solutions will certainly grow. To meet this demand, banks and traditional finance need to ensure that they have scalable infrastructure that can effectively secure the minting and burning process, and effectively store and manage the tokens as well. In effect, the custody solution needs to be able to manage the complete token lifecycle from issuance to burning.
Even on the retail investor front, storing tokens on a retail wallet is too risky because clever thieves will certainly try and find a way in if the ROI is big enough. In fact, I myself, managed to hack one of the most popular retail solutions (just for fun, of course). Even today’s most popular enterprise-grade custody solutions have risks due to poor risk-management as to how to protect the institution’s private keys.
Therefore any institution, hoping to offer tokenized real-world assets must first and foremost build the infrastructure capable of safeguarding and securing its private keys. This means institutions need to partner with digital asset custodians or technology providers to provide enhanced security and safeguard their assets. Of course, self custody has many benefits, including costs, efficiencies, and fewer attack vectors. With a self-managed tokenization solution, institutions can control their own destiny by enabling complete control over the token lifecycle in the most secure way possible.
Tokenization will inevitably take place on a massive scale because it benefits both businesses and individual investors, all with the highest levels of transparency. And these are too great to ignore. For businesses, tokenization represents a mechanism to increase liquidity and for investors it provides greater accessibility and lowers the barrier of entry. That said, financial institutions need to build a secure infrastructure for token lifecycle management to ensure they protect their assets and their stakeholders.
About the author:
Lior Lamesh is the Co-Founder and CEO of GK8, a company which offers both traditional and crypto-native institutions an end-to-end platform for managing blockchain-based assets, including custody, DeFi, staking, NFT, CBDC, and tokenization support. Having honed his cyber skills in Israel’s elite cyber team reporting directly to the Prime Minister's Office, Lior led the company from its inception to one of the most impressive acquisitions of 2021. In 2022, Lior alongside his co-founder Shachar Shamai, were selected by Forbes to be included in its prestigious ‘Forbes 30 under 30’ list.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.