In this 2-part blog series, I plan to cover the burgeoning area of Tokenization and digital assets, why this space is exploding and some of the barriers to further adoption. Blog 1 will cover what Tokenization is, how it works conceptually and what some of the big challenges are that hamper further adoption. Blog 2 will take a look at a foundational issue facing Tokenization, namely, security and how IBM is addressing this challenge.
Tokenization on Blockchain is emerging as the key trend of 2019 and appears set to be the big Blockchain use case. It seems that everything is being tokenized on Blockchain from paintings, diamonds and company stocks to real estate and this is just the beginning. In this article, I will describe what it means to tokenize an asset on Blockchain and how it relates to physical assets.
Let’s park Blockchain and smart contracts for a moment. Imagine the scenario is that you want to invest in real estate, but your budget says $10,000. You want to get on the property ladder and build equity and increase your investment gradually. Over the first few years, you want to invest your $10,000 in monthly sums as your budget allows. Obviously, with the traditional real estate market, this approach is impossible, and you would naturally save in another way and then hope to enter the property market in a few years’ time once you have saved a lump sum. Put another way, how are you supposed to buy two- or three-square feet in an apartment monthly?
Let us flip the scenario. Imagine that you have some property — say a condo. You need cash quickly. The condo is valued at $200,000 but you just need $10,000. How do you raise cash against your investment, re-mortgaging is one option but its costly and takes time?
Enter stage left – Digital Tokenization. Tokenization is a method that converts rights to an asset into a digital token. Suppose you convert your condo worth $200,000 into tokens. Tokenization can transform this apartment into 200,000 tokens (the number is totally arbitrary, we could make it as easily 10 million tokens). Thus, each token represents a share of the underlying asset. Finally, you issue the token on some sort of a platform supporting smart contracts, so that these tokens can be freely bought and sold on different exchanges.
When you buy one token, you actually buy a share of the ownership in the asset. Buy ½ of the available tokens and you own 50% of the asset. Buy all the tokens and you are 100% owner of the asset. Obviously, you are not becoming a legal owner of the property. However, because Blockchain is a public ledger that is immutable, it ensures that once you buy tokens, nobody can “erase” your ownership even if it is not registered in a government-run land registry service… It should be obvious now why Blockchain enables this type of services.
Thus, we took an asset, tokenized it and created its digital representation that lives on Blockchain. Blockchain guarantees that the ownership information is immutable.
If only life were so simple, in reality, some problems need to be solved before we can successfully tokenize real-world assets on Blockchain.
One big issue problem is that so far no country has a solid regulation for tokenization. For example, what happens if a company that handles tokenization sells the property? Token owners just own tokens. They have no legal rights on the property and thus are not protected by the law. Therefore, a robust legal framework is needed to accommodate these new business models and the whole digital asset and tokenization space.
Another inherent problem is that this system brings us back some sort of centralization and regulatory framework. The whole idea of Blockchain and especially smart contracts is to create a frictionless environment where state-level actors play a lesser role or no role at all. While this is possible to achieve when tokenizing digital assets, with real world, physical assets, this is a challenge. In reality, we will have to accept a certain amount of centralization, legal oversight and government involvement.
Tokenization of other assets works is the same principle. If there is a Monet painting valued at $10 million, it can be tokenized as well. The same applies to gold, jewellery and diamonds basically anything of a monetary value that would warrant fractional ownership. Company stocks is a more complicated space, as in most jurisdictions it is prohibited to sell fractional parts of company shares. Again, to make this fractional ownership of stocks real legal and regulatory changes are necessary to successfully implement tokenization.
Finally, one of the biggest barriers facing Tokenization across all use cases is security. If the Tokens are stolen by hackers along with it goes cold hard money and asset ownership. In a world where ledgers are immutable and by their very nature open to the business network, security is a real concern. How do you secure the Tokens is the ball game? Without confidence in this space, the whole value chain falls down. Think of it this way, you are keeping cash under your bed and you have no way to secure your doors and windows and you live in a bad part of town, do you want to put cash under your bed?
The good news is that the progress in this space is very fast. We see new solutions nearly on a weekly basis. Once these problems are solved, nothing can stop the tokenization process. Check back next week for part 2 where I cover how to address some of the issues raised above.