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Definition

Tokenization is the process of converting ownership rights into purely digital representations of an asset that can be subdivided, traded, and stored on decentralized ledger technology (DLT).

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What is Tokenization

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Tokenization is the process of converting ownership rights into purely digital representations of an asset that can be subdivided, traded, and stored on decentralized ledger technology (DLT). A token can theoretically represent any asset type, but they are usually considered either native to the blockchain and have no physical presence, such as Bitcoin, or are not native to the blockchain and represent some form of a real-world asset, such as shares of a company.

 

Tokenized assets are widely considered the next generation of book entry processing in which a digital token is used to represent an actual security for example. While book-entry and tokenized assets are both digital representations of value, there are key differences in terms of the verification process and degree of centralization. For book-entry securities, transfer authorization ultimately depends on the  ability of the central security depository (CSD) to verify the identity of the account holder who is its direct participant. By contrast, a digital token’s authorization depends on the validation of matching public and private keys on a DLT or blockchain to unlock ownership rights.

 

With traditional securities, only the CSD can update a central ledger and is the single entity responsible for recording all transaction histories. Tokenized asset accounting and transfer are completely decentralized, meaning that ownership is validated by multiple participants in the network. However, most tokenization platforms today are not completely open and have had to incorporate various restrictions to ensure accountability for compliance with regulatory requirements relating to know-your-customer (KYC), anti-money laundering (AML), and cybercrime.

 

Introducing tokens also changes the way payments are made for the delivery of assets. If both the securities and the cash required for payment reside on the same DLT and are already linked to an account on that ledger, then a single-ledger transfer can take place through a process called atomic settlement. In the future, though, we should expect that tokens will also be required to represent cash in the payment legs between different DLT platforms. Because the order and timing of those transfers is critically important, smart contracts, or transaction protocols that automatically execute based on a sequence of processing steps, will likely be needed to conditionally process both transaction legs across platforms where true atomic settlement is not possible. In order to fulfill the cash transfers on a blockchain without introducing additional volatility associated with cryptocurrencies, many existing tokenization platforms currently take advantage of a special type of token called a “stablecoin” whose value is tied to a stable real world asset like the US Dollar or gold. Likewise, the industry may soon be able to leverage digital currencies issued by central banks (CBDCs), which would be backed the issuing government’s monetary authority.

 

What type of assets can be tokenized?

Because a token is just a digital representation of an asset and not the asset itself, any asset can be tokenized. Common examples today include:

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• physical objects, such as fine art and collectibles

• precious metals, like gold and silver

• real assets, such as real estate

• intangible assets, such as equities, bonds, and mutual funds,

• other intangible assets, such as licenses, patents, copyrights, Intellectual Property (IP)

• unlisted, physical securities

 

In most cases, a token is just a digital representation of an actual underlying asset. Examples of token types and the models of their use include:

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• Securities token offerings (STO)s which can represent any financial asset issued as a token.

• Stable coins which are tokens with a fixed exchange rate to a fiat currency or other convertible real asset.

• Central Bank Digital Currencies (CDBCs) issued by central banks as electronic versions of fiat currencies such as digital renminbi issued by the Chinese Central Bank as parallel method of payment.

 

Alternative investments such as hedge funds, private equity, venture capital and private debt and real assets such as real estate, infrastructure, and natural resources are attracting investors in increasing numbers. These asset classes are generally less liquid, less accessible, and less transparent than traditional assets, making them a perfect target for tokenization.

 

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