Tokens function as protective substitutes for sensitive information, forming a shield around data such as credit cards or identification numbers. This encapsulation of non-sensitive data within a token (hence its name) is analogous to a hotel key card's transformation upon check-in; initially devoid of intrinsic value, it becomes a valuable asset once programmed with specific data, providing access to a room for a predetermined duration. Whilst tokenization has become synonymous with blockchain technology, initially tokens were used to describe cryptocurrencies and, more recently, for the digitization of equities, bonds, real estate, funds and even cash. Furthermore, tokenization has been widely used for years by credit cards firms such as Visa, Mastercard and Amex to protect sensitive data. In the financial landscape, tokenization extends beyond the hotel key card analogy and credit cards and these tokens, each symbolizing a distinct right of ownership over the corresponding asset, revolutionize how assets are represented and managed in the digital era.
Assets that can be tokenized
Source: Teamblockchain
This innovative approach streamlines transactions, enhances accessibility and enables fractional ownership so presenting a paradigm shift in the traditional concept of asset ownership and representation. Tokenization involves the conversion of data into randomized character strings, providing a protective layer for sensitive information by replacing it with non-sensitive counterparts. In the context of blockchain applications, tokens emerge as a digital twin whereby an underlying asset remains the same but its ownership is represented as a digital asset. This then enables the digital assets to be integrated into smart contracts, so can be operated on a blockchain infrastructure to facilitate, verify, or enforce contractual terms and conditions. Furthermore, tokens (representing ownership rights) play a vital role in the digitization of both tangible and intangible assets, expanding possibilities for decentralized applications and a “tokenized economy.”
McKinsey's insights into tokenization provide a comprehensive understanding of the process of how to tokenize an asset. According to McKinsey, tokenization is the issuance of a digital representation of an asset on a blockchain, enabling diverse possibilities for transforming the exchange of assets. The McKinsey-outlined tokenization process involves key steps such as asset sourcing, digital asset issuance and custody, distribution and trading, and asset servicing and data reconciliation. So, with:
asset sourcing
· identify the nature of the asset to be tokenized
· determine whether the asset falls under the category of a security or a commodity
· understand and apply relevant regulatory frameworks based on the asset type.
digital asset issuance and custody
· move the physical counterpart of the digital asset to a secure facility neutral to involved parties
· select a suitable token, network and compliance functions
· create a digital representation of the asset on a blockchain.
distribution and trading
· investors set up digital wallets for storing tokenized assets
· depending on the asset, consider establishing a secondary trading venue for increased liquidity.
asset servicing and data reconciliation
· implement ongoing maintenance procedures for the distributed asset
· ensure compliance with regulatory, tax and accounting reporting
· manage notifications of corporate actions and other relevant updates
However, understanding regulatory frameworks, determining the asset's categorization, and selecting appropriate compliance functions are critical in the process.
The bank, CLS, emphasizes the real-time settlement through Delivery versus Payment (DVP) and the concept of an ‘atomic swap’. Notably, ‘atomic settlement’ significantly reduces counterparty risk ensuring that one leg of the transaction settles only when the other leg successfully settles also. Atomic settlement, originating from the crypto and blockchain realm, is gaining traction in financial services, particularly within the foreign exchange (FX) world. Some herald it as a game-changer, with the potential to enable almost real-time settlement. The term 'atomic' draws inspiration from the Greek word 'atomos,' signifying indivisibility. In the crypto space, atomic swaps emerged around 2013, denoting exchanges of crypto assets across blockchains without intermediaries - having only two atomic states: fully complete or fail. In the context of delivery-versus-payment (DvP) and payment-versus-payment (PvP) arrangements in a blockchain environment, atomic settlement denotes simultaneous transfers, where one leg settles if, and only if, the other does. This synchronization is facilitated by technologies such as hash time lock contracts (HTLCs), introducing conditionality between assets through cryptographic passphrases and predetermined timeframes.
Source: X
Meanwhile, data tokenization, a ground- breaking concept, transforms sensitive information into unique tokens thus enhancing data security and compliance in terms of the way data is stored and transmitted. It has the potential to play a pivotal role in banking, insurance, healthcare and asset management, so ensuring privacy and efficient data processing. Through tokenization, assets ranging from real estate and art to intangibles such as data, can be digitized, converting them into secure digital tokens on a blockchain. This transformative process not only digitizes traditional assets but also non-tangible elements such as spending patterns, driving data, travel data and medical records. The result is heightened liquidity, fractional ownership opportunities and increased accessibility for a broader investor base. This innovation extends beyond mere digitization; tokenization has the power to streamline transactions, cut costs and introduce 24/7 trading possibilities. The integration of smart contracts further revolutionizes how assets are bought, sold and managed. In the financial realm, assets are evolving into robust alternatives to traditional currencies and legally defined digital representations of real estate and stocks are assuming roles akin to 'money,' demonstrating resilience as stores of value.
Real estate is currently a focal point of interest for digitalization through tokenization. Antony Abell, CEO of TPX Property Exchanges, emphasizes the intrinsic value of reliable money and its role as a secure savings tool. Abell likens it to: “A battery holding its charge, particularly in times of fiat currency devaluation and rising inflation. In such scenarios, people turn to assets like stocks, real estate, or gold for wealth preservation”. The innovative concept of tokenization, introduced by TPX in 2016, is unlocking the potential of real estate to be a globally traded asset. This marks a significant shift, allowing fractional ownership of buildings to be utilized as a form of money, addressing historical limitations. With an estimated $379 trillion of global real estate becoming tradable in real-time, property emerges as accessible, inflation-resistant money, reshaping traditional fiat and debt-based economies. Indeed, tokenization stands as the vanguard in safeguarding sensitive data and reshaping traditional assets into digital tokens. From McKinsey's roadmap to CLS's 'atomic settlement,' the journey through tokenization unfolds, promising transformative shifts in finance and beyond. As we witness real estate becoming globally tradable and assets evolving into resilient alternatives, a fundamental question emerges: Are we on the cusp of a new era, where traditional currencies give way to the enduring allure of tokenized wealth? The transformative potential is immense, challenging established norms and ushering-in a future where assets redefine the very essence of value. In this tokenized age, the question beckons: What role will you play in shaping this economic evolution?
This article first appeared in Digital Bytes (30th of January, 2024), a weekly newsletter by Jonny Fry of Team Blockchain.