Asset Tokenization: Essential to Powering the Next-Generation Digital “Instance” Economy

This is a long-overdue post. After expending time and energy on a recently published book, I figured I should get back to sharing my learning and soliciting your feedback on that learning. While the book title suggests hyperledgers, my co-authors and I have attempted to keep the content agnostic and relevant to all blockchain projects.

It has been an interesting journey in the blockchain world, and in my very first post in 2018, I discussed several focus areas. One of them was asset tokenization. In this post, I intend to expend some time on discussing this topic, as I believe it is essential to not only powering the next-generation digital economy, but also to paving the way for new business models built upon the “instance economy.” Let’s begin with some back ground.

In the past, I have also discussed the divide between the permissionless world, which refuses to adhere to any conventions and forges ahead with many innovations that are bound to disrupt many industries, either with new business design (e.g., initial coin offerings (ICOs)) or conventional industries attempting to adopt the technology to either transform the industry or beat or simply keep up with disruption. This spectrum of technology-driven platform and the use cases that exploit them rely on some of the manifestation of value. This digitization, be it systemically generated in the form of a transaction utility coin or a layer-two token that relies on the underlying coin for its valuation, is nothing but a digitized notation of an instrument that has a real or perceived value.

While the genesis of blockchain, which was largely permissionless (e.g., crypto-asset-based networks such as Bitcoin, Litecoin, etc.), relied upon technology-based systemic governance comprising incentives and mechanisms of coordination. This systemic governance has its own set of challenges in the enterprise business networks attempting to exploit the tenets of blockchain technology. In the enterprise world that is largely regulated and relies upon (mostly) permissioned blockchain models, the checks-and-balances system is complicated by transactions between competing entities, often with regulated data and a fiduciary responsibility, which can neither account for the tangible or systemically generated incentives (crypto-assets) nor have network-wide mechanisms of coordination due to privacy and confidentiality issues.

Introduction to Tokenization: Understanding the Token Revolution

It is widely understood and accepted that blockchain technology lays the foundation for a trusted digital transactional network that, as a disintermediated platform, fuels the growth of marketplaces and secondary markets due to new synergies and co-creation due to new digital interactions and value-exchange mechanisms. While blockchain itself provides the technology constructs to facilitate exchange, ownership, and trust in the network, it is in the digitization of value elements where asset tokenization is essential. Let’s take a closer look.

We have established that digitization is the first step in many enterprise and permissionless blockchain projects. Tokenization is the process of converting the assets and rights or claim to an asset into a digital representation or a token onto a blockchain network. At this time, I would like to draw a difference between an (crypto) asset or currency from a tokenized asset. An (crypto) asset or currency is a medium of exchange or a protocol-driven exchange mechanism that often embodies the same characteristics of a real-world currency, such as durability, limited supply, and recognition by a network, while being backed by a common belief system (like a fiat currency). An (crypto) asset or cryptocurrency also represents a byproduct of trust systems (consensus) as a vehicle to back the incentive economic model that rewards and fuels the trust system of a network, making it a trust currency of the network. A token, on the other hand, can be many things: a digital representation of a physical good, making it a digital twin, or a layer-two protocol that rides on the (crypto) asset or currency and represents a unit of value. This distinction is an important construct to understanding the exchange vehicles, valuation models, and fungibility across various value networks that are emerging, posing challenges around interoperability, not just technical, but also business challenges, around equitable swaps.

Asset tokenization presents interesting technology challenges such as (but not limited to):

1.    Ensuring the integrity of physical assets, such as containers, gold bars, cars, etc.

2.    If a token is to be a digital twin of a physical asset, the seamless linking of physical asset movement to the token movement in the digital network

3.    Ensuring uniqueness and integrity of the token in and across the network

4.    The ability to hold, transfer, and preserve the value of underlying assets that a token represents

5.    Effectively managing the lifecycle of the token in the business network

6.    Using tokens effective to the asset class and the economic/business models that govern the asset class

7.    Privacy-preserving characteristics of the token and the asset(s) it represents

8.    Cross-ledger token resolution and token lifecycle and governance systems

9.    Preserving value while transferring value to other value networks and secondary markets

While these challenges can be addressed with well-thought-out solution designs using not only blockchain constructs to embed trust, but other adjacent technologies, such as tokenization platforms, registries, token vaults, detokenization systems, and so no, we can rely on proven blockchain solution design practices to ensure the integrity, uniqueness, and value preservation of tokens in a network; we have thus begun to see the rise of new intermediaries when it comes to exchanges of the “value” that these tokens embody in a network with other value tokens. These intermediaries come in various forms, ranging from token exchanges, decentralized exchanges, network “asset” bridges, or simply token registries and repositories. These intermediaries, while solving a token fungibility issue, create the same set of cost and settlement challenges of current value-exchange systems. I will not discuss solutions to this problem in this post, but this issue does warrant its own dedicated paper (so stay tuned!).

There are many different token types and classifications that exist today, and while there is no standardized nomenclature, all of these tokens have one thing in common: They represent and digitize value. Some of the token types include:

a.    Pegged tokens

b.    Stable coins

c.    Tokenized securities

d.    Security tokens

e.    Utility tokens

f.     Collateralized, decentralized tokens

g.    Non-collateralized, decentralized tokens

h.    Collateralized, centralized tokens

i.     ICOs

j.     STOs

Various Industry Definitions

This is where stable coins come in. Stable coins are price-stable cryptocurrencies, meaning the market price of a stable coin is pegged to another stable asset, like the US dollar. 

Preston Byrne: a stable coin claims to be an asset that prices itself, rather than an asset that is priced by supply and demand. 1

In their most simplistic form, stable coins are simply cryptocurrencies with stable prices measured in fiat currency. 2

Types of Stable coin – Fiat collateralized, Crypto collateralized, Non-Collateralized, collateralized decentralized, collateralized centralized, Pegged etc.2

Tokenization is a method that converts rights to an asset into a digital token.5

Tokenization is the process of converting rights to an asset into a digital token on a blockchain. There is great interest by financial intermediaries and technologists around the world in figuring out how to move real-world assets onto blockchains to gain the advantages of Bitcoin while keeping the characteristics of the asset.6

The varying industries (crypto and financial services and analyst communities) have varying points of view and definitions, making it incredibility difficult to subject these concepts, be it technology or digital assets, to traditional and conventional risk models.

Now that we have explored the token revolution and drawn a distinction between (crypto) assets and currency, let’s explore the token valuation models and why this is important.

Token Valuation Models and the Instance Economy

While an (crypto) asset or currency derives its value as a medium of exchange with a shared common belief system of a network (often confined to that network), tokens may have complex and fragmented valuation models. Many coins (launched via ICOs and STOs) that aspire to morph into their own crypto assets, either as utility or security tokens, rely on the community to develop and recognize value, while many tokens are simply digital representations of the assets they represent. Assets today, such as stocks, bonds, securities, mortgages, mortgage-backed securities, and so on, are difficult to physically transfer or subdivide, so buyers and sellers instead trade paper (or digital records) that represents these assets. The issue with paper (or digital records) and complex legal agreements is that they are cumbersome and pose a challenge to transfer and track, leading to opacity, and then to fraud, opportunity, and transaction costs. One solution would be to switch to a digital system along the lines of digital assets, such as tokenized assets on a blockchain network, but linked to an asset.

It may be prudent for us to classify these token valuations by either industry type (such as non-financial, supply chain, financial services, etc.) or asset type (dematerialized, virtual, real asset, etc.). Such a classification would be necessary not only to establish a trail of governance with check and balances, but also represents some industry-recognized valuation systems. With this thesis, it may seem like all we are achieving from tokenizing assets on blockchain networks is mimicking or creating a digital twin of current value networks, and while a fiat currency addresses the duality of a transaction, it could be replaced by a crypto currency (including digital fiat). But I think that the promise of blockchain-based business networks is not just digitization and solving the inefficiencies of time and trust, but rather is creating new business models and co-creation from synergies of the network participants that did not exist before.

Enter the instance economy and secondary markets that are fueled by the instances of an asset. Tokenization of assets can lead to creation of a business model that fuels fractional ownership or the ability to own an instance of a large asset. Fractional ownership does open up a market to participation from entities that were in the past prevented from participating due to high capital requirements or due to the opacity of value transfer systems. Furthermore, fractional ownership opens a whole new range of asset classes and asset types, unlocking the economic value of locked capital due to the inaccessibility of investment opportunities. I use the term instance economy, as this fuels tokenization of assets, leading to ownership of an instance of an asset class, thereby creating markets and secondary markets of value that simply do not exist today.

Conclusion

While blockchain itself provides the technology constructs to facilitate exchange, ownership, and trust in the network, it is in the digitization of value elements where asset tokenization is essential. Tokenization is the process of converting the assets and rights or claims to an asset into a digital representation, or token, onto a blockchain network. This distinction between crypto currency and tokenized asset is an important construct to understanding the exchange vehicles, valuation models, and fungibility across various value networks that are emerging, posing challenges around interoperability, not just technical, but also business challenges around equitable swaps. Tokenization of assets can lead to the creation of a business model that fuels fractional ownership or the ability to own an instance of a large asset. The promised asset tokenization on blockchain-based business networks is not just digitization and solving the inefficiencies of time and trust, but it is creating new business models and co-creation from synergies of the network participants that did not exist before.

 Interesting reads and. References:

1.    https://hackernoon.com/stablecoins-designing-a-price-stable-cryptocurrency-6bf24e2689e5

2.    https://medium.com/@argongroup/stablecoins-explained-206466da5e61

3.    https://www.dhirubhai.net/pulse/understanding-settlement-blockchain-powered-business-network-gaur/

4.    https://www.dhirubhai.net/pulse/forging-ahead-blockchain-2018-my-focus-technology-industries-gaur/

5.    https://medium.com/coinmonks/asset-tokenization-on-blockchain-explained-in-plain-english-f4e4b5e26a6d

6.    https://www.nasdaq.com/article/how-tokenization-is-putting-real-world-assets-on-blockchains-cm767952