Detokenization - The True Test of Tokenization

Joel L. | 17 Feb 2023

Tokens "Backed" by Assets?

The term “Real World Asset backed tokens” typically refers to tokens that have values tied to that of its corresponding Real World Asset.

The off-chain assets form a foundational layer of value for the tokens, allowing the tokens to be traded with a valuation consistent with or above the layer. Thus, making the token “backed” by assets.

Stablecoins Protocols that We Need

Stablecoins are an instance of such tokens. While Stablecoins differ in that their values are pegged to an asset rather than backed by it, the concept that these tokens are tied to an underlying asset that contributes to their value is similar to tokens backed by Real World Assets.

Stablecoins have showcased the importance of protocols building a rigid detokenization structure. Detokenization refers to the ability to redeem the underlying asset of an asset backed token. The belief behind Stablecoins is that one would be able to redeem the token for the underlying asset, in this case being one US dollar. While the various Stablecoin protocols each come with their individualized detokenization structure, not all are robust and guaranteed to remain successful.

Take Terra’s UST as a case study. The collapse of the former billion-dollar market cap Stablecoin was a result of its problematic redemption mechanism, also known as detokenization structure. Upon redemption of one UST token, one would be provided with LUNA tokens equivalent to the value of one US dollar. The design flaw here was that while redemptions of UST were occurring, LUNA’s value was rapidly dwindling. There was no guarantee that one would be able to redeem one UST token for one US dollar worth of LUNA.

In contrast, USDC and Paxos (USDP) can be redeemed for one US dollar in fiat currency. This enables it to retain its value regardless of the market condition because if the USDC or USDP falls below one US dollar, arbitrageurs would buy the USDC or USDP for cheap and redeem it for one US dollar in fiat.

The Ultimate Tokenization Test

Real Estate Tokens (RET) are prime examples of Real World backed assets. While Real Estate Tokens typically represent fractional ownership of a Real Estate asset, there are variations to this. Real Estate Tokens can also be representative of certain rights relating to the asset.

A solid detokenization structure is especially important for Real Estate Tokens as it involves a far more illiquid and inaccessible asset. Real Estate Tokens derive their backing from their innate ability to detokenize the underlying Real Estate asset. This is to ensure that the token value do not drop to zero as in the case of UST and is achieved by providing an arbitrage opportunity should the value of a token fall significantly below the value of the Underlying Real Estate. RET holders would be able to buy all Real Estate tokens at the offer price, detokenize the Real Estate and claim the title deed, ensuring there is always value for the Real Estate Token.

However, not all Real Estate Tokenization projects possess such a detokenization structure, and this is something that investors should be wary of in the wake of failed projects such as the Luna and UST Project.

For the Better Blockchain Ecosystem

These projects may purport to sell tokens that are intended to represent fractional ownership of an asset. Yet, the reality is that there is no true path that holders can take to redeem their share of ownership of an asset. Holders are limited to either buying more tokens or selling their position. This limitation hinders the integrity of a tokenization structure as it puts token holders at risk of holding Real Estate Tokens that are not truly backed by any asset, and such token price could go to zero if placed in similar scenarios leading up to the Luna UST collapse.

It is therefore, paramount that Real World Asset tokenization projects start adopting a robust detokenization structure. Such a structure should not be dubious and the process that holders undertake to detokenize an asset must be clear and transparent. Only then would we be able to build a robust and successful blockchain ecosystem that is backed by Real World Assets. ■

The Author

Joel L. is a Contributor to Citadao.io . Joel is experienced in Real Estate & Blockchain, being skilled in Real Estate Strategy, Real Estate Economics, Capital Markets, Private Equity, and Financial Modeling. He has strong finance professional with an MSc focused on Real Estate from the National University of Singapore.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official position of Proptech Institute, including its directors, employees and affiliates.

?

PropTech Institute | https://www.proptechinstitute.org/ | [email protected]