The Rise of Asset Tokenization: A New Era in Investing

Introduction

In recent years, a new trend has emerged in the world of finance: the tokenization of assets. This refers to the process of converting traditional assets, such as real estate, art, and securities, into digital tokens that can be traded on blockchain-based platforms. Asset tokenization has the potential to revolutionize the way we invest, providing greater liquidity, accessibility, and transparency to investors [1].

If we take a hard look at the asset tokenization situation that is now taking place on the blockchain, it is clear that financial institutions are seeing the prospects. Comparatively speaking, a smaller portion of the overall assets are tokenized in total. Due to market data and the fact that asset tokenization is still in its early phases of development, this minimal contribution is the result.

According to the research, the worldwide market for asset tokenization would approach 2.3 billion USD in 2021. By 2026, it is anticipated to have a market value of 5.6 billion USD, growing at a compound yearly growth rate of 19.0% overall [1].

“The next generation for markets, the next generation for securities, will be tokenization of securities,” said Larry Fink, the CEO of BlackRock, the world largest asset manager, with $10 trillion assets under management, at a December 2022 New York Times.

In this article, we will explore the key concepts behind asset tokenization and its potential impact on the investment landscape.

What is Asset Tokenization?

Tokenization refers to the process of converting an asset, such as real estate, art, or stocks, into a digital token on a blockchain. These tokens represent ownership rights to the underlying asset and can be traded and exchanged like traditional securities.

Simply put, in the financial context, tokenization of assets refers to the process of issuing a digital token that runs on a blockchain. This token is a digital representation of an asset – tangible or intangible – and its value is based on the value of the asset it represents, like the process of traditional securitization, but with a digital twist [Nasdaq, March 6 2023].

Understanding the function of smart contracts in converting physical assets into digital assets is the first step in learning how to tokenize an asset. Smart contracts are used to control and carry out the operations of digital tokens backed by underlying assets. The terms of the parties' agreement are incorporated into existing lines of code on the blockchain network, resulting in a smart contract that is self-enforcing and self-executing.

A smart contract that makes contractual terms and historical data publicly available allows for the direct delivery of tokens to investors after the parameters of the contract have been met. This increases efficiency and transparency for all parties involved.

In technical terms, asset tokenization refers to developing an informatic code that highlights the essential elements of the asset while also providing some methods that enable the user to interact with the digital representation of the asset. This informatic code is created in Solidity for the Ethereum blockchain [2].?

Tokenization offers major cost-efficiency advantages by eliminating third-party middlemen that are often engaged in the post-trading process. More openness is also made possible by a smooth data flow, provided that stakeholder policies and regional regulations are in place. Tokenization provides also new opportunities, as fractionalization of assets, enhances access to new markets.

Tokenization Methodology Approach

1. Asset Selection: The first step in the tokenization process is selecting the asset that will be tokenized. This can be anything from real estate, art, or private equity to commodities, stocks, or bonds. The asset needs to be evaluated and assessed for its suitability for tokenization, including its liquidity, divisibility, and transferability.
2. Legal Framework: Once the asset has been selected, the legal framework for tokenization needs to be established. This involves identifying the regulatory requirements for the asset and ensuring that the tokenization process complies with all relevant laws and regulations.
3. Tokenization Platform: The next step is selecting the blockchain platform that will be used to tokenize the asset. The platform needs to be evaluated for its scalability, security, and compatibility with the asset being tokenized.
4. Token Creation: Once the platform has been selected, the tokens can be created. This involves creating a smart contract on the blockchain platform that defines the terms and conditions of the tokens, including the number of tokens to be created, the price of each token, and the rights and obligations associated with the tokens.
5. Offering and Distribution: Once the tokens have been created, they can be offered to investors through an initial coin offering (ICO) or a security token offering (STO). The tokens can be distributed to investors via the blockchain platform, with ownership and transfer of the tokens recorded on the blockchain.
6. Secondary Market Trading: Once the tokens have been distributed, they can be traded on a secondary market. The blockchain platform can provide a secure and transparent marketplace for the trading of the tokens, with ownership and transfer of the tokens recorded on the blockchain.

Benefits of Tokenization

Tokenization offers several advantages over traditional ownership and investment methods. For example, it allows for fractional ownership, which means that investors can buy and sell small portions of an asset, rather than having to buy the entire asset. Additionally, tokenization can enable faster and more efficient transactions, as well as increased transparency and security.

Tokenization offers several benefits, including:

1. Increased Liquidity: Tokenized assets can be traded on secondary markets, allowing investors to buy and sell assets more easily and efficiently.
2. Fractional Ownership: Tokenization enables fractional ownership of assets, which can make investments more accessible to a wider range of investors.
3. Reduced Costs: Tokenization can reduce the costs associated with buying and selling assets, such as brokerage fees and transaction costs.
4. Increased Transparency and Security: Blockchain technology provides a transparent and secure way to track ownership and transfer of assets, reducing the risk of fraud and other illegal activities.

Types of Tokenized Assets

There are several types of assets that can be tokenized, including:

1. Real Estate: Tokenized real estate allows investors to buy and sell fractions of properties, enabling them to diversify their portfolio and gain exposure to real estate investments.
2. Stocks and Securities: Tokenization allows for the creation of digital shares in private companies, making it easier for investors to buy and sell securities.
3. Art: Tokenization can enable art investors to buy and sell fractions of valuable artwork, providing greater liquidity in this market.

Challenges and Risks of Tokenization

While tokenization offers many benefits, there are also several challenges and risks associated with this technology. For example, regulatory frameworks are still in development, and there is a risk of fraud and scams associated with tokenized assets.

Despite the available opportunities and increasing scope in digital assets, prospective students and investors still look forward to asset tokenization with caution. The reason behind this approach is directly related to the prospective risks and challenges involved in asset tokenization on blockchain. Here are a few issues that currently exist about asset tokenization on blockchain:

1. Legal & Regulatory Challenges: Blockchain offers both consumers and corporations a wide range of opportunities because it is borderless. Yet, real-world applications of asset tokenization encounter unique difficulties related to existing technologies and legal concerns. Despite the fact that there are numerous prospects, many nations have yet to establish uniform rules for managing asset tokenization.
2. Absence of code of conduct: Lack of a code of behavior and universal norms is a severe issue connected to asset tokenization. Investors may spot any potentially undesirable actions because there are no universal guidelines for the establishment and regulation of digital assets. It could also compel companies to reevaluate their organizational structures and operating procedures. As a result, it's essential to put in place a written code of conduct and framework to enhance the basic regulatory structure and guarantee cooperation among market participants.
3. Security issues: The blockchain is susceptible to online attacks and cybercrime, just like other technology. Despite a dramatic decline over the last couple of years, the frequency of cyberattacks against the blockchain is still unsatisfactory.?
4. Scalability:?Approval and encryption times into the various blocks of the chain take a significant amount of time, making scalability a major bottleneck to be further addressed.
5. Adoption: Still being in its nascent stage, tokenization is expected to take time to catch on; it would take convincing the many retail investors and significant investments in the new technology.

Tokenization, however, has the potential to reduce the difficulties and inefficiencies present in the existing post-trade procedure. For instance, the safe connectivity of traders and financial institutions through blockchain has the ability to do away with the clearing procedure and drastically reduce settlement times.

Regulation of Tokenization

Regulation of tokenization is still in its early stages. However, some countries, such as Switzerland, have already developed regulatory frameworks for tokenized assets. In the US, the SEC has indicated that some tokenized assets may be considered securities and subject to existing securities regulations.

The rapid rise of tokenization of assets has led to a pressing need for regulations to ensure that investors are protected from fraudulent activities and market manipulations. Tokenization involves the conversion of real-world assets into digital tokens, which can be traded on a blockchain platform. The emergence of tokenization as an alternative form of investment has been driven by its potential to provide a more efficient and cost-effective way to invest in traditionally illiquid assets such as real estate, art, and private equity.

However, the lack of clear regulations governing the tokenization of assets poses a risk to investors. The decentralized nature of blockchain technology and the lack of oversight from central authorities can lead to the proliferation of fraudulent activities such as pump and dump schemes, insider trading, and market manipulation. This can lead to significant losses for investors and undermine confidence in the tokenization market.

Therefore, there is a growing need for regulatory bodies to develop guidelines and standards for tokenization of assets. In the US, the Securities and Exchange Commission (SEC) has already taken steps to regulate the tokenization of assets, particularly through initial coin offerings (ICOs). In a 2017 report, the SEC stated that ICOs may be considered securities and subject to existing securities regulations. This was followed by a series of enforcement actions against companies that had engaged in fraudulent ICOs, underscoring the need for regulations to protect investors.

Similarly, in Europe, the European Securities and Markets Authority (ESMA) has called for a harmonized approach to the regulation of tokenization of assets across member states. This would help to avoid regulatory arbitrage and ensure consistent standards across the European Union.

In Switzerland, the Swiss Financial Market Supervisory Authority (FINMA) has developed guidelines for the tokenization of assets, outlining the requirements for companies looking to issue tokens. These guidelines include a requirement for issuers to conduct a detailed analysis of the asset being tokenized and provide clear information to investors on the risks associated with the investment.

Real Life Experiments

The Monetary Authority of Singapore (MAS) Project Guardian, which was started as part of a pilot program to investigate possible decentralized finance (DeFi) applications in wholesale lending markets, supported one of its most recent trials in November 2022. On a public blockchain, JPMorgan carried out its first-ever cross-border transaction utilizing decentralized financing (DeFi).

Using a customized version of the Aave protocol's smart contract code, the deal was carried out on the Ethereum layer-2 network Polygon. The real-time cross-currency transaction included the purchase and sale of tokenized government bonds in addition to deposits in Singaporean dollars and Japanese yen. The first tokenized deposits issued by a bank were Singapore dollar deposits [3].

JPMorgan also created JPM Coin, a variation of a stablecoin pegged to the US dollar. Currently in prototype form, JPM Coin is being evaluated for money transfers among JPMorgan's institutional clients. In the event that the dollar prototype is successful, JPM Coin may be introduced in additional currencies.

Tokenization has great potential to open markets, democratize access, and enhance efficiency and transparency meaningfully. As technology and regulation evolve, tokenized assets will play an ever-increasing role in financial markets and beyond.

Tokenization of Payments

Tokenization for payments is particularly beneficial for businesses that handle large volumes of payment transactions. By tokenizing payment information, businesses can reduce the risk of data breaches and fraudulent activities, as sensitive payment information is no longer stored in their systems. This can also help to reduce the compliance burden associated with handling sensitive payment information, such as the Payment Card Industry Data Security Standard (PCI DSS) requirements.

In addition to improving payment security, tokenization can also improve payment efficiency. Traditional payment processing requires the transmission of sensitive payment information between the merchant and the payment processor. This can be time-consuming and costly, particularly for businesses that handle large volumes of payment transactions. Tokenization simplifies the payment process by eliminating the need for sensitive payment information to be transmitted between the merchant and the payment processor, thereby reducing the transaction time and costs.

One example of tokenization for payments is the use of Apple Pay. Apple Pay enables users to make payments using their Apple devices, such as their iPhone or Apple Watch. When a user adds their payment card to Apple Pay, the card details are tokenized and stored in the secure element of the device. When the user makes a payment, the token is transmitted to the merchant, who then forwards it to the payment processor for authorization. The payment processor then replaces the token with the actual payment card details for processing the payment.

In Android Pay, tokenization works in a similar way. Once your card information has been loaded into the app. Google creates a pay token to represent your account number. This makes it almost impossible for anyone to hack your account and access your actual credit card information [6].

Conclusion

Tokenization is a revolutionary development in the world of asset ownership and investment. It offers numerous benefits, including increased liquidity, reduced costs, and increased transparency and security. While there are still challenges and risks associated with tokenization, it is likely that this technology will continue to grow in popularity as more investors seek to take advantage of its many benefits.

I believe tokenization will democratize access to financial opportunity for everyone in the globe, regardless of nation, income, or background, by enabling an almost unlimited number of new investments.

Ownership of a physical asset, like a house, may be divided up into smaller, more cheap investment units by establishing a digital token that corresponds to it. Due to skyrocketing costs and capital-intensive needs, real estate has long been priced out of the market. Tokenized real estate allows potential stakeholders to own a portion of property.

Blockchain accessibility makes this type of investing more feasible for certain groups. Tokenization merely takes the existing systems and significantly enhances them by utilizing the distributed capabilities of the trustless blockchain and its safe, fast features. As a result, opportunities become more accessible to all people, investor bases are expanded, and the market becomes much more capital-efficient.

Don't dismiss cross-currency swaps between tokenized Japanese Yen and Singapore dollars on Offer by the world's biggest institutions, like J.P. Morgan and the Monetary Authority of Singapore, as institutional experimentation. They are constructing the foundation for a key element of the web3-enabled future economy. Our financial future is closer than you would imagine since it is currently being woven into the fabric.

Citations:

1. https://www.blockchain-council.org/blockchain/asset-tokenization/
2. https://cointelegraph.com/nonfungible-tokens-for-beginners/asset-tokenization
3. https://www.nasdaq.com/articles/what-tokenization-is-and-how-it-can-unlock-illiquid-and-opaque-markets
4. https://www.rolandberger.com/en/Insights/Publications/Tokenization-The-future-of-financial-markets.html
5. https://www.weforum.org/agenda/2021/03/digital-tokens-could-transform-the-economies-of-the-middle-east-and-north-africa/
6. https://www.ir.com/guides/are-you-ready-for-apple-pay-tokenized-payments