Tokenization of Everything

Is tokenization of assets all that it is cracked up to be? Blockchain maximalists eagerly proclaim that in the future “everything” will be tokenized. Let’s break down what it really means to tokenize an asset and what the benefits are and how it would be implemented. First we have to establish what types of assets we are referring to, as there are some assets that lend themselves to tokenization better than others. For example, shares of stock (securities) are already essentially tokens, so making a digital version of a share of stock and putting it on a blockchain is a straightforward application (although there are some issues to be discussed later) and requires no debate. Most of the time, the tokenization of assets discussion is really about tokenizing physical assets like real estate, cars, precious metals, fine art, and collectibles so that will be the focus for this article.

 Titled vs Untitled

The first point of distinction in ownership is that of assets that are titled (like autos or real estate) vs. untitled (like art or gold bullion). In the case of titled assets, at least until governments transition to blockchain record systems we still have to operate under the existing paradigms. For example, Propy’s recently announced that they recorded a real estate transaction on blockchain; however, they still recorded a traditional deed at the county recorder’s office. The recorded deed just contained a transaction hash pointing to the Ethereum blockchain. At some point governments will start to recognize blockchain sources as the definitive source, but until then we are stuck with traditional methods. This was a good first step but it is far from being revolutionary or particularly useful but it does serve to show the potential.

 Asset Binding

For untitled assets the most prominent problem of tokenization is knowing or guaranteeing that the token holder truly has an ownership interest in the underlying asset. That is, how do we bind physical assets to digital titles? If I am viewing a rare baseball card, how do I view or associate the digital title? If I have a 1oz gold token, how do I know there is 1oz of gold sitting in a vault somewhere that I can claim? This is the same problem faced by those who buy into the ETFs on Wall Street. The buyer ultimately has to place trust in the company issuing the token, which is presumably the same entity responsible for providing or overseeing maintenance and services (gold requires storage and security, real estate requires accounting and management). The company Veritaseum has precious metal tokens that can be redeemed for real metal; however, the buyer has to trust that Veritaseum will ultimately fulfill the redemption requests. For collectibles, we could issue a digital (token) title for ownership of a particular collectible item; however, we would need a government or court system to recognize that possession of the token is absolute in determining who legally possess the physical item. We still must devise a method for associating the physical asset with the digital token. Bar code and QR codes might work but they can be easily copied or removed, so there would need to be a unique tag applied to the asset that couldn’t be removed or duplicated. I’m not sure anything like this exists. Until this problem is solved, tokenization is flimsy at best because “possession is 9/10 of the law,” as they say, so a digital token is of limited use.

 Token Bearer

A token-bearer system would be a system where the person in possession of the token is the owner. But will the public accept a token-bearer ownership system for titled assets? It probably won’t be very appealing to most. This would mean that if you have a token representing ownership of an asset (like your home) and you lose it or it gets hacked, you lose your ownership rights and title to the home or asset. Perhaps people would use a custodial service to hold and protect their private keys and tokens, but for the most part I believe the public will shun this idea for the security that existing systems provide and blockchain systems lack (so far). Such systems would also need to be capable of accepting and releasing liens and revoking ownership in order to enforce liens or foreclosures or other legal procedures. With a token-bearer system being untenable for the above reasons (and others I didn’t get into), we must conclude that the ultimate recording solution will necessarily be centralized and controlled by a government (or trusted) entity who can control and revoke tokens as necessary.

 Not Anonymous

Tokenized asset tokens, in most cases, will not be able to be owned anonymously. This is for several reasons:

a)    Unless it is a token-bearer ownership system, you will need (or at least want) a way to reclaim your tokens should you lose your private keys, or if the token holder dies and you inherit them, etc., or any number of events happen, we need a way to recover the tokens. The only way to do this is to have a central authority that can recover the tokens for you.

b)    Most digital assets would presumably be owned for dividend income. In order to comply with US tax laws, the custodian will need to know your information in order to report the dividend distribution on tax forms.

c)    The asset custodian may need to contact the owners to address and fulfill governance issues.

 Value

Finally, I want to touch on value or valuation of asset tokens. For real estate assets, it’s pretty straightforward to implement an algorithm to approximate the market value of an asset and thus proportionately value fractional shares/tokens. But in the case of unique assets like fine art, the problem is more difficult because the market determines what an asset is worth. What is the value of a particular Van Gogh painting that hasn’t been sold for decades? Once an asset like a painting is tokenized, the asset will likely never be sold (as a whole) again without a governance mechanism for token holders to collectively decide to sell the painting. This would presumably never happen because each owner would just sell their shares when the time is right to sell the shares. And what would the order book for tokens for a particular Van Gogh look like? Keeping in mind that keeping an open bid ties up capital for tokens that probably would not trade often, would there always be a willing pool of buyers at (or hopefully higher) than the last known auction price? Or would occasional sales by sellers desperate to raise cash suppress or depress the price? Or would market makers emerge or be used to ensure liquidity, particularly after the novelty has worn off? At this point it’s hard to say and it would be interesting to see how the market would end up valuing items with such subjective valuations. Another consideration is that while someone may be willing to pay $10M to own and display a Van Gogh painting in their home, will 10,000 token holders be just as interested to pay $1000 each for an item to be curated by a custodian with hopes that the share price will increase over time? I’m sure the possibility even exists that in some cases the sum of the parts might be greater than the whole. That is, lots of people might be willing to pay more per share for fine art than one person is willing to pay to own the whole thing. Reasons being accessibility due to price affordability and the other being the vastly improved liquidity of being able to sell a share of a painting on a whim (provided an exchange has sufficient liquidity) which has never been possible before.

 Conclusion

So while the “tokenization of everything” is a fun mantra and popular prediction for blockchain enthusiasts, I think reality may show that the applications will be limited and specialized. Be sure to read my article on tokenizing real estate if you haven’t, as that is kind of its own animal. While tokenized securities are a no-brainer, not every asset will benefit from securitization and fractionalization. Tokenized autos and collectibles appear to have many challenges and limited appeal, but that remains to be proven by the marketplace.

 Please feel free to contact me if you have a tokenization project or plan you’d like to discuss or need help with!