Asset tokenization is the ongoing trend in the crypto space. Some experts actually label it as “a natural progression of investable funds.” But what is really driving this evolution within asset classes?
Creation of the cryptocurrency market was a big shift in finance, raising concerns among some and gaining high praise from others. Alongside with the lack of legislation, this led to a disconnect of crypto market from traditional financial one:
- There are no trading platforms offering simultaneous access to both traditional and crypto markets;
- You can’t trade conventional financial assets for cryptocurrencies easily;
- Financial instruments that are familiar to the market are not widely represented in the crypto market;
- Direct exchange of digital assets for conventional financial instruments is not possible at this time;
All of this leads to lack of liquidity and high volatility of the digital finance market which also slows mass adoption. Bridging the two markets and specifically using real life assets to back digital ones can help balance the crypto market and bring more trading opportunities to both sides.
At the same time, traditional finance markets generally have higher barriers for retail investors to come in, unlike the digital assets that have lower entry thresholds, making it easier for retail investors to join the market. Massive investment opportunities are generally reserved for the select few. Blockchain can change that by using asset tokenization to make investing in real world assets far more convenient and efficient. With this approach, traditional assets can be divided into small units increasing their liquidity and enabling more market participants to join.
But let’s forget about blockchain and smart contracts for a moment and look at the asset tokenization through a simple lens. Imagine you want to invest in a collectable asset worth $500,000 but you can only afford a modest initial investment of $5,000. Maybe you will want to increase your investment gradually and invest a couple thousand every three months. Obviously, with traditional market this is quite awkward to do - how are you supposed to buy a piece of a tangible collectible?
We can also reverse the situation: imagine that you own a rare collectible. You need cash quickly. The collectible is valued at $500,000 but you just need $10,000. Can you do this quickly without much friction? No.
Let’s add tokenization to this scenario. Tokenization is a method that converts rights to an asset into a digital token. The proof of transaction is verified and held in blockchain. Suppose there is a $500,000 collectible. Using tokenization you can transform this asset into 500,000 tokens (the number is arbitrary, you could have issued 1 million tokens). Thus, each token represents a 0.0005% share of the underlying asset. The token is issued on a special platform supporting smart contracts, for example on Ethereum, so that the tokens can be freely bought and sold on different digital exchanges. When you buy one token, you actually buy 0.0005% of the ownership in the asset. Buy 250,000 tokens and you own 50% of the assets. Buy all 500,000 tokens and you are 100% owner of the asset. Because blockchain is a public ledger that is immutable, it ensures that once you buy tokens, nobody can erase the record which is a proof of your ownership rights, even if it is not registered in a government-run registry.
In short, you took an asset, tokenized it and created its digital representation that exists on the blockchain. Obviously, this can be done to most traditional assets such as stocks, commodities, bonds, and art. The traditional asset backing the digital “mirror” is usually helped by the prime-broker or escrow (based on the asset), subject to all the traditional custodian, regulatory, and security levels of protection. The traditional asset then would be frozen and the digital shares are issued, reflecting the real value of the underlying asset. This is done not only to ensure the safety of the traditional asset but also to make sure there is no market manipulation happening, especially in the case of public stocks. The digital assets can be traded using e-wallets for cryptocurrencies. When you want to redeem the digital assets, the underlying shares are released and the digital “mirror” is burnt.
Digitized assets can be easily accessible to retail investors, can be traded worldwide 24/7, adding liquidity to the crypto market, and bringing traditional financial instruments to the world of blockchain. These type of assets are also backed by real life assets that have real value, comparing to highly volatile tokens issues by startups, for example.