@golubevGolubev_Od_UA
Crynet.io (project manager), EU structural funds, ICO/STO/IEO, NGO & venture, marketing projects
‘’Tokenization is a new era of global investment. Nobody wants to take risks”
Where is it from and what for?
In general terms, tokenization is the replacement of real values with conditional ones. Tokens were used in the British Empire from the 17th to the 19th century due to a lack of fiat. These were tokens that either replaced coins or were intended to buy something specific. In fact, money itself is just universal tokens with no intrinsic value. However, they are a necessary vehicle for the exchange of values, goods and services. About ten years ago, and more, this term began to be used in online commerce. Payment for services online today is reliably protected by modern security protocols. Online shops and payment services protect users’ payments and bank card data from fraud intruders. EasyPay, for example, annually confirms PCI DSS certification and protects user data according to the latest international standards. One of the most modern types of data protection is tokenization. Therefore, in online commerce, this is a technology that allows you to secure electronic payments using a data encryption system. Tokenization in this case allows payments to be made without disclosing the user’s card data. Unique digital identifiers – tokens, replace information about the card (card number/cvv-code, etc.) Tokens protect primarily personal information and financial transactions by transferring card data in encrypted form. Tokens are created through mathematical formulas or random alphanumeric generators and cannot be used by hackers, since they do not carry any value. Here, during tokenization, confidential data is not sent, but remains in the application on the cardholder’s device and on the bank’s servers. One way or another, the bank knows which card corresponds to which code and can confirm the transaction. Tokenization does not negate the benefit of encryption, it is necessary when storing confidential data, however, tokenization avoids the direct transfer of personal data where possible, and using both approaches makes the transaction process even more secure. Now, this logic of tokenization has been widely implemented for a couple of years in many sectors of the economy, where the logic of data tokenization guarantees the growth of the added value of a product or service.
By the beginning of 2018, the development of blockchain formed a completely new approach to the valuation of businesses, assets and their financing. So, if earlier only a fairly large enterprise could count on entering the market of serious borrowings through the placement of securities, now, thanks to a new phenomenon – the tokenization of assets – this is available to almost everyone. Therefore, from the standpoint of the blockchain, asset tokenization is a secure process of transferring rights to a property or financial asset to a digital asset. Due to the fact that all transactions are encrypted in blocks of information, and their movement can be monitored in the blockchain network, tokenization is a progressive, secure and transparent way to evaluate and manage any asset that is of value! In fact, this is the stage of modern digitalization of the economy. It may sound distant, but tokenization has a profound impact on our lives and can transform entire industries. Although people are already using tokens on a daily basis (most are unaware of it), the true potential of tokenization is only unfolding thanks to the influence of the blockchain. Blockchain allows you to safely and efficiently tokenize a wide range of real assets and businesses, where the logic of the processes justifies such an application, providing new advantages and applications for a wide variety of industries, such as art or healthcare.
The main principle of the blockchain is decentralization. Excessive centralization of government, from states and corporations to large Internet services, leads to bureaucracy, cumbersome systems, manipulation, uneven distribution of benefits and unequal decision-making. Decentralization is capable of optimizing the system of any process and leveling the chain of intermediaries or fixing their income at an economically justified level. One of the key principles in the development of Internet services is the struggle for the place of an intermediary. Most successful businesses simply took over the markets that existed before. Amazon is replacing shopping, YouTube and Netflix are replacing TV and video rentals, and Uber takes a large share of the taxi market. And so on.
During the 2017 cryptocurrency boom, almost every crypto startup had its own ICO (initial coin offering). The projects promised investors huge profits, and in most cases, in fact, they were just emitting tokens for internal use, not backed by anything other than the price of bitcoin and the hopes of entrepreneurs for success with its endless growth. Since then, in relation to serious investment projects, the concept of a security token has been increasingly revised, that is, tokens as securities. Such an initial offer is called STO (security token offering), that is, tokens that either contain signs of securities, or are their digital counterpart, or are tokenized assets – that is, rights or part of rights to other assets, for example, precious metals, real estate, paintings and other property. The advantage of tokens is obvious, since any property or investment can be divided into a huge number of tokens. This opens up new opportunities for the investment market, especially for small investors (called ‘’unaccredited’’). This allows them to participate in this process without entering investment funds, as well as to trade assets on the secondary market using a simplified scheme, which is also convenient for large investors (called ’accredited’’).
Tokenization can significantly simplify the investor registration procedure and lower the financial threshold for participation, it becomes possible to create a securities market without a stock exchange. It also simplifies the process of registration, registration of ownership and other aspects of the transactions. There are projects to tokenize health-related information such as personal health records and drug supplies. And many more examples from financial payments, real estate, risk hedging, asset management, antiques and collectibles, art, healthcare debt, data management and insurance. In a broad sense, in soon future, an individual’s assets are also his money, professional skills and even social connections. Any tangible and intangible asset can be tokenized. For example, a token can be created for a gram of gold and act as its digital counterpart. Accordingly, the one who will own it is equal to the owner of a gram of gold. In addition, tokenization can be applied in future to intangible assets such as an idea, ability, or time. Previously, such assets were practically not involved, since they are difficult to measure, impossible to transfer or sell, but tokens can become their digital reflection and allow transactions even with them. The tokenization of physical assets is changing the paradigm for managing them. Whereas previously they were managed through the custody or by actual transfer, now the token holder can manage them directly without the need for physical transfer.
All this can be digitized – that is, tokenized. The process today does not stand in the aforementioned industries; by the end of 2019, tokenization projects worth at least $ 1.1 billion are already being implemented. Experts expect significant shifts in solving some regulatory problems, when companies and service providers will establish proven methods and simplify participation for institutions. If the authorities, conducting settlements with traditionally illiquid assets, accelerate the process of introducing new technologies, trading in tokenized assets will become as accessible as trading in shares. However, the challenges of this new technology should not be downplayed, and breakthrough will only be achieved with the coordinated efforts of all major players and stakeholders. This all takes time and patience. The digital asset market affects not so much the economies of individual countries as the global economy in general. Digital assets, by their very nature, do not have to fit into one or another jurisdiction, and regardless of the further fate of the legalization of crypto assets, citizens and enterprises of any country must find legal ways to participate in this market, whether they are entrepreneurs, investors, contractors or clients. But there are also barriers to the transition of the economy (that is, real assets) to the digital space. First, unrestricted access to assets and the simplicity of registering and closing accounts can lead to chaos. Secondly, there is still no single approach to tokenization, affecting many other nuances, such as asset management and distribution of roles, security, integration with traditional payment systems, etc. So in many aspects, government regulation will be necessary, and in a few years it is quite possible to expect the arrival of some kind of general consensus both among blockchain projects and in terms of their interaction with existing government institutions.
Pros and cons
Little practice to analyze decision-making
Tokenization as a transfer of rights to a real object on the blockchain quickly attracted the attention of the financial market. This is not surprising, since cryptocurrency can be classified as an alternative financial instrument. In addition, participants in the financial industry consider blockchain as a possible way to solve a number of problems: simplifying the accounting of rights to an asset, increasing transparency and security of operations, reducing costs, and the possibility of creating funds. Intermediaries – exchanges, depositories, clearing – become unnecessary. When securities are tokenized, the creator becomes the holder of the token collateral. He also guarantees the execution of rights on the basis of, for example, an offer. Supporters of a new kind of derivatives talk about democratizing the market and argue for tokenization. Unlike the classic stock market, in the world of cryptocurrencies, non-professional investors with any start-up capital can become indirect shareholders, bypassing infrastructure barriers and costs. This principle can only be violated if clear rules for regulating the industry are introduced. From a technical point of view, such transactions can be transparent and therefore conditionally safe, and the cost of entering the market is really close to zero. But this raises a question: how likely is the scenario of a speculative growth in the value of the underlying asset, for which the crypto derivative was issued? There is no material for comparison yet.
Trust issue
Also, questions and problems of trust constantly arise. We can say that in the case of asset tokenization, we are talking about a kind of quasi-securitization. The creator of the token will not be a regulated financial institution, the security of the asset may not have documentary evidence, and the court practice may be very limited. As a result, business models are based solely on trust and authority, but these are the patterns that are often encountered in the formation of a bubble. In financial markets, the investor is played by the regulator, which builds a system of accounting and supervision to minimize fraud. Regulatory authorities may be powerless whith tokenizing shares, since sellers of secured tokens often avoid recognition of their product as a security token in various ways – this status imposes certain obligations on the seller.
No regulation, weak infrastructure
Unlike securities, low-liquid assets can be a suitable area for tokenization – in particular, real estate and works of art. Tokenization in this area has a positive economic effect: the asset is transformed into a liquid form with the splitting of rights to it. In addition, the asset can be used as collateral. However, by analogy with securitization, the provision of low-liquid assets with tokens can become both an engine of progress and another “bubble”. So far, such initiatives are met with skepticism, since there is no intelligible regulation, and business models run into the documentary nature of the underlying asset. To date, there is no working system for tokenizing real assets or financial instruments on the market. The idea of tokenizing assets also has technological limitations – the modern IT infrastructure of financial markets is not adapted to the logic of smart contracts. It is worth noting that there are no fundamental obstacles – theoretically, a completely autonomous software architecture for tokenization could already exist. This requires adapting the financial industry and legislation.
Blowing bubbles again
The tokenization process has functions similar to securitization – transferring an asset into a more liquid and simple form, as well as splitting the rights to it. But it has a serious difference – it is an unregulated process. We can talk about the excessive conservatism of the financial authorities, but this attitude is due to the lack of clear regulation and appropriate infrastructure. As a financial derivative model, all other things being equal, a token outperforms a security or derivative in terms of security, which is achieved through its decentralized nature. In addition, the public ledger of transactions makes the usual intermediaries unnecessary: registrars, depositories, centralized exchanges. Unsurprisingly, many large market participants are paying attention to the benefits of blockchain. Tokenization can replace securitization as a more efficient market instrument, because token has a number of advantages over securities. However, today the development of tokenization is hampered by many obstacles: the legal framework, infrastructure restrictions, and distrust of market participants.
Asset tokenization problems
You can hear in various media that soon a digital asset will be launched for every sector of the economy, and the blockchain will turn out to be the most important component of the economy, without which it will be impossible to complete any transactions. But the reality is that global tokenization is far from being implemented. First of all, this is due to the fact that for tokenization of assets, software systems are needed possibilities that allow transferring assets to digital media. At the moment, there are not many software solutions that can tokenize assets, and most of them are still at the concept stage or exist in the form of prototypes. For tokenization of assets, a clear concept is needed, which must necessarily address a number of important issues as:
• provide all participants of the decentralized system with interaction algorithms;
• have a clear mechanism for managing tokens, control over the issue and their burning;
• provide users with a mechanism for withdrawing, entering and exchanging assets, as well as appropriate software for this;
• be consistent with legal and tax aspects.
Tokenization opens up almost limitless possibilities, but first it needs to be improved. The token itself is not legally binding, so investors have to rely only on the honesty of its developers. In the worst case, the funds invested in the token can be spent for other purposes, and the investor irretrievably loses his money. Now there are several platforms that allow tokenize any asset based on smart contracts. Anyone can issue tokens, which should transfer the right to own an asset. But taking into account the current possibilities, this will be nothing more than a verbal agreement that the owner of the asset (who sold the token), at the request of the investor (who bought the token), will transfer the asset to him as ownership. Ideally, all transactions within the digital system should have legal force, similar to changes in the real estate register when the owner changes. This is not the case yet, which is a problem. In reality, crypto enthusiasts are still only fantasizing when they talk about how blockchain technology and decentralized tokenization can change the world where we live in. Decentralized asset management systems don’t work without software. While the project is at the development stage, this is still a conventional centralized asset management system with blockchain elements. And very often, it remains so. Crypto enthusiasts also prefer to keep silent about this.
Benefits of asset tokenization
The main advantage of tokenization is that tokens are useful only within the system where they operate. This method is ideal for protecting sensitive data. Unlike the encryption used, where anyone who has a key to solving the cipher can calculate the initial data, the token cipher may not contain any personal data at all, so it cannot be stolen and used for harm. When tokenizing assets, the function of dividing the token into parts is useful. Thus, a share of a token can transfer a part of the asset assigned to it, without physically dividing the asset into parts. In addition, the transition to digital form allows to increase the speed and safety of transactions, as well as to make them as simple and convenient as possible, and eliminates the need to cooperate with intermediaries. For stock market traders, tokenization of assets will eliminate the paperwork that is the main difficulty in trading, and provide an easier way to sell and buy assets, and therefore eliminate the need to hire asset management companies. All this should significantly increase the liquidity of assets.
Business tokenization will allow you to save on payment processing, as well as make accounting easier. In particular, modern encryption algorithms that protect payments require the implementation of PCI DSS protocols in applications and platforms. Tokenization, on the other hand, will allow you to store and manage data, operating only with a token, without putting the data of the company and customers at risk. Of course, the main advantages of tokenization remain the decentralization, transparency and security of transactions characteristic of the blockchain. Settlements in the DLT network can lead to a decrease in counterparty risk and operational risks if transactions are carried out on blockchain networks with access permission. However, uncertainty about the finality of settlements in non-authoritative blockchain networks precludes such a benefit. At the same time, the ability to carry out instant transfers, that is, a direct exchange of digital assets between two “wallets” (accounts) through different blockchain networks without the participation of a centralized intermediary, can significantly reduce, if not completely eliminate the counterparty risk. Interestingly, some experts argue that issuing securities in a tokenized environment will help create new products and asset classes.
Investors can benefit from the wider use of asset tokenization by being able to own stakes in underlying assets (or stakes in funds). Asset tokenization will allow assets to be fragmented into smaller fractions than is commonly seen in stocks and bonds, similar to structured products and securitizations. Investors, especially retail investors, will therefore be able to access asset classes and risks that might otherwise be beyond their ability (participation in private equity funds) and participate in capital markets with smaller portfolio sizes.
What is required for successful asset tokenization?
For successful tokenization of assets, you need to develop a clear concept, business model, and solve a number of other issues:
• work out and implement algorithms for the interaction of all participants in the decentralized system;
• determine the mechanism for issuing tokens, their life cycle and ways of managing the distribution of tokens;
• define the procedure for registering system users and managing keys;
• work out mechanisms for deposits and withdrawals of funds, internal exchanges, management of limits and write-offs of transactions;
• develop trading and payment systems, mobile and web wallets;
• think over and solve legal issues and mechanisms of interaction with tax systems;
Asset tokenization opens up new, almost limitless prospects, but first you need to do a lot of work. Hundreds of asset tokenization systems are currently being developed in the world, but there are still only a few finished work products.
Main conclusions
• Tokens are the next step in the development of blockchain technologies, allowing us to move from speculation on highly volatile cryptocurrencies, created several years ago, to ensuring the accelerated development of the real sector of the economy due to new cryptocurrencies.
• Tokenization of real assets – is becoming an increasingly popular area of investment activity.
• Asia has actually become a leader in the development of blockchain technologies.
• Tokenization is already spreading to many industries
• Lack of regulatory mechanisms and legislative framework is still hindering development
• The low level of knowledge in the field of blockchain technologies and cryptocurrencies among the mass investor (non accredited) – while seriously hinders the processes of adaptation and mass distribution
• Development of cooperation between traditional banks, fintech and blockchain companies will help to promote the topic of tokenization in fintech faster
Sergey Golubev (Сергей Голубев)
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