What is asset tokenization – a beginner’s guide

This is the first article in a mini-series of research articles we have prepared which analyzes asset tokenization and its relevance. Before we go more in-depth on digital security offerings, we have decided to first lay down the fundamentals, so that you can really understand the concept of asset tokenization. In our next article, we will discuss security tokens more in-depth. If there is anything we don’t cover in our articles, get in touch with our expert analysts by subscribing here so you can ask all the questions you’d like.

What is asset tokenization?

Asset tokenization is a method and a topic that are fairly new in the cryptocurrency community, but the underlying principles they operate on are very familiar. What asset tokenization is can best be explained in an example.

Let’s say you have the opportunity to own a piece of something; a chocolate bar. You go to the store and you can either own 100% of the chocolate bar and pay for it or 0% and leave it on the shelf. Let’s say that you buy this chocolate bar, keep it for some time, decide you’re not going to eat it after all and want to get rid of it. You can offer the other person to either buy it whole or not buy it at all – selling it piece by piece is time-consuming and not profitable (or is it?). This kind of approach – that an entity either owns 100% of an asset or 0% of it is essentially very illiquid, meaning that when the asset changes the owner, it is either 100% in the new owner’s possession or 0%.

If we replace a chocolate bar from the above thought experiment with a 10-story building, things get interesting – what can you own? You can own a shop on the ground floor, an apartment, two apartments, or the whole building even. Now, this asset’s liquidity has increased, and if you are a building owner, you can sell off 10% of the asset (1 apartment), 20%, 50% or even 100% and everything would be fine. But, can you sell 0.1% of the asset or a couple of square meters from one specific apartment?

In comes asset tokenization or simply put – a means to convert asset rights into digital strings of code. Of course, today, the answer is no on the above question – selling a couple of square meters from one apartment isn’t feasible – it makes little sense according to today’s view of what ownership represents. But, if we introduce asset tokenization in this experiment, we definitely can sell 0.1% of an apartment to the interested party. We can even sell 0.001% - 1 marble tile in the bathroom, as to how the asset is tokenized is arbitrary. Does this make the asset more liquid? Definitely so – asset liquidity has dramatically increased with this approach since it’s completely arbitrary.

How does asset tokenization work?

Asset tokenization is a process that takes place when tokens are minted on a blockchain which represents ownership of the underlying asset. To comply with various security laws, these tokens are distributed through a security token offering (STO). Security token offerings are different from initial coin offerings (ICOs) as STOs are very regulated and specific laws must be followed before, during and after any offering takes place. With the use of smart contracts, the compliance of these laws can be built into the token issuance.

In order for asset tokenization to take place, there are two conditions that have to be met – an asset has to be evaluated and a place where the digital tokens are going to be distributed has to exist. Asset evaluation can be done through an audit, and blockchain ledger can be used for the token purchase, distribution, and placement. Without an objective audit, the asset prices can be inflated, and without a network, the digital token cannot be distributed properly, that is why both of these conditions have to be met.

What are the advantages of asset tokenization?

Asset tokenization brings new solutions into large systems and allows for assets that weren’t usually liquid – for example real estate or art assets – to become liquid. It ushers in more democratic approaches when it comes to asset ownership, and opens the possibilities of co-owning assets.

Apart from making assets that were traditionally seen as illiquid (real estate) become very liquid, it is argued that asset tokenization will also bring fast and very cheap transactions due to the fact that smart contracts will be used for processing transactions.

Asset tokenization will also be immutable as every token’s ownership change will be written directly into the blockchain. This leads to the tokenization to become transparent too, as all ownership information will be written directly into the token, along with all rights and legal responsibilities.

What are the disadvantages of asset tokenization?

The most important obstacle that asset tokenization processes need to overcome is of regulatory nature, as it is not yet known how government bodies will observe this kind of fractalization of assets and how the responsible parties will be seen. Also, it is not likely that a ‘one size fits all’ regulation will be implemented, and if the markets want to go international with their offering, so these laws need to be coordinated too. As this new approach is still being developed, a concrete framework for operating it is necessary.

Why is asset tokenization relevant?

Asset tokenization, though the process of digital securities offerings or STO’s will radically disrupt traditional finance. This recent rise in activity has more than spurred investor’s interest. According to ICOdata, 1,253 Initial Coin Offerings (ICOs) raised more than $7 billion in 2018. It is, however, worth noting that many of these raisings were for utility tokens which are not backed by any assets.  STO’s have witnessed a significant surge throughout 2019, this can be seen thanks to stockblock.io statistics.

Alec Ziupsnys believes the entire traditional financial securities infrastructure— valued at $544 trillion—could eventually become tokenized!

At Bull Bear Analytics, we are following these mega trends and providing our members with opportunities to take advantage of them. In the next article, we will be discussing what a security token is in more detail.

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