Tokenization is definitely not a new concept. However, thanks to the rise of the blockchain and cryptocurrencies, there has been a steady surge in tokenization endeavors. Everyone seems to be using tokens for different purposes, allowing the assets themselves to gain widespread notoriety.
With token-based markets getting more prominent, it is worth understanding the tokenization phenomenon and what it is.
What is Tokenization?
In its simplest sense, tokenization is the process of converting virtual or physical assets into digital versions for transaction purposes. The process can eliminate intermediaries and long territorial barriers for asset ownership, allowing small investors to also get a piece of assets that they like.
Today, we can tokenize pretty much any asset - gold, real estate, artwork, etc. Tokenization itself functions as a significant investment disruptor. Companies and players see the token economy as an exciting way of developing new markets and bolstering their ability to make sales. Estimates show that the tokenization market should reach a $4.8 billion valuation by 2025 - up from just $1.9 billion in 2020.
Markets that have invested in tokens include sports, gaming, and precious metals. Then, there is currency tokenization, thanks to the entry and prominence of stablecoins that provide stability in uncertain crypto climates.
The Simple Mechanism of Tokenization
As many know, tokenization has been especially popular in the blockchain sector. However, the concept has actually been available for a while now. Financial companies have been using tokenization for data security as far back as the 70s. These firms used alphanumeric combinations to replace sensitive customer information, essentially protecting their details - financial statements, credit card details, etc.
In the blockchain space, however, tokenization is used to represent physical and digital assets. They can also represent a unit of value in a system, such as a voting right or an actual ownership stake.
Imagine you have a piece of land worth $100 million. You want to sell a portion of it to finance a recent debt worth about $5 million. But you still want to keep ownership of the land because you believe it will appreciate even further. You could use tokenization to fractionalize the farm’s ownership.
All you have to do is create a token - let’s call it $LAND. You can give each $LAND token a value and sell it to investors. Each token will represent an ownership stake in the asset, allowing investors to purchase it. Now, you can enjoy ownership of your piece of real estate while being able to generate enough funds to pay your debts.
Blockchain-Based Token Types
In the blockchain industry, we have different types of tokens. The most prominent options include:
Also known as app coins or user tokens, utility tokens are given out during a project’s crowdsale period. They are representations of value forms that users can redeem in the future.
Utility tokens don’t get their value from any external asset. Companies create them, and they serve a specific purpose. You can’t trade them on exchanges as they aren’t available to everyone.
A security token is a digital asset that represents ownership of a physical asset. It can be bought, exchanged, and resold, and you can find some security tokens on exchanges as well.
Most security tokens are gotten through a Security Token Offering (STO). They can represent just about anything, from ownership stake in an organization to governance of a protocol or platform.
In the example above, the $LAND token is an example of a utility token. You can sell the tokens for a piece of your real estate, allowing them to get ownership rights and giving you money in return.
However, we can also classify tokens based on fungibility. Fungibility is the ability of an asset to be exchanged for another. Say you owe a friend $1,000 and are trying to pay back. You could pay with a $1,000 note or two $500 notes - or ten $100 notes, and so on. As long as the value is the same, you can pay your debt.
In the token world, we have the same classification. Essentially, tokens can be fungible or non-fungible.
Fungible tokens are pretty simple. They hold inherent value, and they can be exchanged for one another on the open market. Most cryptocurrencies are fungible tokens.
We already understand the concept of fungibility. However, while you can pay different notes to a friend to whom you owe money, it’s a bit trickier when we’re considering physical goods.
If you borrow a car from your friend, you will need to return the same car - not just any other vehicle.
In such a scenario, the car isn’t fungible.
Essentially, a non-fungible token is built to hold a specific value. They can’t be exchanged or interchanged, although their values could vary from time to time.
The Benefits of Blockchain-Based Tokenization
Tokenization is taking the world by storm, delivering impressive benefits to investors across the board. However, it is worth understanding the benefits of this concept and what makes it so remarkable.
Today, the traditional stock market is riddled with intermediaries. You need underwriters, banks, and more to sell your company’s shares on the stock market. Each of these intermediaries will charge a fee.
Tokenization removes these intermediaries entirely, making it quicker and easier to raise capital. With a quick and inexpensive process, you don’t have to waste any effort.
Tokenization works with blockchain-based smart contracts. Thus, certain aspects of the buying and selling process can be executed much quickly.
Tokenization allows you to split an asset into parts. This improves market liquidity, making an asset more lucrative and allowing more investors to get in. You can take a piece of art selling for $20 million and tokenize it with ten million tokens. So, everyone can purchase a part of it for just $20.
Tokenization is an interesting asset management concept that is sure to take the world by storm. While it is in its nascent stages, it has shown significant promise on several fronts. Asset developers can use tokenization to easily make money while retaining control of their assets, providing the best of both worlds.
As for asset purchases, the opportunity to make quick and easy transactions while cutting down on entry barriers is an interesting one that is worth exploring. As we advance, a lot of eyes will be on the development of the tokenization space.