Presently, a great segment of global wealth is locked in illiquid assets. However, the emergence of asset tokenisation could fundamentally change the way investors unlock access to illiquid assets, potentially allowing millions of people around the world to invest in assets previously unavailable to them. A recent report by Boston Consulting Group [ 1 ] conservatively estimates that the total size of tokenised illiquid assets could reach $16 trillion by 2030, with a potential best-case scenario of asset tokenisation reaching up to $68 trillion.
Asset tokenisation is the process of converting physical or digital assets into digital tokens on a distributed ledger or blockchain. While cryptocurrencies are the most popular tokenized digital assets, the space is expanding to include tokens for real estate, cars, and traditional financial assets like bonds, funds, or corporate stocks. JP Morgan, for example, recently announced its ambitions to tokenize trillions of dollars of assets to develop new mechanisms in financial services such as trading, borrowing, and lending.
Tokens as Investments
Tokenisation reinvents finance by creating a fungible and global market, accessible to anyone, anytime, and anywhere. In a tokenized market, assets are fractionalized and have advantages compared to other assets. Therefore, digital assets become increasingly attractive to progressive asset managers that recognize the growing demand from investors,
With the development of modern digital technology, anything can be tokenized. Tokenisation is essentially the transformation of an asset into a digital unit. That is, transforming any real-world asset into a digital asset in the form of a single notional unit whose information is stored in a blockchain. This transformation allows the token holder to interact with real-world assets with far greater security and speed.
How does Tokenisation work
Asset tokenisation refers to the process of representing real-world assets (such as real estate, stocks, and bonds) as digital “tokens” on a blockchain, where transactions are more secure and efficient. The real-world assets backed by digital tokens continue to exist “off-chain,” while digital tokens exist on the chain, acting as a store of value and carrying the rights of the assets they represent.
Table 1: “ RELEVANCE OF ON-CHAIN ASSET TOKENISATION IN ‘CRYPTO WINTER” Boston Consulting Group, 2022
Blockchain creates verifiably scarce digital tokens to split up assets and makes them easier to trade. This leads to better experiences for traders, with more money flowing around assets; this, in turn, stabilizes prices and makes it easier to buy and sell assets in larger volumes. Blockchain also provides customers the ability to monitor and manage the entire lifecycle of a token.
The entire tokenisation process takes between 3 weeks to 3 months. The most time-consuming parts are finding the correct stakeholders involved with the entire asset lifecycle, creating documentation, and setting up compliance and legal structures.
Types of assets and Tokens
The types of assets most likely to be tokenized are stocks, bonds, real estate, digital assets, and currencies. There are four different types of tokens, each with a unique use:
- Security tokens – A token that represents another asset (e.g., a share, a bond, or an interest in a real estate asset)
- Utility tokens – A token that gives the right to perform a specific action
- Non-fungible tokens (NFTs) – A token that represents ownership of a unique digital asset (e.g., a tweet or an in-game item)
- Currency tokens – Blockchain-based currencies (e.g., cryptocurrency or stablecoins)
Key Benefits of Asset Tokenisation
The key benefits of tokenisation are wide and varied and include innovative opportunities such as increased liquidity, real-time traceability and operational efficiency. For example:
- Increased liquidity: Tokenisation of assets using blockchain enables investors to perform actions using only a portion of the asset. This makes investing more accessible to a wider range of people by reducing barriers to investment
- Automation: Blockchain based smart contracts can allow for trading, compliance, document verification and dividend payments to be executed automatically. This removes the need for intermediaries and reduces the logistical challenges involved in the creation, purchase, and sale of securities.
- Increased transparency: By default, blockchain implies transparency. Asset tokenization allows users to view the entire history of activities performed over the asset; ownership over a certain asset and the associated chain of ownership can be easily identified.
- Immutability: All data stored on the blockchain is immutable, meaning asset information and transaction records are verified and data cannot be manipulated once recorded.
- Increased accessibility: Being divisible, investors can buy tokens which represent very small percentages of an asset. For those who can’t afford high-ticket assets, fractional ownership enables a wider range of investors to access the market, spurring greater financial inclusion. In addition, tokens can be exchanged globally and 24/7/365.
Challenges of Tokenisation
Slowly but steady we are moving into a tokenized economy. Tokenisation of real-world assets keeps challenging the status quo of the traditional financial world, forcing key players to adapt to a blockchain-based world. New players in the DeFi space are driving innovation and also accelerating the push for regulation and legal clarity.
Besides the general concerns that any blockchain project should have regarding security, making sure the smart contracts are well-coded, as well as having constant auditing to avoid exploits, hacks and 51% attacks, tokenisation projects have their own unique technical challenges.
These projects need to ensure that there is consistency between the off-chain real-world assets and their on-chain counterparts. This can be achieved through several ways, the most common by coding an oracle into the smart contract, which is a way to access data from the world outside the blockchain, and that ensures that all information is up-to-date. In real-life, a property that has been tokenized can burn down or a tokenized energy grid or power plant can experience disruptions. This needs to be reflected on the on-chain token that represents those real-world assets.
Another concern tokenisation projects need to take into consideration is the need for a seamless user experience. This is a prerequisite for the mass adoption of not only blockchain technology but to onboard retail investors into the tokenized assets ecosystem. An asset-based token should not be harder to invest in than a traditional security.
Legal and regulatory challenges
Legal and regulatory uncertainty can be one of the biggest challenges for tokenisation projects. Tokenisation projects are normally managed in a decentralized manner, with global teams working remotely, while being targeted to investors worldwide, making it nearly impossible to comply with all the existing regulations worldwide.
Startups and companies launching tokenisation projects must look into several aspects related to legal, tax and regulatory aspects, such as deciding where to incorporate a company, which jurisdiction to launch their token on, how to legally tokenise a real-world asset, registering their company with central banking authorities and/or with the securities exchange commission of one or more countries where they intend to operate.
The European Union has been working on standardizing regulation across the Member States regarding blockchain and crypto-assets. Two of the upcoming European legislative documents are the Markets in Crypto Assets Regulation, commonly known as MiCA, and the DLT Pilot Regime.
MiCA will come into force until 2024, with the aim of protecting investors by requiring crypto assets service providers to comply with certain requirements, and will apply to the issuers of asset-referenced tokens, e-money tokens and other cryptoassets such as utility tokens.
The DLT Pilot regime will apply to tokenized securities, such as stocks, bonds, money market securities and funds. It will come into force on 23 March 2023 for three years, with the possibility of another three-year extension. Existing projects will need to carefully study this new legislation and prepare to adapt to their future requirements, such as obtaining a license to operate in the European market, or risk having to move their businesses to other jurisdictions, and have to start all over again.
Another relevant point for the mass adoption of tokenisation is standardization. Token standards facilitate trade and protect investors, but it takes time to create these standards and for them to be adopted by an industry. Some organizations like 2Tokens Foundation are trying to raise awareness about tokenisation standards, organizing discussions between key players and studying how to reduce barriers for the adoption of tokenisation. Mass adoption of tokenisation of real-world assets is going to take years to fully come into fruition, and it will require efforts and cooperation from several actors in the ecosystem. Defactor is working closely with 2Tokens Foundation to study the creation of token standards for invoices.
Dispute resolution challenges
Like with any other business transaction between two parties, there is potential for disputes to also arise out of the negotiation of asset-based tokens.
Because of the globalized nature of the issuance and negotiation of tokens, there are jurisdiction issues, leading to uncertainty of which court has jurisdiction to solve these disputes. Including an exclusive jurisdiction or arbitration clause in the token purchase agreement can clarify this issue.
Another question is regarding the type of dispute resolution, between the traditional courts, arbitration centers and decentralized courts. Are traditional courts prepared to solve these types of disputes? Are lawyers, arbitrators, mediators, judges and prosecutors prepared to deal with blockchain-based disputes?
This is a controversial question, and some people believe that decentralized courts are the answer, which can be capable of solving these disputes but they also do not come without their own challenges.
Most of these solutions rely on jurors to make decisions, who may be lacking in expertise of the legal and technical aspects involved, and whose decisions can be influenced by monetary incentives, which are normally paid on the decentralized solution’s own token. These decisions will also typically be decided through the analysis of very scarce information, as well as submitted proof, with no possibility for oral submissions nor questioning of witnesses and involved parties. Besides, there is normally no possibility of appealing a decision, as well as enforcing it through the traditional legal mechanisms.
Tokenisation of real world assets through blockchain has the potential to unlock liquidity, and improve access and choice for multiple investment instruments at scale, especially for those assets that are traditionally illiquid such as real estate, high-value art, public infrastructure, and private equity. This potential is increasingly being investigated by regulators and traditional corporate investors, however challenges remain to widespread institutional adoption.
Mass adoption of tokenisation will not take place for many years to come, but current players are driving the ecosystem forward and collaborating with regulators to ensure the creation of regulatory frameworks that allow for new projects to be created as well as the protection for future investors.
Kelroy James is a Supply Chain, Logistics & Operations Management professional, and a Percy Hobart Innovation Fellow in the Royal Navy. A graduate of Aston University with a BSc (Hons) in Logistics and Operations Management, and recently completed a Micro Masters in Predictive Analytics using Python with the University of Edinburgh. He has a research interest in Blockchain applications and is a recent DeFi Talent with Frankfurt School Blockchain Center. He is the London Ambassador for Defactor. Connect with him on Linkedin, Twitter, Medium, DataDrivenInvestor
Inês Bragança Gaspar is a technology lawyer, specializing in Web3, Blockchain and Crypto assets. She holds an LL.M. in European and International Law and is a DeFi Talent with the Frankfurt School Blockchain Center. Her main areas of academic research are DeFi, especially tokenisation of real-world assets and decentralized justice. She is the Lisbon Ambassador for Defactor. Connect with her on LinkedIn, Twitter and Medium.
[ 1 ] On-Chain Asset Tokenization. BCG (2022)
[ 3 ] Pablo Picasso’s Oil on Canvas Painting Fillette Au Beret to be Tokenized. The Coin Republic
[ 4 ] Tokenization of Assets. EY
[ 5 ] Compared to cryptocurrency, token has much wider scope of application Crypto Newsflash