Tokenization of assets is a much talked about topic these days and for good. With the advent of Bitcoin as the first crypto-token, the Blockchain has come a long way to tokenization of both digital assets and physical assets.
What is Tokenization in simple terms?
Let’s say you own real estate worth $500,000 and would like to trade it in the market. You will have to go through the tedious process of finding the right buyers willing to give the right valuation. It may take weeks to months before you can sell it. If your current need is immediate and for a smaller sum only like $50,000, this whole process of selling the property does not make sense. But the traditional process of real estate transaction lends to the illiquidity of this asset.
Now let’s say if you break down this asset into smaller parts of $5,000 each and are able to trade just 5 such parts, it would be much easier to find the right buyer and quickly. This is what tokenization does in simple terms.
Tokenization allows you to convert your asset ownership into digital tokens. For your $500,000 worth of real estate, you can create 100 tokens each with a value of $5,000. Each token gives the token holder ownership of 1% in the real estate. For your immediate need of $50,000, you can sell 10 tokens to the right buyer.
Now we need to ensure two things for this to work in the real world –
a) First, the token should hold the rightful owner information with details of the transaction, and any new transaction is recorded immutably to have a clear title or ownership assigned to the rightful owner of the token.
b) Second, the underlying real estate should be secured by legal means so that the digital tokens continue to hold the value assigned to them.
The first part is taken care of by using Blockchain and Smart Contracts to tokenize the asset. Each token holds the ownership record as well as the immutable audit trail of all historical transactions.
The second part requires a legally binding way to secure the asset and needs a proper regulatory framework for it. This includes KYC/AML checks, legal custody of the underlying assets, and regulatory checks in place.
5 Ways Tokenization is redefining Financial Industry:
Tokenomics is paving the way for a new token-based economy that is much more efficient and accessible. Now the buyers and sellers can trade in securities and assets at the comfort of their homes with minimal involvement of intermediaries. The core benefits of the tokenization are as follows:
Wider Investor Base and Enhanced Liquidity The traditional assets have an inherent limit of the level of fractionalization. For example, a real estate property cannot be broken into more parts, so the ownership of real estate can be limited in number. The issue enhances if we take more illiquid assets like artwork. The cost of some of the artworks can be in hundreds of millions of dollars thereby keeping retail investors at bay. This results in a lesser investor base and liquidity of assets. Moreover, an investor who is invested in one such asset cannot move out easily as finding a suitable buyer is onerous.
By tokenizing assets, these assets can be traded in much smaller units, as low as $1. This changes the whole business model. The assets can now be traded in the secondary market opening up a much wider investor base and also allows the existing investors to cash out whenever they want. This also gives rise to a “liquidity premium,” resulting in greater value from the underlying asset.
Broader Geographical Access:
Blockchain-based platforms provide transparency and auditability of transactions and are accessible across geographies. So, the tokenized assets are accessible to people from other countries, further increasing the investor base and liquidity. The regulations like KYC/AML need to be adhered to for such investments which are being followed by many platforms, both public and permissioned Blockchains.
Faster and cheaper transactions
Tokenization of assets on the Blockchain platform enables 24×7 trading with minimal involvement of intermediaries. The transactions on Blockchain are executed using Smart Contracts (Coded business logic that is immutable and executes automatically based on pre-defined triggers). Thereby, it makes the transactions cheaper as well as reduces the settlement time from traditional T+2 to near real-time.
Clear Title or Ownership
One of the major issues today with the trading of physical assets is the clear title or ownership. A significant no of the litigations today is related to the clear title. Since a security token is like a digital passport of the underlying asset and embeds the token-holders rights and all previous transactions, it helps in establishing clear title as well the traceability of previous ownerships. This enhances transparency and ease of doing business.
As more and more illiquid assets are tokenized, the overall no of the assets increases in the market. Since now even retail investors can participate in more asset classes, the assets available as collateral in secured lending increases. Owing to clear ownership and transaction traceability, taking a lien on such assets is much easier for both the borrowers and lenders.
So, as you see that Tokenization of assets is a revolutionary concept and is being applied to regulated financial instruments such as equities, mutual funds, or bonds to tangible assets such as real estate, precious metals, artwork, and even to intellectual properties. There are some challenges like necessary regulatory framework and compliances, but things are moving at a great pace to solve them.
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