In March 2021, the media went agog over the news that a JPG image had been sold for a whopping $69 million as an NFT. I remember asking myself why anyone would pay such a humongous amount for digital art when they could right-click and save.
Thank you for reading this post, don't forget to subscribe!The artist behind the JPG, Mike Winkelmann (aka Beeple), began working on the collection in May 2007, creating a piece of art every day for 5,000 days. And on March 11, 2021, the non-fungible token (NFT) titled “EVERYDAYS: THE FIRST 5000 DAYS” was sold at Christie’s for millions of dollars. But beyond the high-value sale and all the frenzy that followed, NFTs gave a glimpse into the power of tokenization.
This article explores the power of tokenization and its immense potential to democratize asset ownership.
What is Tokenization?
Tokenization, in the realm of blockchain and cryptocurrencies, is the process of creating a digital representation of an asset. This asset could be anything from real estate to pieces of art, intellectual property, stocks, precious metals, and what have you. Virtually any asset can be tokenized. In a rather bizarre case, for instance, Croatian tennis player Oleksandra Oliynykova sold a part of her right arm for over $5,000 as an NFT in 2021.
Tokenizing an asset makes it easily divisible. This opens the door to fractional ownership, allowing more people to invest in the underlying asset. Furthermore, it allows for direct peer-to-peer trading, eliminating the need for centralized middlemen.
How Does Tokenization Work?
According to financial services company, The Motley Fool, the average home price in the United States is around $412,300. This price tag already limits the number of persons who can own a home or invest in the real estate industry. This is where tokenization comes in.
Thanks to blockchain, this real-world asset can be converted into a digital token, with a pre-defined number of units. So, instead of having a single investor fund the ownership of a real estate property, I can have around 400 investors, each owning $1,000-worth of units.
One popular example of tokenization in action is the now-defunct CityDAO. The decentralized autonomous organization (DAO) raised an enormous $8 million from over 5000 members globally to collectively buy 40 acres of land in Wyoming. The goal was to experiment with “building the city of the future on the Ethereum blockchain.”
Participation in the DAO and ownership of the land was in the form of NFTs – Citizen, Founding Citizen, and the First Citizen NFTs. There are countless other examples of retail investors pulling funds to purchase tokenized assets. Generally speaking, tokenization is a five-step process involving:
- Token Creation: Digital tokens representing shares in the entity or underlying asset are first created. Depending on the nature of the asset, a legal entity may need to be established to own the property.
- Smart Contract Implementation: Smart contracts are developed to govern token issuance, balance tracking, and benefit distribution.
- Token Distribution: Tokens are sold to investors through private sales, public offerings, or a combination.
- Asset Management: In cases involving fractional ownership, token holders are allowed to participate in property management decisions through voting mechanisms.
- Secondary Trading: Another important aspect of tokenization is liquidity through secondary trading. Tokens can be traded on secondary markets, potentially increasing liquidity.
Benefits of Tokenization
Asset tokenization has the potential to revolutionize global finance as we know it. Digital Asset Manager 21.co predicts that the market for tokenized assets could reach $10 trillion in a bullish scenario and $3.5 trillion in a conservative outlook by 2030. Undoubtedly, the ability to convert traditional assets into fractional and tradeable blockchain-based tokens is reshaping the investment landscape.
Democratizing Access
In my opinion, this is by far the most important benefit of tokenization. I may not have $400,000 to spend on a piece of art. But with tokenization, I can put my $1,000 to good use and still enjoy similar benefits like institutional investors. This is the real power of tokenization.
Traditionally, asset classes like commercial real estate and fine art have been exclusive domains for institutional investors and high-net-worth individuals due to substantial entry barriers. By enabling fractional ownership through tokenization, these barriers can be significantly lowered. This revolutionary approach allows retail investors to access previously unattainable markets, diversifying their portfolios in innovative ways.
Liquidity & Market Efficiency
Tokenization can also revolutionize market dynamics by enhancing liquidity and efficiency. Assets like real estate, notorious for their illiquidity, can become significantly more tradable through tokenization. Investors can buy or sell fractional ownership quickly and easily, unlike the complex and time-consuming process associated with traditional real estate transactions.
Moreover, blockchain technology’s potential to streamline processes, reduce intermediaries, and create a global 24/7 marketplace can exponentially increase market efficiency. This heightened efficiency could lead to a surge in investor interest, consequently boosting the overall value of tokenized assets.
Security
Security and transparency are paramount in any investment ecosystem, and tokenization offers substantial advantages. Blockchain’s decentralized nature inherently safeguards against tampering, providing investors with unparalleled confidence in their holdings. Additionally, the transparent nature of the blockchain can deter fraud as all transactions are publicly recorded and verifiable.
While the cryptocurrency ecosystem has encountered security challenges, primarily related to DeFi protocol hacks, the tokenization landscape presents a unique opportunity to mitigate these risks. Advancements in smart contract auditing and the potential adoption of permissioned blockchains can fortify the security posture of tokenized assets. By learning from past mistakes and leveraging cutting-edge technology, the tokenization industry can establish a robust and secure investment environment.
In conclusion, asset tokenization, while promising, has yet to achieve widespread adoption despite emerging in 2017. The market currently faces significant hurdles. A primary challenge is the lack of liquidity, as asset issuers are hesitant to tokenize without a robust secondary market, while investors are cautious without sufficient issuance volume. Regulatory uncertainty also hampers growth, with most jurisdictions lacking clear frameworks for digital securities. However, there are positive signs, such as Wyoming’s pioneering legislation recognizing digital property rights, which could pave the way for future regulatory developments.
Overall, the industry is still in its early stages, requiring a concerted effort from all stakeholders to reach its full potential.
