As the cryptocurrency industry continues to mature, the term “tokenization” seems to have become a bit of a buzzword; it gets thrown around quite often, usually following phrases such as “innovative use cases for blockchain technology such as” and “the future of asset management lies in.”
But the concept isn’t as shallow as it may seem to be–certainly, it’s easy enough to understand on a basic level: tokenization is, more or less, the act of taking an asset (ie shares of a company, gold bricks, pieces of real estate, hedge funds) and creating tokens that represent ownership of these assets. These tokens can then be quickly and easily traded on a blockchain network, which theoretically makes ownership easily transferable and revolutionizes trade across a number of different asset classes and industries.
(If we want to get a bit more technical, we can look at legal, tax, and compliance firm MME’s definition: “Tokenization is the process of digitally storing the property rights to a thing of value (asset) on a blockchain or distributed ledger, so that ownership can be transferred via the blockchain’s protocol.”)
Tokenization makes sense from a logistical standpoint
The concept of tokenization has been lauded by individuals in and outside of the cryptocurrency industry: Coinbase co-founder Fred Ehrsam said that “everything will be tokenized and connected by a blockchain one day”; in a blog post for Nasdaq, Blockchain lawyer Addison Cameron-Huff referred to tokenization as “the next phase of [the] evolution” of “commodity exchanges [doing away] with physical paper by substituting electronic transactions and standardized agreements.”
— BNY Mellon (@BNYMellon) July 9, 2019
Indeed, from a logistical standpoint, tokenization seems to make sense: Stephanie Hurder, Ph.D. and Founding Economist at Prysm Group, pointed out in a Medium post that there are a number of benefits that tokenization can provide for trading systems:
“It allows the secure transfer of assets without an intermediary; It improves record-keeping of ownership and trades; It reduces the paperwork associated with trade; It improves market function (speed, ease of use) and liquidity; It improves price discovery and information aggregation.”
That’s all well and good–but what’s in it for companies who are thinking of tokenizing? What kinds of opportunities does tokenization present for them?
Financial benefits for businesses
In an interview conducted earlier this month, former Visa executive, Liqwith co-founder, and CryptoDelta founder Roel Wolfert told Finance Magnates that tokenizing offers the opportunity “to get rid of debt from your balance sheet and to add equity, to increase your credit rating, [and] to become liquid as a company”, noting that becoming tradable immediately raises a company’s value.
Wolfert also pointed out that the process of holding a Security Token Offering (STO) in order to distribute tokens to investors can provide a number of opportunities to businesses: “because you do the marketing to promote your business–that is a huge opportunity,” Wolfert explained. “The marketing funds you can use on all sorts of things–you can use them to raise [the amount of capital earned] in crowdfunding; it’s also loyalty to your customers if you are in, [for example,] the retail industry.”
“So, there’s huge potential in STOs,” he continued. “Rather than [simply] getting some quick money in to grow your business–it’s a marketing opportunity, it’s a communications and loyalty opportunity, as well as a great financial construct to clean up [your company’s] balance sheet and take control of your growth.”
“You could continue to light your lamps with gasoline and a match, but you could also just use electricity.”
Lex Sokolin, Global Head of FinTech at ConsenSys (a global blockchain technology company that has a tokenization platform of its own) told Finance Magnates that the benefits of tokenization are continuing to evolve: when asked why companies should tokenize, he explained that “the answer to that question today and the answer to that question last year and next year are quite different.”
Finance Magnates interviewed Sokolin, who will be appearing at the upcoming Ethereal conference in Tel Aviv, to dive deeper into the tokenization process.
From a technical standpoint, Sokolin said that “I have a strong belief–and certainly, ConsenSys has a strong belief–that Ethereum and smart contracts (and blockchain-based systems more broadly) are a step function in innovation for how we build technology systems.”
This is an important concept when it comes to scaling and tokenization. Stephanie Hurder pointed out in the same blog post that “tokenization only works correctly if transferring ownership via the blockchain protocol guarantees that the asset itself changes ownership, and if the blockchain protocol is the only way to transfer ownership of the asset. In other words, the asset changes owners if and only if the owner changes via the protocol. This is a simple, but often overlooked point.”
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Hurder is correct–but Sokolin explained that in his opinion, the world will eventually make the leap to the blockchain as the only logical option: “so, it’s kind of like the moment of electricity, right?,” Sokolin explained. “You could continue to light your lamps with gasoline and a match, but you could also just use electricity, even though that infrastructure isn’t as scaled-out or as maybe fully-developed as what we’ve had in place before. That doesn’t really mean anything for the future of it.”
“Tokens are just abstract wrappers of concepts that refer to the real world,” he added. “You might have legal documentation, 95 percent of which sits outside in the real world, and then 5 percent of it is digitized into a token and refers to this governance of a legal contract.”
The technical benefits of existing on a blockchain
Sokolin continued to say that right “out of the box,” assets that exist on a blockchain “have some amazing native capability that you have to work really hard to manufacture if you don’t have a blockchain.”
“So, for example: to use Ethereum is to benefit from billions of dollars spent on cybersecurity per year. Other people are paying billions of dollars in mining costs to secure your assets in a scarce and authentic way, and that’s something..that is available for everybody.”
“Similarly, you get thousands of open-source developers who are writing code to improve the system that you’re using every single day, and none of that costs a thing on your side, either.”
In addition, “you have full transparency [on a blockchain] for all of the transactions that affect your assets; all the holders of the asset, who they are and how much they have.”
“We now have tools that do full look-through for KYC and AML, that can make sure that the health of the network is robust. You can start to implement controls and you can start to also implement capabilities into the tokens. So I think that over time, what’s going to happen is that instead of having 95% of the legal content sit outside of the token that somebody owns, you’re going to have more and more of that substance [including] governance, dividend distributions, [and] payments…live inside of the blockchain system.”
First steps to tokenization
So let’s say that you’re sold on the idea–where do you start? In other words, if a company wishes to take the leap and tokenize, how would it go about doing such a thing?
“In 2019, the first step is to hire a lawyer,” Sokolin said, jokingly–but in all seriousness, “you do need to have a strong ‘legal hat’ as you approach the space for your own mental health, as much as anything.”
Sokolin explained that the first question to ask when considering tokenization is fairly simple– “where?”
“There’s a global regulatory battle for creating environments and laws that allow tokenization in different ways. End of the day, wherever you’re based, you have to figure out what the implications are from an investment-management [and] securities-laws point of view for the type of asset that you want to offer.”
Indeed, the classification of the asset that you’re attempting to tokenize can have a profound effect on the tokenization process: “it’s one thing to take a share of Apple stock and to try and create a token of that–that’s very, very difficult. It’s another thing to try and take an early-stage, venture-funded type company and tokenize the shares of that, which we see quite frequently.”
“But then, it just becomes a share like anything else–you have to think ‘do I want to crowdfund that on something like an AngelList or a Cedar’s?’ What are the regulations if you go in that direction? Do I want to just sell it to wealthy, sophisticated, or accredited investors and do a venture round?”
“So, that process really has not changed yet just because you’re doing a token,” Sokolin continued. “You have to think through all of the requirements in that case.”
“Things get a little bit different if you’re talking about commodities or real estate–we’ve seen projects trying to tokenize cars or tokenize horses…but you [always] start with the question of ‘what is the underlying legal wrapper for the thing that you’re offering?’”
Who should do it?
Once the legal side of the tokenization process has been established, it’s time to get technical: how are these tokens created?
The best piece of advice may be to leave it to the pros: “in terms of who should do it, or who can do it–one of the great things about Ethereum [for example] is that it’s a public chain and you can learn how to put smart contracts on it and build things yourself.”
However, “you can kind of analogize this to the early days of the web where you could [either] learn how to do web design yourself, you could pay your niece or nephew $500 for a website that looks like it was designed by your niece or nephew… you can pay somebody $5000 to do it, or you can pay an agency $100,000 or $200,000 to get it done on a branded, bullet-proof level.”
“People are pursuing these projects at various levels of cost and complexity and risk tolerance and desire for what outcomes they want.”
The quotations from Lex Sokolin that were used in this piece are excerpts from an interview that Finance Magnates did with Sokolin on our Blockchain Podcast. To hear the full interview, click here.