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Everything You Need to Know About Tokenization

Digital transformation has been introducing profound improvements across various sectors, especially in the case of digital payments. However, the growth of payment technology has also created noticeable threats for sensitive customer data. As your data passes through various points when making digital payments, it becomes vulnerable. Therefore, tokenization blockchain combination has been historically accepted as a reliable approach for isolation of data in ecosystems. 

Most recently, the applications of tokens have increased in the payments processing industry for storing credit card information without exposing the original data. In addition, the use of tokenization in blockchain has been making news for prospects of converting tangible and intangible assets into digital tokens. So, what does the new age of tokens mean for the future of blockchain and the world? Let us discuss the definition of tokenization in detail along with the value it brings by referring to examples. 

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What Does Tokenization Mean?

The arrival of blockchain has transformed the ways in which we invest in assets. How? Tokenization is the answer you are looking for here! It is the process of transforming ownership rights of an asset into a digital token. For example, you can transform an apartment worth $200,000 into a total of 200,000 tokens, with each token amounting to almost 0.0005% of the apartment’s value. 

Basically, blockchain tokens provide a digital representation of complete or shared ownership for any entity having specific value. The common applications of blockchain tokens are evident in payments and settlement of transactions among participants. Tokens also provide representation for multi-party ownership for indivisible assets such as artwork or a music video. In addition, tokens also provide an easier exchange of ownership of indivisible assets through a blockchain network.

The tokenization blockchain combination could open new prospects for optimization of business processes, which include multiple partners, and introduction of new business models. According to the IDC, the global tokenized asset market would reach a valuation of $500 billion. Although you can notice promising opportunities for tokenizing assets on the blockchain, the concept of tokens didn’t start here. 

As a matter of fact, tokens have been serving as a unique data security mechanism in financial services for safeguarding confidential information like credit card numbers, personally identifiable information and financial statements. The traditional tokenization example in financial services involved the transformation of sensitive information of users into the token. 

The token, in this case, included a string of numbers and non-sensitive letters. However, the applications of traditional tokenization were not limited only to the sector of financial services. Hospitals can implement tokens for patient records, while government can use tokens for voter registration. 

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Working of Tokenization

After the definition, it is inevitable for you to wonder about the working of the technology. The understanding of ‘what is tokenization and how does it work?’ could help you find out the scope of tokens. As you must have already deciphered from the definition of tokenization, it involves transforming indivisible assets into tokens. However, you can find many types of assets in the world which are difficult to divide and transfer. Therefore, you need to have a better understanding of the different types of assets that you can convert to tokens. 

  • Intangibles 

The intangible assets find existence only according to legal precedents without any physical object for representation. Examples of intangible assets include copyrights and patents. When you want to tokenize intangible assets, it is important to ensure that the asset transfer model of the blockchain network is same as the real world transfer model. Intangible assets are easy candidates for conversion to tokens without any storage or shipping concerns. On the contrary, jurisdictional differences could create profound difficulties for transferring tokens representing intangible assets. 

  • Fungible Assets

Fungible assets are the ones that are replaceable by a similar item. The most common examples of fungible assets include wheat or gold. Converting fungible assets into tokens is easier as you can divide them into smaller units easily. Furthermore, one token could serve as a representative for a group of fungible assets such as a pile of gold. The tokenization algorithm for fungible assets must also include an abstraction layer. In addition, a set of tokens is related to a collection of interchangeable asset components. 

  • Non-fungible Assets

Non-fungible assets are the ones that couldn’t be broken into smaller pieces. Tokenization helps in breaking down non-fungible assets into digital shares, which you can trade either fully or in a limited way. The tokenization example for artwork and real estate shows the possibilities of converting non-fungible assets into tokens. 

The conversion of artwork into tokens starts with the introduction of an immutable digital signature. The digital signature or token provides representation for the artwork while retaining uniqueness. Subsequently, you can break down the token into smaller sub-tokens which you can sign digitally. Then, it is possible to sell the tokens like shares of the original artwork.

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Technological Underpinning of Tokenization

The different types of assets show the inputs you can put in for creating tokens with blockchain-based systems. However, did you ever wonder how it is technically possible to convert real-world assets into tokens? Let us take a look at the technological foundations of implementing tokenization in blockchain

The implementation of tokens depends considerably on smart contracts, also referred to as token contracts. Token contracts are basically the programs that can help in verification of business rules alongside transferring value from the wallet of one user to another user’s wallet. It is important to note that UTXO and account-based models are currently the most preferred choices for implementation of smart contracts. 

The UTXO model has been a common choice for many cryptocurrencies after its introduction to Bitcoin. Account-based models are suitable for networks running on Ethereum and Hyperledger Fabric. With the account-based model, you would find a world state database, which helps in maintaining the existing state of the token or asset at a specific instance of time. In addition, the existing state of the token would be classified as the balance for transactions. 

The next important thing to note in ‘what is tokenization and how does it work?’ is the lack of a world state database in UTXO-based platforms. On the contrary, these platforms focus on maintaining a balanced output for every transaction they perform. It is possible to calculate the existing token balance from the sum of all unspent balances. 

Interestingly, the sum of input values should be more or equal to the sum of output values in the UTXO-based model. For example, R3 features a robust token-SDK with UTXO model as the foundation. You can find a promising tokenization example with R3, as you can implement token-based solutions in Hyperledger Fabric by leveraging smart contracts. 

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Reasons for Growth of Blockchain-based Emerging

After reflecting on fundamentals such as the definition and practical insights on working of tokenization, it is important to find the reasons for its growth. Here are some of the crucial reasons which can help you find answers to ‘what is the purpose of tokenization?’ in simple words. 

  • Operational Efficiency

One of the foremost benefits of tokenization blockchain applications is operational efficiency. Tokens enable streamlining of IT systems and infrastructure sharing among participants without any central third party. As a result, it can reduce transaction costs considerably. 

Furthermore, automation of manual work and reducing a portion of compliance or reconciliation process could also reduce inefficiencies. In addition, tokenizing assets helps in automation of simple sending or receiving transaction settlements and clearance, thereby ensuring faster transactions. As a result, you can achieve overall efficiency improvements in management of a single transaction.

Also Check: Asset Tokenization On The Blockchain – A Complete Guide

  • Assets Divisibility

The conversion of assets into fractions while also ensuring ownership of fractions of assets allows better prospects for liquidity. The reduced barriers to investment in assets could encourage more people to invest in assets. Tokenization algorithms could help sellers in traditionally illiquid markets for carrying out a transaction. 

At the same time, tokens can also showcase prolific support for inclusive finance. Without any intermediary function, investors could access investment opportunities that would have been conventionally impossible on the grounds of high minimum investment thresholds or infrastructure and geographical reasons. 

With tokenization blockchain applications, the investor’s location could not affect access to financial markets and a range of new types of assets. Interestingly, investment in assets could become simpler with considerable reductions in minimum capital requirements by leveraging tokens. 

The divisibility of assets could also enable the concept of shared ownership. In the model of shared ownership, multiple people could purchase an asset together and use it. Such type of concept of dividing ownership is crucial in times where usage is taking the limelight from ownership. For example, few people can purchase a vacation house together with agreements on who will use the house each week. 

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  • Transparency

If anybody asks you, ‘what is the purpose of tokenization?’ you can easily refer to transparency as one of the answers. Blockchain offers the benefit of transparency by default, and all transactions on a blockchain network are accessible to all network participants. 

In the case of physical assets, the value of transparency allows better traceability while improving trust over origins and ownership of the asset. Therefore, tokenization can serve exceptional benefits in easier identification of ownership of a specific asset and the related chain of ownership. 

However, the applications of tokenization in blockchain do not come with complete assurance of transparency. In the case of many industries, transparency is not systematically acceptable in certain use cases. For example, transparency is a tricky concept in the asset management industry and in cases where competitors share the same infrastructure. The plausible solution in these cases would refer to the introduction of privacy-enhancing technologies for avoiding exposure to sensitive information. 

  • Single Source of Truth

The next important aspect in validating the growth of tokenization blockchain applications would refer to a single source of truth. Organizations collect a considerable amount of data for every asset. However, mapping and interlinking data points like intellectual property rights, licenses, product ownership and rights to specific products are difficult. As a result, multiple fragmented data points regarding an asset can create avoidable circumstances. 

With the help of a tokenization algorithm, blockchain brings in a single layer of trust. The layer of trust can enable business partners or competitors to share their data collectively. As a result, multiple participants in an ecosystem could find ease of interaction with a singular digital representation of a concerned asset. Subsequently, it can improve efficiency throughout the value chain alongside introducing new approaches for collaboration. 

The examples of multiple initiatives in the trade finance industry show the capabilities of tokenization to serve a single source of truth. The initiatives have been focusing on empowering companies for sharing information regarding an asset that is transferred worldwide. Tokenized assets could also support automation and simplification of the process of high volume trading by leveraging smart contracts.  

If you are new to smart contracts, you might not be sure of its capability. This article will try to clear all your confusions by sharing the best Smart Contract Use Cases out there.

Example of Tokenization

One of the most important questions in an introductory discussion on tokenized assets would obviously be ‘what is an example of tokenization?’ with a really obvious answer. Have you heard of NFTs? A $69 million NFT sale by digital artist Beeple caught the attention of the world for all the right reasons. 

Now, the world is discussing prospects of using tokenization as a vital instrument for transforming the conventional precedents of asset ownership and management. NFTs or non-fungible tokens help digital artists in transforming their works into digital tokens, which they could sell in auctions. Apart from NFTs, tokenization also finds applications in many other innovative use cases such as tokenized precious metals. 

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Final Words

The value advantages for enterprises opting to tokenize their assets are prolific reasons for driving the growth of digital tokens. With a detailed understanding of what tokenization actually means and how it works, one could clearly estimate the foundation for its benefits. Enterprises can get transparency for better traceability of physical products, streamlined IT processes and automated tasks. 

Most important of all, individual users could also find exceptional benefits from digital blockchain-based tokens. For example, people could have a stake of ownership in assets that were conventionally inaccessible to them due to capital requirements. The key to understanding the true potential of tokenized assets always starts with a detailed overview of the concept itself. Start exploring more information about the world of blockchain tokens right now!   

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The post Everything You Need to Know About Tokenization appeared first on 101 Blockchains.

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Author: Diego Geroni

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