Lesson 6: Asset tokenisation, the crypto machine gets going
Tokenising involves representing and transforming a physical, financial or intellectual asset into a digital file. We look at one of the most promising uses of blockchain technology, such as its role in raising funds for projects in the real economy or issuing bonds and shares.
What exactly is a token?
The fact is tokens are nothing new. Humankind has always resorted to some type of value unit to do business and for trading purposes. However the digital token has taken on an important role since the creation of blockchain technology and the emergence of the crypto ecosystem.
In essence, a digital token is a code the content of which grants someone a particular right. This right may refer to the ownership of an asset, access to a good or service or to the making or receiving of a payment. Indeed, its characteristic exchangeability enables it to work somewhat like money, representing as it does any negotiable asset.
Accordingly, tokenisation involves the transformation and representation of an asset or real object into a digital file that is inserted into a block on a blockchain. Once recorded, the token can be negotiated or filed away. Hypothetically, tokenisation can refer to absolutely anything: real property, a work of art or a financial asset. Its extreme versatility goes some way to explaining why the tokenisation sector is booming.
Let’s have a look at asset tokenisation
Asset tokenisation is a process through which a physical or financial asset is transformed into a token, in other words, into a digital representation of its value. Representation of the ownership rights of a particular asset is brought about by creating a smart contract that establishes the rules for managing and distributing tokens.
Courtesy of the blockchain, the aforementioned tokens represent assets and items that are, by definition, unique, irreplaceable and cannot be interchanged. Moreover, they can be stored or traded freely and securely. Asset tokenisation is based on what is known as Distributed Ledger Technology (DLT), which is the protocol behind a decentralised database that is administered by several participants. As it is decentralised, there is no central supervising authority involved.
Payments in the future
Great cost effectiveness, higher returns, speed and transparency are just some of the benefits of tokenisation. As is the more inclusive participation of market investors, which generates greater liquidity. Indeed, tokenisation is a method of splitting that enables more people to hold an interest in part of an asset, which otherwise would have been sold whole and at a higher price.
Tokenised assets can be:
- Native: such as, for example, cryptocurrencies like Bitcoin, because they were created inside the blockchain technology. Initial Coin Offers (ICOs), which refer to initiatives aimed at funding a blockchain based project in the development phase; they also generate native tokens.
- Off-the-chain: these are securities’ tokens (like shares and bonds), raw materials (like gold) and other physical or intellectual assets (like property, works of art or patents), the value of which is backed by a physical commodity.
Fiat money issued by central banks (dollar, euro, sterling, yuan, etc.) can also be tokenised. In this case we are dealing with what is called a fiat pegged token, in other words, the digital representation of a fiat currency, the value of which is linked to the traditional currency.
This is one of the cases of what are known as stablecoins, which are digital coins the value of which is linked to another medium of exchange considered to be stable. There are around a hundred of these, which are classified into three types: those backed by fiat currencies (but they may also be backed by gold, oil or even property), by other cryptocurrencies and non-backed ones (algorithmic stablecoins).
- In the case of fiat currency backed stablecoins (e.g., the dollar), the issuer must offer reserves in dollars for the same value as a guarantee (USD Coin, Tether, TrustToken or Gemini Dollar)
- Cryptocurrency backed stablecoins are highly volatile and may require a relatively large amount of cryptocurrencies as a reserve to issue even a small number of tokens (MakerDAO, Synthetix, Reserve)
- Algorithmic stablecoin stability is based on a consensus mechanism to determine if token supply should be increased or cut down as necessary, thereby functioning like a central bank (Terra, Frax, Fei USD)
NFTs are digital content that represent real world objects, like works of art, music, games and any sort of collection. Popularly referred to by their acronym, these non-fungible tokens indicate something that cannot be replaced. For instance, a cryptocurrency can be changed for another asset, whereas a work of art is unique and, as such, non-fungible. The block chain is used to buy an NFT, which is tied to a smart contract that attests to the purchasing transaction.