Asset tokenization is disrupting the financial industry already. It’s an emerging trend, with recent origins in unique use cases for blockchain technology, but one which is predicted to account for up to $27 trillion by 2027.
What is asset tokenization?
Asset tokenization is the process of creating tokens that stand in for a specific fraction of the value of an asset. Rather than buying shares in a company that owns the asset, it’s now possible for investors to purchase direct, fractional ownership of the asset. That has several major advantages.
Why tokenize assets?
Assets are tokenized to allow multiple purchasers access to an asset whose price would otherwise be unaffordably high. Imagine selling this:
This painting, Les femmes d’Alger, by Pablo Picasso, sold for $179.4m in 2015. Finding another buyer with the money to purchase it directly — should its new owner, former Qatari prime minister Hamad bin Assim bin Jabber Al Thami, wish to part company with it — would be difficult. The potential market, of investors and HNWIs, is small.
Alternatively, imagine you own an apartment whose value is $100,000. That doesn’t place you in Al Thami’s league, but you still own an asset. What should you do if you need to make $10,000 quickly? You can’t sell a tenth of an apartment. There’s no simple, practical way to handle this without involving banks or other firms whose fees will eat into the modest sum you aim to realize. This is the same problem as our Picasso — just the other side of the coin. The value of assets is real but they are not portable, can’t be traded easily and can’t be broken down into parts.
The tokenization solution is to sell shares of ownership in the asset, not as share certificates (themselves assets), but as fungible tokens that can be exchanged, bought and sold. The only way to do this is on the blockchain.
Tokenization allows investment by higher numbers of smaller investors, resulting in a larger market and more sales without reducing prices.
How does asset tokenization work?
Some assets lend themselves to being broken down into smaller fractions. In the case of cash, the owner of $1m can break that sum in any way she pleases, spending it $1 at a time. In the case of traditional investment vehicles like shares, the situation is less clear: while shares are intended to act as tokens of fractional ownership of a company, a single Berkshire Hathaway share trades at $308,000 — a sum at least large enough to be unwieldy. Other assets — a Picasso, a building — can’t be broken down in a traditional way, piece by piece.
On the blockchain, it’s possible to create tokens that represent anything. These tokens can then be bought and subsequently used as coins, traded on exchanges instantly for other assets and immediately transmitting their value to the new purchaser. This is an entirely different process from buying and selling share certificates which requires third-party oversight and is both time-consuming and complex in comparison.
To tokenize an asset, you create and issue tokens that represent ownership in that asset. (If you create tokens that represent ownership of value the asset will create in the future — apples from your orchard, say — be careful: you could be dealing in securities!) Rather than stablecoins which are tied to asset value but don’t represent ownership in the asset, these tokens actually confer ownership. If our apartment owner from earlier created 100,000 MyApartments, each conferring 0.001% ownership in her apartment, she could sell 10,000 to realize $10,000 and retain the remainder.
In technical terms, assets are usually tokenized using a custom digital token on the ERC20 model, which uses smart contracts on the Ethereum blockchain to create tokens:
How much is an asset token worth?
Initially, an asset token is worth the percentage it represents of the total value of the asset. If we look at our hypothetical apartment owner again, we can see that each MyApartment token is worth $1 — 0.001% of the value of her apartment.
However, what happens if she sells 10,000 tokens, which are then traded openly on exchanges? Now the price of the tokens — and thus the value of her apartment — is on the market. The 10% share of her apartment’s value which our owner has sold via tokens may rise or fall in value as the tokens are traded freely on an exchange, or on multiple exchanges using
While in theory this could lead to price volatility and create a secondary market in speculation on these tokens, the actual result is more likely to be that the price of each MyApartment hovers around the $1 mark, and changes only as the market value of the asset itself is seen to change.
For asset owners, there’s the possibility to realize gains by selling the asset in whole or partly, and using the money so gained to rejuvenate the asset. Imagine selling shares in a building which is too expensive to sell to individuals but which is economically unproductive: the money generated by partial sale of the building by token sale could be used to make the building more inviting to businesses, raising the value of the asset itself. This increase in the asset’s value would also raise the value of the tokens representing fractional ownership, providing an incentive for investment.
Tokenized Asset Offerings and Tokenization as a Service
Token and coin offerings are partial analogues of asset tokenization, in that they allow larger numbers of smaller investors to involve themselves in funding new companies and provide those companies with a larger market. However, the tokens in ICOs typically don’t represent direct ownership in an asset. Instead, they represent shares in the company (rather than its assets), or shares in the future products or profits of the company but not equity.
Tokenized Asset Offerings (TAOs) operate in a similar way to ICOs, but the tokens they offer do represent direct fractional ownership of a real-world asset. While this is little help to start-ups whose only asset is future promise, it does allow companies to leverage the equity in their assets without offering equity in the company and without entering the tightly-regulated securities market. For investors, TAOs offer a different kind of security: investors don’t have to believe that a company really has a marketable idea, or that its coins will one day be worth something — only that its assets are real and accurately valued, something which can be easily checked during due diligence.
Tokenization as a Service consists of operating tokenization and TAOs, performing the technical process of creating tokens on clients’ behalf and — in some cases — also performing marketing and PR to promote a successful TAO.
Asset tokenization use cases
The three main use cases for tokenization are fungibility, divisibility and responsiveness. Fungibility is the capacity to be traded: money is fungible, gems are somewhat fungible, a property portfolio is very infungible. Divisibility is obvious: can the asset be divided and sold or traded in separate portions? Gold and cash can, but art cannot: what’s the value of 1% of the Mona Lisa? Finally, responsiveness: in markets where the physical assets are typically held apart from the market and deals are made on futures, securities or deeds, how quickly can this be done? In cases where the proof of ownership relies on physical paperwork in multiple locations around the world, the answer is usually ‘too slow to be satisfactory.’
Thus, there are three major markets which tokenization is likely to enter first: real estate, art and precious metals.
Real estate is a prime candidate for tokenization, and was one of the earliest asset classes to be tokenized. In October of 2018, digital assets firm Propellr and blockchain tokenization company Fluidity joined forces to tokenize a $30m new-build Manhattan apartment block on the Ethereum blockchain. The ensuing token sale was pronounced satisfactory by real estate author Ryan Serhant, the listing broker on the deal, who observed that ‘the market in New York is always strong, but it can take some time to sell for the right price in a new construction building,’ adding that ‘tokenization is paving the way for a new forefront in real estate development.’
In 2019, Invenium Investment Partners (ICP) announced plans to tokenize $260m worth of real estate assets in four separate deals carried out through Dutch auction and requiring that investors hold at least $10m in digital assets to participate. Templum, a regulated token sale platform, carried out a token sale on behalf of a Colorado ski resort in 2018. Real estate tokenization may change the whole way real estate is owned and traded.
It could have a similar effect on the art market; last year, Andy Warhol’s 14 Small Electric Chairs was tokenized by the London art gallery that owns it, and partly sold. And bullion is beginning its tokenization journey too. In October of 2019, Australian tech firm InfiniGold announced a plan to launch a token representing gold held by the Perth Mint. ‘With The Perth Mint as custodian of the underlying physical gold that backs PMGT, buyers will be able to access a secure and reliable token representing the strongest asset class to date — gold,’ said InfiniGold CEO Andreas Ruf.
Asset tokenization works to enable more investors to get involved in the purchase of high-value items, creating opportunities for investors, owners and exchanges as well as custodians and other financial experts with built-in incentives. Thus, we expect to see the space grow as its benefits are more widely recognized and an ecosystem develops to accommodate asset owners who lack their own infrastructure, with tokenization eventually becoming among the more reliable value sources for digital assets.