How Tokenization is Transforming Crypto World and Global Finance
Tokenization is the trend of the season, one that has been the talk of multiple sectors for a while now. To keep up with the rise in crypto popularity central banks around the world are working on launching their CBDCs (central bank digital currencies).
Word is that there might be a possible digital euro and dollar as well. Starting from start-ups and corporations to governments all are trying to explore their tokenization options through the use of both decentralized and centralized blockchain. No wonder, there is so much interest surrounding tokenization.
However, people are yet to get acquainted with the concept of tokenization and there have been significant queries from financial, regulatory, and technological standpoints. On that note, this blog will delve deeper into the subject, highlighting the ways tokenization is going to affect the crypto and financial sector and the roadblocks in the way to its mass adoption.
Tokenization — What does it Mean?
The process of digitizing the assets and making it available on a distributed ledger is known as tokenization. Blockchain is the underlying technology that powers the process ensuring that all balance and transaction records remain immutable.
Immutability is one of the highlighting features of blockchain. Once data is recorded in the distributed ledger it can neither be tampered nor altered.
The process of tokenization varies depending on the type of asset and the purpose of the token. Whether it will be a centralized or a decentralized blockchain network is also determined by the same factors.
Built on a decentralized architecture allows ownership verification of the token instantly and in a trustless environment. Although it might have compatibility and performance-related issues in certain use cases when integrated with legacy systems. Digital tokens represent the ownership of the asset that they are backed with. It can be handy when one is trying to improve the liquidity, transfer, or exchange it either fully or partly.
Tokenization has found its relevance beyond financial use cases, as it is getting increasingly popular in sectors such as real estate, gaming, art, etc. With a strong standing in the fintech world, tokenization has the prospects of transforming major sectors around the world.
The Advent of Tokenization
Crypto and tokenized asset might have their foundation in blockchain but both are different from each other. In the present scenario, blockchain technology has effectively proven its worth of successful deployments in major sectors. Contrary to that, crypto is yet to reach its mass adoption stage.
While many enthusiasts argue that crypto will replace the fiat in the future, there are significant debate points due to both technological and regulatory constraints related to the processing of transactions.
Tokenization is the grey area in the middle that utilizes the values of both physical assets and cryptos, which has led to its rise in popularity and the experimentation across sectors. Tokens do not necessarily require a high throughput capacity and can be applied on a small scale too privately. Digital assets can exist in both centralized and decentralized environments, opposing the fundamental concept of crypto which is one of the biggest roadblocks in its mainstream adoption.
● Non-Fungible Tokens
Non-fungible tokens or NFTs are probably one of the most popular and successful use cases of tokenization. In the NFT category, each digital asset differs from the other in property and value. It initially gained popularity through collectible virtual games like the Cryptokitties followed by its disruption of the gaming industry. Tokenization has found a great use case within the gaming community. Major gaming platforms at present are collaborating with blockchain and crypto development companies to include NFTs within their gaming model.
Non-fungible tokens are used as a technique to hold ownership of the in-game assets. It allows the exchange of assets outside of the game and through smart contracts as well.
The use of NFTs has addressed the issue of fraudulent transactions, that plagues the gaming arena. The use of non-fungible tokens in the form of in-game assets ensures that funds get released instantly. It fortifies and confirms the ownership of in-game assets even in an unlikely scenario of hacking or server malfunction.
NFT is slowly invading the finance sector as well, with the aim to improve the liquidity of non-liquid assets such as real estate. Using non-fungible tokens as collateral for a mortgage, property owners can raise funds easily and quickly for their real estate investments.
● Security Tokens
Security token offerings or STOs are more like an alternative of Initial Coin Offerings (ICO). ICOs are the crypto counterpart of the initial public offerings, which gained immense popularity as an avenue of equity investment due to its fund-raising abilities. However, a few controversial frauds encounters put ICO in a regulatory fix in the US and that's when STOs came into being.
Security token offerings are tokenized versions of company shares. Blockchain-based STOs have its advantages as it allows a wide array of entities to possess the tokens. On top of that, the fact that security token offerings enable instant settlements adds to its benefits list as the property comes in handy in economic crises when people are seeking liquidity in their assets.
● Stablecoins
Stablecoins are also the result of tokenization and were introduced as a substitute for crypto to tackle the volatile markets. These assets are backed by an equivalent amount of fiat, crypto, or other assets which helps in value from fluctuating too much. Stablecoins utilize the advantages of blockchain technology and safeguards the token from the crypto volatility. Being backed by other commodities and assets it can be redeemed at a 1:1 ratio. Other than NFT, stablecoins are also getting significant exposure across different industries due to its enhanced reliability.
● Crypto-Synthetic Assets
With the advent of tokenization, there has been an increased use of smart contracts and has opened a lot of advantageous avenues in the market. This has led major industry players to collaborate with blockchain companies for smart contract creation and its application in a wide range of operations.
Smart contracts are built on a blockchain platform and can get executed automatically when a consensus is reached among participants. It does not require the interference of any third-party intermediary. They have made the existence of decentralized applications (Dapp) and decentralized finance (DeFi) a reality. Even in the case of NFTs, that it can be exchanged in a trustless environment is possible due to the use of smart contracts.
Crypto based synthetic assets are powered by smart contracts as well. It gives users access to a wide range of assets such as stocks, commodities, etc within the worlds of cryptocurrency. This too acts against the volatility of crypto, giving users a chance to profit more through trading.
● CBDCs and Tokenization of Securities
This is by far the most interesting and experiment, not to mention the hyped tokenization concept that has successfully disrupted the traditional finance system. CBDCs or Central Bank Digital Currencies are gaining a stronghold in both financial and public sectors, with major central banks working on respective or collaborative projects.
Notably, the World Bank recently published a report stating the significance of CBDCs in the global financial future. China is gearing up to launch its digital Yuan any day now, the delay is caused due to the COVID-19 situation. The Dutch Central Bank has shown interest in spearheading research and development of digital Euro, alongside its own domestic CBDC project. Significant talks are revolving around a digital dollar as well. Various other banks are working on collaborative projects to create a unanimous design of the CBDC so that the monetary policies do not go through a drastic alteration.
Other significant institutional use cases of tokenization can be found in Swiss Bank’s upcoming stable coin which will be reportedly backed by the Swiss Franc, the Commonwealth Bank of Australia’s issuance of STO named Bond-I, and the Central Bank of China’s tokenization of 20 billion Chinese yuan worth of bonds.
Commercial banks like the JPMorgan and Signet and Wells Fargo are running their stable coins projects like JPM Coin and Digital Cash. These have been gaining momentum due to its inherent ability to settle payments instantly at a reduced cost.
However, there is one point that needs mentioning here which is the prevalence of centralized blockchain architecture in the institutional applications. Most financial institutions and banks prefer the base of their projects to be centralized and permissioned blockchain as against the fundamental decentralized concept of cryptocurrencies. Although, experts believe that it is a temporary mindset that will change with time.
Tokenization Downsides
Every coin has two sides, so does blockchain-based tokens. There is no denying that tokenization has numerous benefits. It facilitates cross border financial activity, improves the liquidity of assets, reduces the costs of settlement making it instant, minimizes the risk of frauds, allows shared ownership, and a lot more.
However, with upsides come the downsides as well, and tokenization has its flaws too. The success of the ones built on decentralized blockchain is debatable as to its majorly depends on its performance when working with traditional systems. Regulatory compliances still pose a hindrance to mainstream adoption of tokenization as most countries are yet to start working on their laws and regulations.
On a concluding note, tokenization refers to a fundamental shift from the legacy systems, which is bound to take time. The general population and industries need to be convinced of its efficacy and long-term benefits against traditional ways. It’s a work in progress that till now is showing fair results and interest from major sectors and governments. They are collaborating with the leading blockchain and cryptocurrency development companies on important projects which will significantly impact the global financial future.
