How tokenization can revolutionize finance and its barriers to adoption
How tokenization can revolutionize finance and its barriers to adoption
By Kai Ren and Zakie Twainy
Tokenization has the power to revolutionize the financial landscape‒intrinsically changing how investments are managed, used and monetized. The process of tokenization facilitates the creation of a multitude of new financial products, allowing every person and organization in the world to diversify their portfolio of investments on a global scale, regardless of income or size.
Let’s look at an example scenario that highlights the power of tokenization. A middle-class woman named Ms. Ganbold in Ulaanbaatar, Mongolia, makes the average income in the city, which is approximately $400 USD1 per month, and she would like to invest in Manhattan real estate, where prices nearly doubled in the 2010s.2
With traditional financial products, this would be extremely challenging considering the usual initial capital investment, if not a near impossibility. However, with tokenization, fractionalization—the division of an asset class into portions that are smaller than the whole3—opens the door of opportunity for Ms. Ganbold.
Tokenization of assets involves the process of digitally representing real, physical assets on distributed ledgers, or issuing traditional asset classes in tokenised form.4 Within the context of blockchain technology, tokenization is the process of converting something of value into a digital token that’s usable on a blockchain application and a token represents a share of ownership in the underlying asset. This process can work for tangible assets like gold, real estate, debt, bonds, and art, or certain forms of intangible assets such as ownership rights or content licensing.5 What is even more exciting is that tokenization allows for transforming ownerships such that traditionally indivisible assets can be fractionalized into token forms.6
The owner tokenizes his apartment at a value of $900,000, into a total of 90,000 tokens, with each token amounting to almost 0.001% of the apartment’s value. In addition, with a contract, he ensures selling the apartment within 10 years or when the market value is at least 50% higher, whichever comes first.7 With each token at $10 USD, investing in Manhattan real estate now becomes a possibility for Mrs. Ganbold, despite her level of income. Unlike traditional ownership rights, the apartment tokens would be just an investment, and she would not be able to use or live in the apartment.
Tokenization’s importance stretches far beyond investment access; it could also facilitate new investing models. Currently, most investments leverage shareholder capitalism, striving to optimize profits and share price.8 For example, when you buy a company’s stock, you provide money in exchange for a share, but how the company is run and governed is largely outside of your direct control. Since tokenization leverages smart contracts, it could manage both the financial investment as well as facilitate the voting and/or ownership rights associated with the investment. There is a possibility of incorporating a stakeholder capitalism model,9 a popular management theory in the 1950s and ‘60s that promoted benefits provided to the wider community, not just shareholders.10
With tokenization, is it possible to invest in a company but insist that the CEO be paid no more than 100x the median employee compensation or you automatically reclaim your original investment? (Currently, in the United States, the average is 274x that of the median employee.11) Or could one invest in cutting-edge technology—computer vision, for example —and make the investment contingent on the fact that the owner could never sell the intellectual property to a company in the defense industry?
Beyond this, with tokenization, the transactions of digitally native assets are stored and listed on a digital ledger on a blockchain network giving one golden standard of truth across the globe. Further, the process of leveraging smart contracts permanently records transactions and makes them immutable and instantly executed.12 This not only provides speed in transactions, but also reduces administrative work as there are fewer intermediaries, lowering costs.13
While tokenization provides a wealth of opportunities to transform the marketplace, there are challenges.
First, there is an absence of consistent regulation across the spectrum of tokenization. In order to achieve wider adoption, there would need to be a global taxonomy (i.e., definition of token); stronger legal framework; regulatory framework (i.e., roles and procedures in digital asset value chain), and supervisory framework (i.e., developing consistent regulatory frameworks, as well as who should supervise and how.) These challenges combined with the borderless nature of blockchain, create challenges for the widescale adoption of tokenization.
Secondly, there are barriers to production grade solutions and scale. The value of tokenization is driven by a network effect—the utility of the technology increases for a user, the more it scales and is adopted. However, incentives do not currently exist to create a network effect.14 This creates a lack of synchronicity among large market players, resulting in fragmented markets that reduce liquidity. While consortia have attempted to solve this problem, they have run into execution challenges, such as IP ownership, and in some cases limited benefit for large players to give access to smaller fintechs and other emerging technology companies in the market.
Beyond this, there are issues with security; blockchain applications have encountered cyber security issues and attacks. Also, the technologies to create, manage and secure tokenization are relatively nascent. Hence there is a need for infrastructure to bridge tokenization easily with legacy systems to ensure a smooth onboarding and management of the assets.15
Despite all the challenges, several tokenization projects have been launching globally in different industries, advancing the wider ecosystem, such as:
Holders of the tokens will be entitled to a percentage of the sale value of any player to the athlete's forming club.22 These examples illustrate how tokenization could help financially support athletes throughout their career journeys.
In review, tokenization could provide:
While tokenization offers a myriad of possibilities, there is still much work to be done in terms of consistent global regulation and development of the production grade solutions necessary to widen adoption. As investment in tokenization technologies continues to increase and the benefits of new assets becomes more evident, financial institutions should begin thinking about what infrastructure is needed to support tokenization, e.g., onboarding, management and integration with legacy systems, in order to be part of finance of the future.
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