Asset tokenization: What is it and why does it matter?

The future of value storage — Chapter#1

PREFACE

The digital era has profoundly disrupted our economy. From hospitality to entertainment, numerous industries have seen their foundations shaken and consumer patterns, production, sales and marketing strategies entirely redefined.

The financial sector has, however, only partly benefited from this revolution. Main impact is almost limited to the way actors operate and communicate leaving many frictions and inefficiencies unaddressed, and the full potential of the trading and investment markets, unexploited.

The turning point for this situation was the outset of the blockchain technology in 2008. By enabling borderless and disintermediated value exchanges, and supporting fractional ownership and trading anywhere and any time, the tokenization of the economy — through the blockchain technology — gathers the ingredients to disrupt our financial system and make it more efficient, accessible and democratic.

“Finance hasn’t gone through fundamental revolutions. At best, one can argue that most trades today take place electronically and financial infrastructure uses the internet to communicate; However, it has not been transformed at its most critical point: the creation of new instruments, contracts and agreements”

Johannes Höhener, Head of Fintech, Swisscom Digital Business

The objective of this article is to deep dive into one of the fundamental use cases of the blockchain technology applied to the financial sector: the digitization of assets. From the very essential aspects of asset management, to the ins and outs of asset tokenization, this paper exposes the reasons why — far beyond cryptocurrencies — digital assets have the potential to redefine the notion of valuable asset and foster a more efficient, inclusive and sustainable marketplace.

THE PRESENT OF VALUE MANAGEMENT

In its purest definition, an asset is a valuable resource owned by someone or something which represents a good (e.g., land, patent) or contractual agreement (e.g., financial instruments, such as cash, stocks, equity, bonds or derivatives), and which can be used as means of exchange or investment.

Despite all valuable assets being worth considering for trading and investing, our economy only qualifies the most liquid ones — those which can be easily converted into cash, are easily accessible and present lower transaction costs — as ‘bankable’. As a result, assets such as land, real state, fine art or gemstones, which cumulate to trillions of euros, are left out of the market, making it difficult for mainstream investors to access them, and holding up the size and potential of the marketplace.

Furthermore, this marketplace is subject to inter-operational inefficiencies which remain unaddressed. Obstacles like operational frictions (e.g., excessive intermediation) or territorial barriers (e.g., diversity of jurisdictions, time zones) prevent buyers and sellers to connect and exchange anywhere, at any time.

We do acknowledge that globalization and innovation have transformed the financial sector and boosted efficiency and trading volumes to levels never seen before. However, with an enormous amount of assets unexploited, and numerous standing barriers to trading, there is much room for the capital markets to still develop and generate value for all its stakeholders.

Unlocking the capital market’s potential means enabling individuals to trade with any valuable asset, anywhere and anytime in a reliable and swift manner. To do so, the economy requires a framework which allows to generate and exchange ownership rights in a formal yet agile manner. The catalyst? The digitization of assets through tokenization and management in the blockchain.

WHAT DOES IT MEAN TO TOKENIZE AN ASSET?

Tokenization is a method that converts rights to a tradable asset into a digital token that is represented and managed in the blockchain — or more generally some form of distributed ledger. Tokenized assets are commonly referred to as digital assets or crypto-assets.

Asset tokenization does not only allow to digitize an asset (inclusive those currently considered non-bankable), but also to fractionalize its value so that an arbitrary number of (sub-)tokens, acting as shares, can be purchased, traded and settled in the blockchain. This is the so-called fractional ownership, and it allows unrelated investors to generate, buy or sell shares from any valuable asset, including traditionally illiquid ones such as real state, land, artwork, aircrafts, patents, etc.

“Digital assets are the financial instruments of the future. They are tradeable on a more granular basis and enable more differentiated portfolios”

Johannes Höhener, Head of Fintech, Swisscom Digital Business.

The implications of asset tokenization are vast. On the one hand, fractional ownership boosts liquidity by making bankable and non-bankable assets accessible to a much broader pool of investors, increasing secondary markets’ trading volumes, as well as liquidity premiums for sellers. On the other hand, relying on blockchain technology means benefiting from the immutability, transparency and efficiency properties of the distributed ledgers.

WHICH ASSETS CAN BE TOKENIZED AND HOW?

Effectively, any valuable asset (tangible or not; real or financial instrument) can be tokenized. The resulting digital asset can be considered a coin (or cryptocurrency, which serves as mediums of payment) or a token (digital representation of a tradable asset or utility).

Among the main tokenizable assets we can distinguish:

• Blockchain native currencies: referred to as cryptocurrencies and which are used as means of payment within a blockchain network (e.g., Bitcoin).
• Government issued currencies: CBDC or Central Bank Digital Currencies, which are a digital form of fiat money issued by a government or its affiliates, subject to the state’s legal, regulatory and monetary policy framework.
• Securities: Security tokens are blockchain native digital bonds, equities, derivatives and other securities which draw their value from an external, tradable financial assets and are subject to the state’s security laws and regulations. Securities are issued through STOs (Security Token Offering).
• Commodities: Asset-backed tokens which represent digitized commodities such as gold, power, gas, diamonds, etc. Differently to securities, they are normally not subject to securities’ regulations.
• Access or usage rights: Utility tokens are programmable blockchain assets that provide users with future access to a product or service. Utility tokens are generally not designed as investments but rather function as tickets that enable certain user rights and are generally issued through ICOs (Initial Coin Offerings).
• Platform incentives: Platform or Protocol tokens are on-chain valuables designed to incentivize and support the execution of operations of decentralized applications; they are generally issued through ICOs (Initial Coin Offerings).
• Information: such as healthcare records, intellectual property or titles.
• Contracts: The blockchain technology supports the so-called, smart-contracts, which essentially act as self-executing contractual agreements. (ex. Escrow, notarization, etc.).
• Collectibles: Crypto-collectibles are digital collectibles that can be exchanged for money.

“Tokenization is essential to create much more granular assets than traditional assets: from a denomination view, the administrative burden is reduced as everything is automated. From a content side, tokens will enable more granular business rules”

Philippe Meyer, Head of Innovation, Avaloq

*Terminology and taxonomy for digital assets still in standardization process and therefore, subject to change.

CONCLUSION by METACO CEO, Adrien Treccani

A decade after the creation of Bitcoin — the first fully distributed ledger and peer-to-peer payment system — the financial sector seems to have reached a consensus on the opportunities provided by a more transparent, accessible, flexible, robust and cost-efficient infrastructure as promised by distributed ledgers. Beyond cryptocurrencies, which have shown to bear unique statistical properties and to provide a valuable hedge in diversified portfolios, the underlying technology is now expected to revolutionize the way assets are stored, represented, and moved. The trend has started with multiple of the largest infrastructure providers globally committed to this evolution: it is now only a matter of time until the tokenized economy becomes part of our habits and integrates our lives.

This article is property of METACO SA. The information contained herein is of general nature and not intended to address the circumstances of any particular entity. This paper represents the opinions of the authors, and is the product of professional research.

Author:

Lourdes Monso, Marketing and Communications Manager, METACO SA

Contributors:

• Adrien Treccani, CEO, METACO SA
• Johannes Höhener, Head of Fintech, Swisscom Digital Business.
• Philippe Meyer, Head of Innovation, Avaloq

Main sources:

• Institutionalization of cryptoassets-KPMG United States, 2018
• The token classification framework-Untitled INC,2018
• The tokenization of assets is disrupting the financial industry. Are you ready?- Deloitte, Inside magazine, 2018