Tokenization — What’s it good for?
A different view
This article aims to provide a look behind the curtain with regard to the increasing popularity of tokenization platforms which offers the tokenization of a huge variety of assets by using smart contracts and blockchain or distributed ledger technology (DLT) . Thereby, it shall be seen as contribution to foster the discussion about tokenization in the blockchain\DLT community. In this article I try to shed some light upon the phenomenon of tokenization.
From a technological perspective, digitisation and tokenization seem to allow the creation of digital representations of almost every kind of asset (often referred to as “token” or “crypto-asset”). Moreover, tokenization based on a Blockchain or DLT environment could provide additional benefits because this underlying technology offers among others a transfer function to settle a token across a high number of users without a trusted third party.
Firstly, one may note that most of the tokens created by the newly emerged tokenization platforms are still digital representations of already existing assets (such as securities, real estate, paintings, commodities or diamonds) [for the concept of tokenisation and the digital representation of already existing assets please see Demystifying the phenomenon of STOs (Security Token Offerings) in Germany].
While it makes perfectly sense from a business perspective to build on the beginning of the life-cycle of a crypto-asset trough tokenization (independently from the specific type of asset) it seems that many of the current tokenization platforms only provide tokenization as issuance service for the digital representation of traditional assets.[1] In doing so, these fintech companies engage in competition to traditional player such as operators of stock exchanges which are trying to expand their range of traded products or adapting new technologies.
As a result, the prospects to establish new additional business cases remain limited to trading platforms, information services or custody services for these crypto-assets.
Let’s take a look behind the curtain.
As an experiment, we are tokenising a car which leads to 12 fractions (each 0.083) of this car. Furthermore, the designated use of this car is to drive one or more persons from A to B.
To allow trading of these fractions we have to ensure that each of these fractions is fungible. As a consequence, we cannot link specific physical components of the car to a corresponding token (e.g. a tyre, engine or steering wheel) which at least would potentially enable a holder to claim ownership of this specific component of the car. Insofar, each holder of a token may only claim fractional ownership of the digitally represented car.
What’s it good for? — The next chapter brings up additional questions to take different aspects into account and which could be helpful to streamline the evolution of tokenization.
a) Is the holder of a token able to enforce its right to use the car as foreseen by its designated use?
b) Is the holder of a token able the make use of other parts of the car?
c) Is the holder of a token in a position to determine or specify a single physical part of the car as his\her own?
d) Is the holder of a token the legal owner of the car which is digitally represented as token?
I guess the answer to all these questions is currently “no”.
Moreover, this principle generally applies to all kind of digitally represented physical assets.
In addition, to ensure that a token represents a physical asset or a fraction thereof, it would require a permanent irrevocable link to this specific asset (e.g. ID number, QR-code) to provide evidence of ownership.
What remains is the potential tradeability of the tokens as kind of investment if a price increase is expected by others. Usually, only this situation would lead to increased liquidity in the token.
To address the aforementioned concerns an “issuer” of a token might only create additional benefits for the holder by adding additional financial rights. Guess what?— Beside the underlying technology, this type of token looks familiar to financial instruments we already have in traditional financial markets for years.
Conclusion: Since many of the created tokens solely replicate (fully or partially) a traditional financial instrument tokenization often does not approach the business sector of the digitally represented physical asset directly but rather the financial market. As a consequence these tokens do no longer act as record of ownership (or digital representation) of the physical asset. Instead, this type of token could be seen as crypto-asset for investment purposes (similar to traditional financial claims\instruments) without providing new significant benefits for the originally related business sector. From a business perspective, tokenization platforms restrict themselves to advantages arising from the implementation of blockchain\DLT.
At the same time, there are great opportunities to review currently existing business processes or legal frameworks for record keeping and\or transfer of ownership of the underlying physical assets and to consider reasonable steps to adopt and support innovative technological solutions offered by blockchain or DLT.
To also indicate where tokenization opens chances in digitisation by using blockchain\DLT, a perfect example would be micropayments as fractions of a means of payment. This approach would accelerate the evolution of Internet of Things (IoT) and Industry 4.0 because it facilitates the digital interaction such as machine-to-machine payments.
With regard to the above mentioned experiment, DLT could be used for the digital representation of ownership of a car as a replacement for the vehicle registration document (in paper form). This might be an promising approach for each of us but from a business perspective especially in a digitised management for a) leasing arrangements or b) pledged cars in relation to car loans. In this example, a car already has an unique identification number which could be used for the digital representation of the car.
[1] Please note that this article aims by no means to judge about the economic success of the company, the project nor the business model of the tokenisation platforms.
Disclaimer: For the avoidance of doubt, the views expressed are those of the author and not those of the Federal Financial Supervisory Authority (BaFin)
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