As an example, the Internet today runs on a relatively “thin” layer of protocols such as TCP/IP, SMTP, HTTP, and HTTPS. These protocols establish rules for computers across a network to follow in order to communicate effectively.
Thinly traded tokens: Let’s be very clear about this one: the mere act of token generation to represent ownership claims on a traditional asset does not impact liquidity in and of itself. If a token is thinly traded it is still relatively illiquid. Improvement in liquidity comes from increases in market depth, meaning more participants and more trade. The reason tokenization improves liquidity is because it enables deeper markets. Since tokens are highly divisible and global, the potential number of market participants is substantially higher than what we see today in markets for illiquid assets.
How big is the illiquidity discount? Financial economists have attempted to measure the illiquidity discount in a variety of ways. A common rule of thumb is 20–30%. This represents a huge amount of value and therein lies great promise. Tokenizing relatively illiquid assets and creating a market in which to trade these tokens can reduce the illiquidity discount substantially by reducing frictions to trade. Traditional assets will tokenize because they will lose the liquidity premium if they don’t.
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