Tokenization & Securitization: Fundamentally Different or Practically the Same? (Part I)

What is Asset Tokenization?

In our previous articles, we have envisioned the scenarios where the ownership of tangible and intangible assets can be fractionalized into thousands of digital tokens, with each token representing a tradable share of the underlying asset. The information of the fractional ownership is subsequently stored on blockchain, a public ledger that is immutable, such that the fractional ownership, however minute, is stored permanently and cannot be altered or erased. Ideally, the new “token economy” is destined to disrupt the entire financial industry, and offer the potential for a ground-breaking infrastructure that aims to reduce friction and costs involved in the creation, buying, and selling of assets and securities. We mentioned sporadically the benefits of asset tokenization in our cheatsheet series, but here is a brief recap. According to the research conducted by Deloitte, there are four key advantages that tokenization provides for both investors and sellers.

• Greater Liquidity

Asset tokenization, especially the tokenization of private securities or illiquid assets such as artworks or precious metal, opens up investment opportunities to a broader base of investors and enables the trading of such assets on a secondary market. With more traders venturing into traditionally exclusive market, liquidity increases, and in turn grants more freedom and opportunities to the investors, who can then capture greater value from the underlying asset.

• Faster and Cheaper Transactions

The transaction of tokens is completed on-chain through smart contracts. Smart contracts are computer algorithms input into a blockchain that follow a set of pre-defined terms of agreement settled between the parties involved. Smart contracts are autonomous and will execute automatically to produce the necessary output once they have detected and verified that the prerequisite conditions are met. The automated process can reduce the risk of fraud and embezzlement, in addition to removing the administrative burden involved in buying and selling. With fewer intermediaries, deal execution can be significantly improved with lower transaction fees.

• More Transparency

Asset tokenization offers an unrivalled level of transparency by leveraging on the characteristics of blockchain, including decentralization, immutability and traceability. The immutable record of ownership is stored permanently on-chain, together with a track record of past transactions, allowing both parties to acquire necessary information before making an informed decision. Some tokens have the feature of embedding token holder’s rights and responsibilities onto the tokens. With crucial information made available to all, investors will be able to stay informed of whom they are dealing with and other relevant data and background information.

• More Accessibility

Most importantly, asset tokenization can open up investment in private and niche asset classes to a much wider audience as minimum investment amounts are greatly reduced. With lowered barriers to entry, investors can actively participate in asset investment at a fraction of the original cost. Moreover, higher liquidity can also reduce the minimum investment periods since the transaction and exchange of tokens take place on a blockchain-based platform that transcends geographical boundaries and is theoretically 24/7.

By simply listing the benefits of asset tokenization, it is quite apparent that the key to revolutionize the financial industry is achieving high liquidity. Sounds familiar? It is not entirely wrong to claim that history indeed repeats itself, in the cyclical process of rehashing ideas that first emerge, then being negated, and eventually uprise, repackaged with dazzling buzzwords of the new era, in a brand-new dialectic way. Specifically, “pouring liquidity into all assets” is not exactly a new concept. A case in point is the securitization of assets that triggered a chain reaction which eventually led to the financial crisis of 2007 and 2008.

So What is Asset Securitization?

Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, credit card debt obligations, or other non-debt assets which generate receivables, and selling their related cash flows to third party investors as securities. Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. In simpler words, securitization is about repackaging mortgages and other assets into profitable financial instruments.

Based on definitions alone, asset securitization and tokenization share rather similar fundamental concepts. In Part I of this article, we have attempted to lay the groundwork for our comparative discussion on asset tokenization and securitization in the second part of this article. So stay tuned!

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