What is Tokenization? Everything You Should Know

Within the world of blockchain, the word “token” is part of the general vocabulary, often as part of a discussion about whether any given token should be classified as a security. However, tokenization isn’t a concept borne of blockchain innovations. In fact, digital tokenization pre-dates blockchain by several years. So, what is tokenization?

A Brief History of Tokenization

Physical tokens have long been used to replace real money. Casino chips are one such example, as are banknotes and coins, which denote a legal right of ownership of the underlying currency.

The use of tokens in the digital world came about as a means of replacing sensitive data with a non-sensitive digital equivalent. Digital tokenization was first introduced by TrustCommerce in 2001 as a means of protecting credit card information. Prior to this, merchants would store credit card data on their own servers which meant that anyone with system access could view potentially sensitive information.

The system that TrustCommerce developed replaced the primary account number (PAN) with a randomized number, called a token. When a merchant needed to process a payment, they could reference the token and TrustCommerce would process the payment on their behalf.

This system eliminated the need for merchants to store credit card data themselves, and thus vastly increased the security of cardholder data. Tokenization is non-reversible ­ — it doesn’t matter if hackers intercept the payment details as no account numbers are intelligible from the encrypted token.

Blockchain and Tokenization

While tokenization is a highly useful tool in PCI data security, when combined with blockchain it becomes exponentially more powerful. When a token is issued on a blockchain, the blockchain records the issuance and maintains a ledger of every single movement of that token.

A critical feature of blockchain with regards to tokens is that it overcomes the “double-spend” problem. Before blockchain, any digital asset such as an image, or document, could be copied an infinite number of times by anyone with access to it. Consider an email trail with an attachment — everyone on the email trail has their own copy of that attachment.

The creation of Bitcoin overcame this issue by using a distributed ledger to keep a permanent, immutable record of Bitcoin transactions. Each Bitcoin is a token, and every time a Bitcoin transaction takes place, the ledger is updated to reflect the spend. Thus, no Bitcoin can be spent twice.

Overcoming the double-spend problem now means that with blockchain, digital tokens can be used in a similar way to casino chips or banknotes.

Asset Tokenization

Bitcoin and other cryptocurrencies enable the trading and exchange of digital tokens as assets by themselves. A cryptocurrency is used as a store of value or as a medium of payment. In this sense, the digital token of a cryptocurrency is itself, an asset.

However, asset tokenization of real-world assets is the next evolution in tokenization. Tokenizing an asset involves issuing a digital token on a blockchain, whereby that token represents an underlying tangible or intangible asset. In this way, the economic value of the asset is conferred to the token. Ownership of the asset is represented by ownership of the token on the blockchain.

Because there is virtually no limit to which assets can be tokenized, tokenization of assets on the blockchain offers compelling and far-reaching implications across many industry sectors. It’s already possible to trade digital assets representing underlying financial instruments such as commodities, futures or stocks. Supply chains are using digital tokens to manage the movement of goods.

Benefits of Asset Tokenization

There are several reasons that asset tokenization is becoming so popular. A valuable and physically indivisible asset such as fine art or real estate could be represented by multiple tokens, enabling fractional ownership.

Tokenization also opens up these markets to new pools of investors. For example, a recent graduate may be unable to take advantage of a booming real estate market due to student loan debts. By the time the debts are paid, the graduate is priced out of the market.

However, imagine that they could purchase tokens representing fractional ownership of a piece of real estate, which appreciate in line with the increasing market value. These tokens could in turn raise sufficient funds for a down payment on a home a few years later.

As well as opening up new avenues for investment, tokenization creates new liquidity in markets for real-world assets which are traditionally highly illiquid. Transacting in digital tokens is faster and cheaper and may not require an intermediary such as a broker. For this reason, tokenization of financial instruments is making waves in the trade finance sector. The Swiss SIX exchange is among the first to open a fully regulated digital asset exchange during the second half of 2019.

Finally, asset tokenization provides transparency and security. Ownership is indisputably recorded on the blockchain independently of where an asset is stored. Any ownership rights can also be embedded directly into the token, with the possibility of having contractual obligations enshrined into smart contracts which execute automatically.

Takeaway

The full potential of asset tokenization is still unfolding. Perhaps unfairly, blockchain has come under some criticism for acting as little more than a glorified database. However, tokenization elevates the technology far beyond record-keeping, providing a myriad of use cases that will ultimately prove invaluable to enterprises and individuals alike.

This article is brought to you by CoreLedger.

As a prominent blockchain infrastructure provider, CoreLedger is making blockchain technology simple for businesses to use. With CoreLedger’s offerings, clients can readily tokenize their offerings with fast-to-implement resources that will allow them to modernize their services. Thanks to our in-house developed software solutions and experienced blockchain specialists, CoreLedger is ready to help you make your next move with blockchain technology.