Tokenizing Loans
What is tokenization?
Coined in late 2017 the term tokenization refers to turning assets into non-fungible stores of value which can be transferred between parties using blockchain.
Tokenization is important because it allows almost anything to be traded securely, transparently and traceably on the blockchain. “Anything?” You ask. Yes. Pretty much anything can be tokenized — from shares in a company to artworks to loans.
How does the tokenization process work?
Tokens fall into three distinct categories:
- Payment tokens like Bitcoin, Stellar Lumens and Ethereum — these are substitutes for a currency provided by a country such as British Pounds or USD and are used to make and receive payments.
- Utility tokens these are intended to allow token owners to access the services of a particular blockchain platform or blockchain-enabled application. Like tokens at a games arcade these are ‘bought’ through fiat or cryptocurrencies. Whilst these tokens may increase in value as more and more people seek to access what the company offers, these tokens hold no use outside that specific blockchain based application.
- Asset-backed tokens these represent real-world or digital assets. They can represent ownership interests in real estate, personal property, or equity in businesses.
What is loan tokenization?
Loan tokenization falls into this third category of tokens and allows a loan to be split up via the creation of tokens which can then be traded on a secondary market.
Take a LendLedger loan as an example. LendLedger is a decentralized marketplace which facilitates loans to financially underserved small businesses using blockchain. If LendLedger lenders chose to tokenize the loans provided through our platform this would allow them to be sold off in increments to those willing to take them on as a longer term commitment. This cash would allow lenders to make more loans due to their added liquidity.
What are the benefits?
The advantages of a token over traditional modes of securitization are as follows:
- Ease — securitization has previously been incredibly process heavy with extensive due diligence. With blockchain a parties reputation is traceable — thus the need for heavy background checks is remediated.
- An increased pool of buyers — with prior securitization loans would be bought as a whole, commonly by accredited institutions. Therefore only individuals willing to spend large quantities of capital operated in the space and, in the case of micro-loans, these were bundled together for buyers. With tokenization loans can be sold off in minute increments. Not only does this democratize who can buy a loan but also what size loans can be bought individually.
- Security — as tokenized loans move through the blockchain they are secure and entirely traceable. This reduces the potential for fraud and allows more actors to participate in the space.
