Evolution Of Tokenization
By NOVUM INSIGHTS
The Distributed Autonomous Organizations (DAO) is one of the pivotal features of the Ethereum Network along with its Smart contracts. It is another set of computational code through which a set of smart contracts are connected together and function as a governance mechanism. On June 17, 2016, a successful hack exploited a loophole in the code that allowed the draining of funds from the DAO. In the first few hours of the attack, 3.6 million ETH were stolen, an equivalent of $70 million at the time. To refund the lost money, Ethereum hard-forked to send the hacked funds to an account available to the original owners.
Following the hack, an unprecedented number of investors reached out to the SEC to which the SEC started to take considerable concerns with the crypto and blockchain market. On July 25, 2017, SEC published a report on this event and stated that ‘the automation of certain functions through this technology, “smart contracts,” or computer code, does not remove conduct from the purview of the U.S. federal securities laws. That is: cryptocurrencies would no longer exist in an unregulated state. The DAO was immediately listed as a security and this brought the possibility of more tokens to be defined as such.
Many ICOs made efforts to avoid being defined as security tokens, and in fact, a profitable business layer emerged advising companies on how to avoid their tokens being classed in this way. The motives behind this are clear enough: with this definition, comes the need to make tokens compliant with the regulations, and potential fines if promises to investors are not met. For some companies, a desire to avoid the oversight of the regulations is undoubtedly a way of avoiding potential legal consequences. Moreover, some even argue that making the cryptocurrencies compliant to regulatory bodies is against the philosophy of blockchain and cryptocurrencies. In the midst of this debate, there is a complementary and opposing shift emerging amongst more traditional investment firms. SEC stepped in to take control of the situation and the reassurance of the regulations and safety measures attracted the investors and the list of security tokens crypto started to gain popularity. Hence, it is safe to say that since the end of 2018, the charm and magnetism which ICOs had has been shifted towards STOs.
Evolution Of Tokenization Landscape
Financial markets currently offer a wide spectrum of assets: Stocks, Carbon Emission Credits, Real Estate, Lithium, Oil, etc. In most cases, it is difficult to subdivide these assets or transfer from one market participant to another. Due to this complexity, actors prefer trading papers that represent these assets. Key global stakeholders including Wall Street have shown keen enthusiasm about the depth of possibilities that comes with Ethereum tokens and other alt-tokens to proposes to move real-world assets onto blockchains while maintaining the fundamental characteristics of the underlying assets. In short, securitization consists of the following steps:
The securitization process is a costly and timely process as it requires agreements with various parties under conditions of asymmetric information, as well as a heterogeneous structure of asset data. Adding to this, the lack of transparency in various stages of securitization hinders auditing and rating of the underlying asset.
Tokenization is different from securitization in that it is the process of assigning a token as a unit of value for the specific asset it represents. In the blockchain and cryptocurrency space, a token is a computing protocol for assigning a digital token to represent an asset so it can be used as a medium for value exchange in a network. It provides a global economic infrastructure with more efficient means registering, transferring, and proving ownership of assets. The biggest difference between tokenization and securitization is the programmability that is introduced into the tokenized asset.
It has only the following essential requirements:
- Blockchain should be able to store claim/ownership rights of an asset.
- Blockchain should be able to transfer these rights legally.
- Tokens should be the exchange of value giving the assets its value.
Tokenization has taken the epicentre of debate since the recent ICO frenzy. The variations of tokenization have also garnered a steady upward trend since the start of 2018. There have been a large number of attempts of various assets being tokenized on the Blockchain such as intangible assets (copyrights, trademarks, and patents), fungible assets (gold), physical assets (real-estate, paintings), marketable securities, and even cash equivalents. Tokenization promised various benefits like liquidity (including fractional ownership of assets), programmability, and immutable proof of ownership. Tokenization on decentralized networks can now create a significant increase in the ease of value exchange across all these dimensions. Trades can be fairer, transactions can happen faster, and costs can be lowered. The decentralized organizations can make customer-oriented solutions which keep them more engaged in the network rather than focussing on costs, exits, and shareholder’s value. The market undeniably accepts the importance of the tokenization and the benefits associated with them. However, it is also aware of the obligations to make the tokens compliant to the regulations. The regulatory landscapes across different countries of the world will be discussed later in the report.
About Novum Insights — Novum Insights is a frontier market intelligence company tracking blockchain, artificial intelligence, and other emerging technologies. To download our free STO Handout and request a full report on Security Tokens, please visit www.novuminsights.com
