A Brief History of Tokenized Real-World Assets
The trend of tokenizing real-world assets continues to take the world by storm. With over $3 billion in real-world assets, this trend is only accelerating. Analysts project that over $16 trillion worth of economic activity will undergo tokenization by 2030.
Understanding tokenization’s foundational principles and history is essential for contextualizing this trend’s implication and role in the coming years. In this piece, we help set the stage for contemporary tokenization initiatives by outlining the rationale and histories that underpin their technological and regulatory feasibility.
We stand on the shoulders of giants, many of which have already gone the way of the dinosaurs. The trails they’ve blazed and the insights they leave behind are the oil that powers today’s mass migration to tokenized ecosystems.
If tokenization is the future, and it’s happening now, then its roots lie somewhere in the past.
Early Concepts and Predecessors
Basic Principles Behind Tokenization and Real-World Assets
Tokenization involves converting the rights to an asset into a digital token. Today, this often entails using a blockchain for data processing and storage. At its core, tokenization allows for fractional ownership, easy transferability, and real-time settlements. Real-world assets like real estate, art, or commodities, which traditionally have high entry barriers, can be broken into smaller, more affordable shares via tokenization. Multi-party international transfers can leverage tokenization to ensure state finality and ledger homogenization between counterparties. The processes democratize access, enable greater participation in the global economy, and improve supply chain logistics and processing like never before.
Participants in the global supply chain have already begun using blockchain tokenization to manage their inventories and touchpoints more seamlessly. These approaches are generally built on the backs of existing digital management systems, making the jump to tokenized real-world assets smaller and more manageable. As the technical, operational, and legal processes of tokenizing real-world assets have become more streamlined and defined, the volume of assets undergoing tokenization continues to increase.
Pre-Blockchain Real-World Asset Tokenization (1990s)
There have been many forms of digital representations of real-world assets to date, many of which predate blockchain. The most familiar approach to tokenized real-world assets is Real Estate Investment Trusts (REITs) for real estate and Exchange-Traded Funds (ETFs) for commodities. These familiar financial instruments fit comfortably within the definition of tokenization and have transformed these otherwise physically limited asset classes into highly investable and digital segments of the economy.
E-gold’s digitization of gold via redeemable certificates was one of the first approaches to tokenizing a real-world commodity for retail markets. While E-Gold proved unsuccessful at scale, tokenizing commodities for the retail market remains a salient point of interest across many industries. Global supply chain participants continue to opt for tokenized assets due to the elevated efficiency and accessibility it introduces.
Tokenization before blockchain almost exclusively involved financial instruments. The success of ETFs and REITs demonstrates that digitizing transactional mediums can have significantly positive effects on liquidity and access. However, without distributed computing and homogenized consensus, tokenization intrinsically relies on a third party for database management. This limitation capped the applicability of the tokenization process until the advent of decentralized blockchains in the early 2010s.
Public Blockchain Tokenization (2010s)
The advent of public blockchains ushered in a monumental increase in asset tokenization for several reasons.
They allow people to transact directly in a verifiable and reliable way, circumventing cumbersome and often costly intermediaries. This access is very appealing to the long tail of the human population and makes markets more fair overall. For this reason, cryptocurrency has seen wide adoption in global remittance markets.
Public blockchains allow for mutually verifiable, immutable, third-party records of accounts. This reliability in reporting is crucial for all real-world assets and significantly reduces the implementation costs associated with tokenization. This benefit underpins contemporary tokenization initiatives that we see today.
Early attempts to tokenize real-world assets on the Bitcoin blockchain via initiatives like Colored Coins and Mastercoin ultimately proved challenging. While pioneering, these approaches fell short of enterprise qualifications and retail market interest.
The release of Ethereum opened the floodgates for more complex asset tokenization via smart contracts. Early Ethereum-based initiatives sought to decentralize financial tools like investment funds but were hindered by regulatory challenges and technological limitations.
Today, we’re seeing the future of tokenized real-world assets finally take shape. Early milestones and innovations like those outlined here have laid the groundwork for large-scale real-world asset tokenization. They continue to serve as the catalysts for regulatory evolution and technological refinement in the sector, paving the way for continued innovations and use cases.
Milestones in Tokenizing Real-World Assets
Smart Contracts Programmability
Smart contracts fundamentally transformed the tokenization landscape. First conceived by computer scientist Nick Szabo in 1994, smart contracts became widely accessible with Ethereum’s launch in 2015. Since then, smart contracts have seen broad mainstream usage. These self-executing agreements written into lines of code allow asset ownership to be verified, transferred and managed without intermediaries. This automation has begun to alleviate frictions in traditional asset management and has laid the essential groundwork for tokenizing real-world assets. Today, virtually all tokenized real-world assets are operated via smart contracts.
Standardization and Interoperability Improvements
Ethereum’s ERC-20 token standard established a foundational framework, quickly becoming the ‘universal language’ for tokens. Since its advent, other standards have emerged to address various asset classes and functionalities. These include standards for non-fungible tokens like ERC-721 and ERC-1155 and those specifically designed for tokenized securities, such as ERC-1400. The rise of multiple token standards has been instrumental in streamlining interoperability and integration across different platforms and services. This standardization has had a positive impact on asset liquidity. Interoperable tokens, including those representing real-world assets, can be more easily traded and transferred across various platforms, broadening their market reach and appeal.
Regulation and Compliance Milestones
Clear regulatory frameworks have gradually started to shape the real-world tokenization process within the industry. In the United States, the Securities and Exchange Commission (SEC) has played a pivotal role by setting precedents through actions against non-compliant projects, thereby providing a more transparent regulatory path for future endeavors. However, a lack of definitive regulatory clarity has led to a migration of transaction volume outside of the U.S. jurisdiction. Turnkey securitization via tokenization offers the potential to reverse this trend.
In Europe, the implementation of the Markets in Financial Instruments Directive II (MiFID II) and Markets in Crypto-Assets Regulation (MiCA) laws have set stringent requirements for transparency and investor protection. These and other regulatory milestones have legitimized tokenization in Europe, paving the way for institutional investors and a broader audience to tokenize real-world assets confidently.
China has thus far led the charge towards tokenized real-world assets in the Asia-Pacific region. While the Chinese government has banned the use of cryptocurrencies, it is actively exploring the tokenization of real-world assets for purposes like supply chain efficiency and cross-border transactions. China’s approach has opened new opportunities for asset tokenization within a controlled framework, with sovereign notes tokenized in Hong Kong. As the landscape evolves, the country continues to set the stage for total integrated supply chain tokenization.
Challenges So Far
The real-world assets tokenization journey is rife with lessons in the form of setbacks and stumbling blocks. Early adopters have faced various challenges, from court disputes over tokenized ownership to market closures due to regulatory complications. Below, we list a few notable historical examples of tokenization failures and challenges:
Mt. Gox Saga (2014)
While this now-infamous first crypto exchange did not host any tokenized real-world assets of which we know, the collapse of Mt. Gox engendered a sentiment of fear and skepticism towards tokenization in general. This fiasco negatively impacted market sentiment for years thereafter, delaying potential institutional tokenization initiatives.
Case of The DAO (2016)
The DAO (Decentralized Autonomous Organization) raised eyebrows with its decentralized investment strategy that ultimately fell prey to an exploitative hacker. This disaster caused a rift in the Ethereum community, resulting in legal repercussions and casting doubt on tokenized investment models. This early failure further relegated institutional interest in asset tokenization to the fringes of research departments.
Illiquidity of Tokenized Real Estate
Early experiments in tokenizing real estate fell flat due to significant liquidity issues. Platforms like Property Coin struggled to find sufficient buyers and sellers, demonstrating that tokenization alone doesn’t solve the liquidity issues found in traditionally illiquid markets. Contemporary tokenization initiatives focused on real estate have far more sophisticated and nuanced models to help address this shortfall.
Regulatory Shutdowns
Various projects faced cease and desist orders from the U.S. Securities and Exchange Commission. These regulatory crackdowns highlighted the gray area of tokenized real-world assets, stalling tokenization initiatives pending greater regulatory certainty. Regulatory clarity in the U.S. jurisdiction remains a high-priority consideration for today’s tokenization initiatives.
Market Timing and Tech Maturity
Many tokenization initiatives entered the market too early relative to technological maturity and market interest. These initiatives faced subdued interest from potential investors, supported by the difficulty of conveying the then-brand-new concept of tokenized assets.
Understanding these challenges and setbacks associated with tokenization is crucial for interpreting the current landscape. Many strides have been made in overcoming these initial barriers to entry. The hardships of these pioneering initiatives paved the way for the emerging best practices and regulatory frameworks we see today. This example again highlights that market timing is as important as technological prowess.
Conclusion
The story of tokenized real-world assets is filled with tepid successes and unforeseen setbacks. Each toddling step has proven instrumental in shaping the current landscape. While the road has been fraught with challenges, these experiences are invaluable lessons for the future of tokenized real-world assets. The growing maturity and volume of the tokenization ecosystem is a testament to its resilience and ingenuity.
As we look toward the future, we recognize the historical milestones, innovations, and challenges that have set the stage for this new wave of tokenized real-world assets.
The preamble has closed, and we are stepping firmly into the first chapter of this exciting journey that promises to upend how we think about asset ownership, transfer, and management.
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