Tokenization of economies and the future of investing

Investing and speculation are as old as humanity, or at least as old as capitalism. Investing used to be, and still is, the privilege of a few. But not for long.

The prehistory of asset tokens

1200%. This is how much money you made if you invested in the world’s first IPO in 1602, and you were smart enough to sell at the top. It’s a respectable return even by crypto standards. But not many could participate in the initial public offering of the Dutch East India Company (the VOC). You had to be informed about the recent developments in history (namely be aware that there are continents in the world other than Eurasia), you had to be rich, and, well, a white Dutchman.

But casting the apparent inclusivity problems aside for a second, this was a truly revolutionary development. Humans discovered the power of financial abstraction much earlier — money itself is such an abstraction — but this was the first time in history “average people” could invest in a company, which owned assets — warships in this case — and used these assets to generate profit and yield to its shareholders. The original, pre-cryptocurrencies definition of the word “token” is “a thing serving as a visible or tangible representation of a fact.” VOC shares (technically, bonds) were, in a way, prehistoric tokenized assets.

These sheets of paper, printed and signed by the issuer, were representing ownership in the company. This is easy for us to understand today, but it was something mind-bogglingly new in 1602. Bonds made investors eligible for yields (50% per year was not uncommon), and they could be traded freely on the world’s first stock exchange in Amsterdam, not coincidentally established the same year. Capitalism suddenly started rolling full-speed.

A web of middlemen

The world of investing became more inclusive and much more confusing over the next centuries. Investment banks started offering trading and custody services, and electronic databases replaced sheets of paper. (Before going digital, losing your printed shares might have meant that you indeed lost your shares in the company, as issuing a replacement was often wildly difficult.)

But over the decades the whole industry became entangled in a web of intermediaries, brokers and other sorts of go-betweens.

For instance, when you buy an Apple stock today, the company has no idea who you are. They don’t even know you exist. It just doesn’t sound right, since publicly traded companies do need to keep a record of their shareholders. So, how is this possible? It might come as a surprise, but most of the time you don’t actually own a share you buy. It’s owned by the bank, and your investment only appears on the bank’s books as a liability. This is called street name registration, and it’s the norm in most countries (Australia being a notable exception).

There are reasons we tolerate a middleman sitting between us and our investment: it makes investing and trading much more convenient (we no longer have to approach the sellers and buyers directly), and proving ownership is more comfortable if there is a trusted third party keeping records. On the other hand, the system is prone to apparent risks (banks are usually trustworthy custodians until they are not), and even more importantly, this structure limits the options of investors. Banks act as curators and gatekeepers; if they don’t offer a vehicle to invest into something you’d love to put your money into, you are mostly out of luck.

Video kills the radio star

If you know anything about blockchain technologies, this is the point when you should get excited. As a recap, there are three main reasons for these middlemen to exist: they provide custody services, they keep ownership records, and they make trading convenient.

Tokenizing these assets and putting them on the blockchain will make them completely obsolete.

The blockchain is an accurate representation of ownership and custody remains at the investor. Trading is easy on crypto exchanges. And it even gets better: business logic can be translated into smart contracts, opening up brand new ways for corporate governance.

Tokenize everything

In theory, any asset can be — and will be — tokenized. But tokenization works exceptionally well when the asset is difficult to buy, as it’s just too expensive for an average investor.

For instance, owning a piece of property in Central London is a big deal. Indeed, it’s too big of a deal for anyone but the one percent of investors. The same goes for private planes, valuable land and a dozen of other investment class. Real estate is perceived as a conservative investment, but the yield can be reasonably attractive. The return on a flat in Mayfair (4–5%) is the double of a 1-year US Treasury Bill. These type of assets also tend to appreciate over time. But very few investors can afford these type of investments, and setting up a pool is legally complicated, inconvenient and requires more trust than most people are willing to grant to strangers. Tokenization solves this problem elegantly, even offering a convenient way to distribute yields (through smart contracts).

Tokenization of economies also works great when the underlying asset requires specialized knowledge.

You don’t need to understand how an iPhone works under the hood to buy Apple stocks. It doesn’t hurt to have some understanding of the industry, but it’s not a requirement. One Apple stock (in the same class) is exactly like the other Apple stock — it is a fungible asset. Not all assets are fungible. A piece of agricultural land this side of the river might worth double the price of the same size of property on the other side. Royalty rights to Hey Jude are a much better asset to hold than rights to a summer hit.

Gold is a famously fungible asset, but gold mines are not — indeed, investing into junior mining companies is especially tricky. It often requires specialized knowledge to pick the right assets in an asset class; something ordinary investors generally do not possess.

Counterfeiting is a real threat when it comes to precious metals, art and collectibles, and it also requires professionals on the field to spot them.

We shall see the emergence of curators, projects tokenizing these type of assets while providing the necessary knowledge and experience. Some of them might be today’s investment banks, searching for a new role in the new economy.

Finally, there is another underappreciated angle of tokenization.

Asset tokens bring the physical world and cryptocurrencies together, and this is a great thing. Imagine a token backed by physical silver, for instance. Silver is an exciting asset, as it’s both a proven store of value and an industrial raw material. Its price movements are relatively slow and predictable, especially compared to pure crypto assets: if you bought 1 silver token for $16.50 today, there is a good to fair chance you can sell it a week from now for about the same price. In this situation a silver token is, essentially, a stablecoin; and it’s just one of the many to come. You can tell such asset-backed stablecoins will be warmly embraced by the community.

Tokenization of economies is here. It’s going to happen right in the next few years, and it’s going to be as big of a game changer as the VOC IPO was in 1602 — except it will create a more inclusive, more democratic and more efficient world.