Asset tokenization on Blockchain (Part 48)
Welcome to the 48th part of the 100-part series on Blockchain.
Asset tokenization refers to converting an asset into a digital token and recording it on a Blockchain network. In other words, digital tokens on the Blockchain represent ownership of the digital or physical assets. Once you buy tokens representing an asset, no single authority can erase or change your ownership; simply put, your ownership of that asset remains entirely immutable on Blockchain.
The term “token” in data science is defined as a value (a randomly generated number) assigned to sensitive data to mask the original information. So, in a Blockchain, a token is a number assigned to data stored within the Blockchain. Giving an asset a token is called “tokenization.” Thus, each digital token on the Blockchain has a unique token ID that distinguishes it from any other token.
Types of tokens
Whether it be paintings, digital media platforms, company shares, venture capital funds, collectibles, or real estate property, everything can be tokenized on a distributed ledger.
Basically, there are two types of tokens:
(i) Utility tokens: They are also known as user tokens or app coins. Utility tokens represent a form of value that can be redeemed in the future. Organizations create them for a specific purpose. They offer token holders several benefits, often access to products and services, like, a discount, ticket, coupon, or access to unique features in a DApp or in a game. A few examples of utility coins are as follows:
· Smooth Love Potion or SLP token, an ERC-20 utility token featured by Axie Infinity metaverse game built on Ethereum. By earning or purchasing SLP, players can perform exclusive in-game tasks, like collecting unique digital pets called Axies which they can breed, sell, or deploy in the battle against other players.
· Filecoin network is a peer-peer system (built on IPFS) facilitating secure data storage on the internet and retrieval through a Blockchain-based decentralized network. The users are rewarded who wish to store data online and who wish to rent out unused hard drive space. The users having the utility token FIL can gain access to the platform’s network and storage space.
(ii) Security tokens: They are digital assets representing legal ownership of an asset, like shares of ownership in a company, intellectual property, land, or any other kind of asset. The name security tokens are often tied to the securities offering. Security tokens could represent a share in a company or an investment in real estate, or a film project.
Simply put, a utility token can buy access to a company’s product or service, while a security token can buy you a stake in the company itself. Additionally, security tokens are regulated by the US and many other governments like any other security, while utility tokens are not.
Difference between tokens and crypto coins
A token is built for a decentralized project on an existing Blockchain and is used to represent some kind of noncash asset, like an ownership stake; special rights within a project, like voting rights; or early access to a product developed by the company that’s issuing the token.
Crypto coins, on the other hand, represent digital currency created for making payments. Coins are created to act like money: they always have a given cash equivalent based on demand and market pressures like Bitcoin (BTC), Bitcoin Cash (BCH), Litecoin (LTC), and Ether (ETH).
Crypto coins are native to their own blockchain. For instance, the Bitcoin blockchain coin is BTC. The Ethereum blockchain has an ETH coin. And the Litecoin blockchain uses an LTC coin. These crypto coins are primarily designed to store value and work as a medium of exchange, like paying for goods or services, transferring to others, etc., similar to traditional currencies. This is why crypto coins are also referred to as cryptocurrencies.
Tokens can have value, but they don’t exist solely as a way of transferring that value. Typically, they’re designed for something more complicated than a simple monetary transaction.
Steps to create a token
If you want to create a token, you would be required to follow these 4 steps:
Step 1: First of all, define the properties of your token
(i) Select an asset that you want to tokenize, for example, real estate, a physical commodity (e.g., a precious stone), an artwork, a collectible, a piece of intellectual property, a medicine, etc.
(ii) Specify total token supply, token’s name, symbol, and value. Also, describe the rights associated with assets.
(iii) Analyze global, country- and industry-specific legal regulations relevant to asset tokenization. For instance, SEC regulations for financial securities, HIPAA for healthcare assets, etc.
Step 2: Develop a smart contract
(i) Choose the optimal Blockchain platform that supports smart contracts for asset tokenization. Ethereum is the most commonly used Blockchain for creating tokens, and the ERC-20 standard is the universal language that all tokens created on the Ethereum network must follow.
(ii) Assigning unique IDs to the tokens and developing smart contracts to program the behavior of the tokenized asset is essential.
(iii) Then, it is required to integrate the tokenized asset with required systems, e.g., a crypto wallet (MetaMask), payment gateways, KYC/AML verification services, and more.
Step 3: Run on a Test chain
If you deploy the smart contract of the token on the Blockchain, it will be immutable and would be impossible to replace it in case there’s a bug. Therefore it is always a good idea to test your smart contract code by running it on a test Blockchain like Rinkeby or Ropsten.
Step 4: Deploy to main net Blockchain
After you have confirmed your smart contract code, you are all set to deploy it on Blockchain. It's just a matter of few clicks, and your token is there on Blockchain.
Thus, the tokens represent a set of rules encoded in a smart contract. Every token belongs to a Blockchain address. These tokens are accessible with a dedicated wallet like MetaMask that communicates with the Blockchain and manages the public-private key pair related to the address. Only the person who has the private key for that address can access the tokens. He can, therefore, be regarded as the owner of that token. If the token represents an asset, the owner can initiate the transfer of the tokens by signing with their private key, which in turn generates a digital signature. If the token represents an access right to something, the owner of that token can initiate access by signing with his private key. If the token represents voting, the owner of that token can vote by signing with their private key.
Benefits of asset tokenization
(i) Fractional asset ownership: Tokenization enables Fractional ownership, which means splitting and converting a physical asset such as real estate into several digital tokens, like stocks of a company. Every token represents direct ownership of an asset and will have a unique ID. Therefore, those who buy the tokens own a portion of the equity in that asset. Additionally, tokenization democratizes the investment space by opening it up to allow more people, specifically those who aren’t in a place, to invest a large amount of money at a time in expensive assets like real estate. Tokenization of land breaks large, expensive investments into fractional slices, creating a security token for each piece of land. With fractional ownership, if the asset increases in value, the value of the shares in the investment does as well.
(ii) Increased liquidity: Tokenizing assets would also increase an asset’s liquidity, as it facilitates fractional ownership. Let’s use the example of an individual requiring $50,000 taken out of a property valued at $500,000. This individual may have tokenized their property into 500,000 security tokens, each worth 0.0002%. They might sell 50,000 tokens on the Blockchain instead of selling the entire property, thus ensuring a more liquid asset.
(iii) Peer-to-peer asset trading: The ownership of tokenized assets can be transferred directly between asset owners and investors. But the transfer of securities follows regulations. All transactions on tokenized assets are automatically validated, timestamped, cryptographically encrypted, and recorded in the immutable distributed ledger available to asset owners and investors.
(iv) End-to-end asset traceability: Asset owners and investors can trace the whole history of activities performed over tokenized assets on Blockchain. It helps verify asset origin and provenance and prevent fraud and counterfeiting.
(v) Smart contract-based automation: Self-executing protocols on smart contracts automatically enforce actions related to tokenized assets upon particular events pre-defined by token issuers. For example, asset ownership is automatically transferred to the investor upon payment for the asset.
Various industries, including healthcare, finance, real estate, sports, banking, entertainment, gaming, etc., are embracing the concept of tokenization of their assets.
Challenges in asset tokenization
(i) There are no universal regulations that would apply in different countries and different jurisdictions.
(ii) Regulators, developers, and governments need to work together to define the legal framework regarding tokenized assets.
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