Key takeaways
- Asset tokenization transforms real-world assets like property or art into digital tokens on a blockchain, enhancing security and transparency.
- Tokenized assets offer benefits like improved liquidity, fractional ownership and reduced fraud risks through blockchain technology.
- Major institutions like Visa, JPMorgan and Deutsche Bank are already exploring tokenization, signaling its growing adoption in the financial industry.
- Despite the potential, challenges like regulatory uncertainty and smart contract vulnerabilities still need to be addressed for widespread adoption.
Asset tokenization is about transforming real-world things like art, property or even stocks into digital tokens that you can buy, hold or trade on a blockchain. It is like giving your assets a digital upgrade.
Thanks to blockchain technology and smart contracts, asset tokenization automates processes and makes them transparent. Asset tokenization has been steadily gaining momentum. According to Boston Consulting Group (BCG), the tokenized asset market could reach an astounding $16 trillion by 2030.
This asset tokenization guide explains asset tokenization, its benefits, how it works, the tech stack behind it, the risks and challenges associated with it, the evolution of asset tokenization solutions, the regulatory approach towards tokenized assets, the future of asset tokenization, and more.
What is asset tokenization?
Asset tokenization refers to turning physical assets, such as real estate, artwork, or commodities, into digital tokens residing on a blockchain. These tokens signify ownership or a share in an asset, facilitating its exchange or transfer.
Blockchain technology promotes security and transparency. Smart contracts on the blockchain manage asset ownership and transaction details.
Tokenization introduces the ability to buy fractional shares of valuable assets like artwork. It enables you to invest in an asset without buying it in whole. For instance, if an artwork is priced at $2,000, asset tokenization can help you buy it in fractions, such as 200 fractional assets of $10 each.
On Oct. 3, 2024, Visa launched its new Visa Tokenized Asset Platform (VTAP), which allows for issuing and managing various digital assets, including stablecoins and central bank digital currencies (CBDCs). Currently, in sandbox mode, VTAP will cater to banks, offering a comprehensive infrastructure for securely minting, transferring and settling digital assets across public and permissioned blockchains.
Notably, tokenized assets are different from cryptocurrencies. Tokenized assets represent real-world assets, whereas cryptocurrencies, such as Bitcoin (BTC) and Ether (ETH), are digital currencies that facilitate transactions in their respective blockchain networks.
While both are digital assets, tokenized assets have underlying things of value. Cryptocurrencies derive their value from market demand, utility and speculation.
Did you know? According to a Chainlink report, the tokenized asset market will hit $10T by 2030. In September 2024, the value of tokenized assets was approximately $118.6 billion, with Ethereum dominating the market with 58% of all tokenized assets.
Benefits of assets tokenization
Asset tokenization offers significant benefits beyond providing a decentralized alternative to real-world products:
- Liquidity: Traditional markets often face inefficiencies, such as high fees and long settlement times. Tokenization helps solve these problems by creating more liquid, interoperable assets on the blockchain.
- Availability: Tokenized assets can be divided into millions of smaller tokens, making it easier to trade them. Fractionalized assets expand the buyer pool and reduce the need for expensive intermediaries.
- Transparency: Tokenization increases transparency by recording ownership, returns, and transaction history on the blockchain. The open system reduces the risk of fraud, particularly in industries dealing with high-value assets like fine art or luxury items.
- Programmability: The ability to embed code in tokens and utilize smart contracts is known as programmability, which enables greater automation. You can apply it to various use cases, such as loyalty programs, micropayments and cross-border transactions.
- Composability: You can use tokenized real-world assets as collateral in decentralized markets, enhancing liquidity in the DeFi space and generating rewards for ordinary investors. This allows cutting-edge financial products like token baskets and synthetic assets to further improve the ecosystem. The term “token baskets” refers to a bundle of crypto assets designed to provide diversification, manage risk and simplify crypto investing.
How asset tokenization works
Broadly, asset tokenization involves four steps:
- Verification of ownership: The owner’s rights over the asset are verified through legal and documentation checks.
- Transfer to blockchain platform: The asset is transferred to a blockchain-based platform that supports tokenization.
- Asset valuation: The asset’s value is assessed and finalized while complying with the regulations.
- Tokenized asset offering: The asset is divided into tokens, which investors can buy and trade.
A compliance-focused asset tokenization solution can be useful for tokenizing a real-world asset. Solutions like Polymath facilitate the creation, issuance and management of security tokens through an interface. With a few clicks, you can make choices about ownership, divisibility and transfer restrictions to configure your tokens. The code enforces your input preferences and restrictions.
An example of tokenized assets: Tokenized money market funds (MMFs).
Tokenized MMFs are blockchain-based representations of traditional money market funds. They provide the same low-risk investment opportunities as traditional MMFs but with the added benefits of blockchain technology. In the first quarter of 2024, these funds exceeded $1 billion in total value.
Blockchain technology ensures accurate data and eliminates errors caused by manual processes. Transactions are settled instantly 24/7, and the ability to combine different assets creates new opportunities for businesses and users.
Major financial institutions like JPMorgan, Fidelity International, Franklin Templeton and Deutsche Bank are exploring and testing tokenization of different assets, including MMFs. This indicates a broader trend toward digital transformation in the financial industry.
Examples of tokenized MMF projects include:
- JPMorgan’s Tokenized Collateral Network (TCN): Allows you to tokenize your MMF shares and collateralize them.
- Union Investment: This European asset manager Union Investment has embraced tokenization by investing in tokenized bonds issued by the European Investment Bank and Siemens. It reflects a broader trend towards the adoption of tokenized assets in Europe.
- KKR: KKR, a global investment firm, has taken a step toward digital transformation by partially tokenizing one of its funds on a public blockchain.
Did you know? According to Cointelegraph Research, investments in tokenized US Treasury bills are expected to reach $3.7 billion by the end of 2024.
Tech stack behind asset tokenization
While blockchain and smart contracts play a key role in enabling asset tokenization, it’ll help to understand how oracles and some specific token standards help in the process. This article covers Ethereum and Solana token standards:
Token standards used in asset tokenization
Token standards play a key role in asset tokenization, supporting uniformity and compatibility across blockchain networks.
Common standards on Ethereum include:
- ERC-721: standard for unique non-fungible tokens (NFTs)
- ERC-20: standard for fungible tokens
- ERC-1400: With extra compliance procedures for regulated assets, ERC-1400 is specifically made for security tokens, combining the features of fungible and non-fungible tokens.
- ERC-1155: ERC-1155 improves efficiency by supporting fungible and non-fungible tokens inside a single contract.
Common standards on Solana include:
The token standards for asset tokenization on Solana include SPL tokens, the platform’s version of Ethereum’s ERC-20 fungible token standard. Solana uses the Metaplex standard for NFTs, which facilitates developing, exchanging and administrating unique digital assets.
Solana suits asset tokenization because these standards enable quick, inexpensive transactions. Moreover, the features of Solana, like its high throughput and scalability, enable the management and transfer of tokenized assets across Solana with ease.
Role of oracles in asset tokenization
Success of asset tokenization depends on secure oracles to provide accurate information on the tokenized assets. This is crucial in all stages of the tokenized asset’s life cycle, such as creation, collateralization, valuation and trading.
A decentralized source of updated information ensures transparency and security in tokenization projects. It provides offchain information onchain, safeguarding tokenized assets. Oracles should offer flexible structures to meet different asset needs, sourcing data from professional appraisers, exchanges or customized sources.
Crypto-economic incentives in a decentralized network of nodes ensure data accuracy by penalizing dishonest valuations and rewarding reliable ones. Such incentives include staking and reputation systems.
Crypto staking refers to locking your digital tokens into a blockchain network to earn rewards and the right to participate in governance. Reputation systems in crypto evaluate the reliability and credibility of participants in the blockchain ecosystem.
Did you know? Oracles typically provide digital data to blockchains. Some systems collect physical data through RFID readers or sensors for weather or health-care information.
Challenges and risks of asset tokenization
Though asset tokenization presents significant opportunities, it also comes with various challenges and risks.
- Regulatory uncertainty: The regulatory landscape regarding tokenized assets is still developing. Laws often aren’t clear, which may lead to compliance issues and unexpected hurdles for both investors and token issuers.
- Smart contract vulnerabilities: While blockchains are generally secure, smart contracts can still have weaknesses. A bug or loophole in the code could expose tokenized assets to security risks.
- Compromised oracles: Oracles bring real-world data onto the blockchain, but they’re not foolproof. If hackers manipulate the data source, it could compromise the entire system.
- Lack of market depth: Tokenized assets might not have the same liquidity as traditional ones, meaning it could be harder to sell them quickly at a fair price.
- Concerns regarding project governance: Holders of tokenized assets might not have the same level of legal protection as traditional investors, which can raise governance concerns.
Evolution of asset tokenization solutions
The advent of blockchain technology, particularly Ethereum’s smart contracts in 2015, marked the beginning of asset tokenization. Tokenization has since spread into a number of industries, including commodities and finance, after initially concentrating on real estate and the arts.
By 2024, thanks to advancements in regulations and DeFi, tokenized assets have become more accessible, liquid and secure. The increased adoption has made it easier to buy and sell fractional shares of assets.
Technically, asset tokenization started off with single-chain solutions, moved on to multi-chain asset tokenization solutions and then permissioned special-purpose blockchains.
Single-chain asset tokenization solutions
Single-chain asset tokenization solutions issue tokens on a single blockchain platform, such as Ethereum or Solana. These solutions streamline processes and cut down development costs, though they also limit scalability and interoperability.
Ethereum is a popular single-chain platform, widely used for tokenization due to its robust ecosystem and vast developer community. Another preferred blockchain for building asset tokenization solutions is Solana, known for its high transaction speed and low fees.
When choosing a single-chain solution, factors like the platform's scalability, security and community support must be considered.
Multi-chain asset tokenization solutions
Multi-chain asset tokenization solutions enable the issuance of tokens across multiple blockchain platforms, increasing interoperability and scalability. Tokensoft, for instance, is replicating its platform as smart contracts on six blockchains. By deploying smart contracts on several blockchains, these solutions can support users on more platforms, thus boosting liquidity and lowering transaction costs.
When evaluating a multi-chain asset tokenization solution, scalability, supported blockchains and governance structure must be considered.
Permissioned special-purpose blockchains
Permissioned blockchains designed for regulated assets simplify processes and create new financial opportunities by addressing issues like identity, compliance, confidentiality and governance. For digital securities, these specialized blockchains offer key advantages over general-purpose ones. Here’s how:
- Identity: Traditional blockchains are built for anonymity, but tokenized assets require verified identities. Permissioned blockchains ensure all participants are verified through a customer due diligence process, allowing only trusted entities to make transactions.
- Governance: Hard forks in a blockchain can cause legal and tax implications for real asset-backed tokens. These blockchains use governance models to prevent such forks, ensuring stability.
- Compliance: General blockchains struggle with complex regulatory logic. Permissioned blockchains have compliance built into their systems, enabling faster processing and scalability as regulations evolve.
- Confidentiality: Market participants often need privacy, but general blockchains make holdings visible. Permissioned blockchains create protocols that allow confidential asset issuance and transfers.
- Settlement: These blockchains offer instant settlement without requiring pre-funding and prevent unwanted airdrops, ensuring smooth final transfers.
Permissioned blockchains also differ because only verified, trusted participants can write transactions, unlike general-purpose ones where pseudonymous users can author blocks.
Did you know? Permissioned blockchains offer enhanced security compared to public blockchains due to their restricted access. Organizations can implement additional security measures to further protect the network and data.
Regulatory approaches and initiatives regarding tokenized assets
When framing rules, regulators may choose to focus on the underlying risks and outcomes, or specific technologies behind the asset tokenization solutions.
A common approach is to use regulatory sandboxes that allow development of innovative financial products like tokenized assets in a controlled environment. A regulatory sandbox is where companies can experiment with new products, services or business models without facing the full force of regulations.
Several regulators are taking a collaborative approach toward regulations, first discussing with industry stakeholders in developing harmonized regulatory frameworks for asset tokenization. On Sept. 30, the Bank of England and the Financial Conduct Authority (FCA) in the United Kingdom opened up the Digital Securities Sandbox (DSS) for applications.
The United States Securities and Exchange Commission (SEC) has provided guidance on digital asset securities, including tokenized MMFs. Federal securities laws in the US require all offers and sales of digital assets to either be registered under its provisions or to qualify for an exemption from registration.
Meanwhile, the European Union is working on a comprehensive regulatory framework for crypto assets, including these funds. The Markets in Crypto-Assets Regulation (MiCA) excludes crypto assets issued by central banks and non-transferable assets from the definition of digital assets. The overall regulatory landscape for tokenized MMFs is complex and constantly changing.
The future of asset tokenization
As more sectors adopt blockchain technology, the trend of tokenizing physical assets such as equities, real estate and artwork will gain more traction. It will create opportunities for investors by enabling them to purchase fractional shares rather than full homes or expensive artwork, therefore increasing accessibility to assets that were otherwise illiquid.
Use of blockchains for recording transactions will lower fraud. As technology develops, more sophisticated smart contracts will automate asset management and compliance, making the process more efficient.
Major financial institutions like JPMorgan, Visa and Deutsche Bank are already exploring tokenization, suggesting that they’re seeing potential in the emerging technology. As the regulatory framework gives more space to innovation in the field, asset tokenization may revolutionize the way you trade and invest in physical assets.