Searching for the tokenization definition on the Internet, you end up thinking that tokenization is one of two things.
1) A process that can be exemplified by the digital copy of a credit card - which was available prior to the blockchain was invented;
2) Something like the transformation of company stocks into the digital assets - which wasn't available prior to the blockchain came in.
As a matter of fact, none of these assumptions is wrong. NFC chip is indeed an example of tokenization and the digitization of securities could also be one. And that's the problem. Tokenization seems living in two entirely different universes at the same time. It sort of raises questions.
A lot of them.
Some preliminary answers
Tokenization is a very broad concept that covers a variety of subjects. From our perspective, the problem is that it's typically analyzed in a vacuum, regarding only one aspect of the matter and totally disregarding all the others. The result is the issue very similar to that experienced by the blind wiseman describing an elephant to one another.
Blind wiseman describing an elephant to investors. Blind wiseman trying to optimize their business by means of an elephant. Blind wiseman coining a brand new elephant-based business model You've got the idea.
So, how does tokenization work?
Tokenization is the process of substituting what is valuable inherently by what gains value if certain conditions are met. It is the replacement of an asset (effectively anything) by what adds security or liquidity (or both) to this asset.
This is crucial for the proper understanding of tokenization and its business potential. Here come some tokenization examples.
Paper money is the token of, well, almost everything. Only a small number of items are priceless. Notes work only when issued by a trusted party and serve the liquidity - the main conditions are fulfilled. A credit card is the paper money tokenization example.
Protecting sensitive information, credit cards attain value only if the combination of the corresponding bank account, credit card data, cardholder data, and infrastructure are in place. The already mentioned NFC chip is the example of the credit card tokenization. Largely the same combination only serving the convenience - a derivative of liquidity.
Simply put, tokenization is not a novelty. It's being around for as long as the basic principles of economy exist and the blockchain is definitely not a key to this notion. Yet, there is a strong connection between the two.
The one that deserves a closer look.
Tokenization & blockchain
As a technology that is meant to protect data while ensuring its extremely secure storage and transactions, blockchain breathes a new life into payment systems, real estate, insurance, and a variety of other domains. Tokenization is one of the windows through which the somewhat theorized concept of blockchain shows itself to the real world.
Tokenization on blockchain not only allows doing things better - with fewer intermediaries, privately, securely, and cheaply. It lets one do what quite simply was never available before.
For example, transform reputation, idea, or vision into the encrypted data by means of the randomly generated tokens that you can actually sell, exchange, distribute, and control. More on this below.
The impact of blockchain for tokenization is so significant that many can no longer see these two ideas separated. That's why the vast majority of content related to tokenization currently looks at the blockchain-based solutions only, preventing the whole of tokenization from being put in a proper perspective.
Now that the role of blockchain in the tokenization world is established, let's find out why it is so disruptive. Time to look at the big tokenization dilemma.
The big tokenization dilemma
Security comes at the cost of liquidity; liquidity comes at the cost of security. Advancement in one direction typically causes a degradation in the other. It's simple as that.
Paraphrasing, advancement in security demands huge investments for maintaining the liquidity because the liquidity traditionally represents a massive, often unsolvable technological problem. A credit card is convenient and secure only thanks to the multimillion infrastructure storing and giving access to the original sensitive data.
The transformation of a $5 million diamond into encrypted tokens is challenging because it would take a dozen trusted intermediaries ensuring the security of the process and making it unreasonably expensive in the end.
Because of this, any actual advancements in the tokenization field are rare. They are always the resultants of technological leaps substantially contributing to either data security or liquidity without compromising the other component of the system. The introduction of blockchain is one of such leaps.
Put it shortly, blockchain is not a core of the tokenization definition now, but will very likely become one in the future because it adds an unprecedented amount of what the very concept of tokenization is based on.
Tokenization business development
With the solid substructure erected, the proper tokenization analysis can be conducted.
By definition, tokenization serves 3 classes of assets:
- Fungible assets;
- Non-Fungible assets;
- Intangible assets.
The fungible assets class considers the goods that can be exchanged for other goods of equal value. A pen, a laptop, a chair - it all belongs to fungible assets because one experiences no problems estimating their prices.
In the world of fungible asset tokenization, blockchain doesn't change anything fundamentally - you can buy a pen or a chair, or get a credit card without going for any fancy buzzwords. Blockchain can only optimize payment processing or logistics by decreasing the number of intermediaries and hence reducing the total of fees.
Things get much more interesting with non-fungible assets. Non-fungible assets represent something unique - a physical piece of art, a one-of-a-kind building, a singular car - the items whose precise value is hard to estimate.
Since they are unique, non-fungible goods tend to be expensive and highly illiquid. And that's where the blockchain starts to shine. Only the tokenization underpinned by blockchain allows non-fungible assets to reach a high degree of liquidity without degrading the security or making fees ridiculously high.
Imagine you own one of 36 Ferrari 250 GTO built in the 1960s. In June 2018, one of them was sold for as little as $70 million. Five years earlier, a similar deal cost the new owner $54 million - the tendency making the potential token holders interested.
Now, imagine you suddenly need some $10 million for pocket expenses. Selling the thing as a whole, which is what you'd do presently, would take a long time while depriving you entirely and (likely) permanently of the precious investment.
On the other hand, a corresponding tokenization platform running on smart contracts can provide the token issuance transforming your Ferrari into any number of sellable security tokens.
Not only does it let you convert only a part of the asset into funds, but it also lowers the barrier of entry for investors and erases all the physical and legal boundaries giving you the funders here and now.
Another field where blockchain tokenization software has already started changing the landscape relates to the intangible assets class. An intangible asset is what doesn't exist in the traditional sense of this word.
Intangible goods include an idea, a history, a heritage, a reputation, etc. These things are not physical, nor they exist in the form of digits, which is why their storage and transactions are barely feasible.
With the blockchain-based tokenization, it all will change. Let's go back to cars for yet another tokenization example. This time, assume that you belong to those preferring the already depreciated, used mainstream cars.
The price of a second-hand car depends greatly on the intangible - its history. Now, imagine each car having a token storing the original data about the service quality, impacts, and mileage on a blockchain, where nobody can change it but everybody can see it.
One more example. You're an amateur singer distributing your tracks via Bandcamp. You spend a good part of the income to pay the resource and other intermediaries such as PayPal.
But what if you could transform your intellectual property into tokens, controlled by smart contracts, and delivered directly to the wallets of those who paid? It would lower the fees and provide the unprecedented protection of the copyright.
Building up a token vault
As said above, proper tokenization represents the problem whose solution is a matter of technology progress. Having appeared a decade ago, blockchain is still a fairly crude tool. Its use is expensive and, as a result, its benefits are still more of speculation rather than the proven use cases. Blockchain in tokenization is no exception.
Today, tokenization capabilities are available in a multitude of blockchain-based software solutions - our own tokenization platform is the example. Developers are gradually conquering the technical barriers and the software gets more and more refined.
One of the major technical obstacles here is the complicated operational logic that the tokens must be capable of. So far, ICOs and the majority of other token applications rely on the Ethereum's conventional ERC-20 tokens.
They, however, are poorly suitable for tokenization purposes because all ERC-20s are made equal. For the complicated and diverse tokenization cases described above, tokens must be able to store more data and be more flexible than ERC-20.
Attempting to solve that, Ethereum developers created the ERC-721 security standard that proved to be moderately successful. Many follow the suit introducing their own standards of tokens with expanded capabilities, but none of them have achieved a lot so far.
One more technical obstacle slowing down the progress in this area relates to the tokenization infrastructure - token issuance, token distribution, etc. The tokenization platform has to be fairly specific in its capabilities and yet the high price of its development makes it too expensive to be custom-built.
On top of all of that is an array of legal uncertainties. You don't really know how will the government treat your new, shiny tokenized system because the government doesn't know itself.
The regulatory basis is either missing entirely or is so weak that you still need to hire a team of lawyers to make sure your tokenization actions don't break the law. Not an unsolvable, but still a fairly serious barrier.
Tokenization is not a breakthrough that is happening now. It's an age-long technology that was born long before the blockchain; long before the Internet.
Tokenization and blockchain are not the same, but the understanding of their interconnections is important for any successful commercial activity in the related areas.
What does happen now is the revival of tokenization triggered by the unseen opportunities and big promises coming from the blockchain technology.