I want to specifically look at the question of “What exactly is Tokenization?”
What exactly are we talking about when you hear the phrase, “Tokenize the World”?
And, furthermore, isn’t tokenization just a fancy way of saying ‘securitization’?
So, the first thing to address is that securitization is not tokenization, but they are distant cousins.
In the securitization process, we see the following:
- The owner of the assets collects the assets in a pool and transfers the pool to a legal entity. Assets are not exposed to counterparty risks, nor do they risk bankruptcy for the originator
- The SPV (Special-Purpose Vehicle) is structured such that the assets within the pool are organized into several tranches based on risk levels and asset characteristics.
- Securities are issued, and typically backed by the cash flows generated by the underlying assets.
- Once the securities are issued, the SPV sells the securities to investors.
- Proceeds are transferred to the originator.
So, this is a tried and true process, but it has its flaws.
First, this process is extremely time intensive and the capital requirements are enormous. We’re talking millions of dollars and likely up to a year. The process requires various parties to sign agreements. Due to the nature of asymmetric information and the heterogeneous structure of asset data, it can really make the whole development quite complex.
Second, there is a distinct lack of transparency throughout the various stages. We saw this in full effect leading up to the 2008 housing crisis. Sub-prime mortgage bonds demonstrated that there was no transparency into the underlying credit pool nor the audit process. This in turn lead to massive amounts of defaults and rocked Wall St. to its core.
So, this leads us back to the big question, “What is tokenization?”
In the simplest terms, tokenization represents converting an asset’s ownership, be that equity, real estate, art, etc., into a digital token on the blockchain.
The big difference, therefore, between tokenization and securitization is how you can introduce programmability into the equation.
Specifically, a programmable tokenized asset gives you access to one of the biggest revelations in the information age: digital business logic.
This way, you cut out the need for manual settlements, instead relying on a series of smart contracts to automatically process such tasks as automatic transactions, calculating asset prices, and other specific features.
So, yes, it’s something we’re somewhat used to hearing at this point: smart contracts and the blockchain help eliminate the middleman and thereby eliminate a lot of waste.
In two words, digital efficiency.
This gives us three key principles with which to weigh the abject value of tokenization over securitization.
When you have value that is inherently represented by a digital asset, like we’ve seen with Bitcoin, you have access to fractional ownership and global liquidity in an instant.
What does a market look like when retail investors are granted access to owning $10 of a piece of real estate as an investment? Fractional ownership and lowered barriers allow for a more diversified portfolio and a market that is less regimented.
Speed, transparency, easier management of investors and their rights, digital compliance baked into the tokens, easily tracked secondary transactions with collaboration of third-party exchanges, and automated checks for conditional events.
Oh, and this is all granted at a fraction of the cost of traditional securitization, allowing for more money to be invested into the business itself and better investor relations.
Specifically, with regard to ownership, this is something we’re also quite familiar with in crypto already.
After all, no two people can own the same Bitcoin. Solving the problem of double spend helps us with the proof of ownership just as much as it helps us have a digital economy.
The digital “fingerprint” of an asset and its transactions helps to ensure that there is less fraud overall and that transactions of ownership can not be falsified after the fact.
So, there are many more questions to ponder because this is not a black and white issue, but at the same time we are moving ahead with a very exciting series of developments that aim to really shake things up.
I, for one, am eagerly awaiting the day I can claim to hold a fractional piece of real estate simply because it represents an important step forward for us.
And, because it’s the future made manifest.