Previously in Tokenization 101, we did a deep dived into tokenization, how it works and shared a few examples.
Before tokenization becomes mainstream there are some challenges that need to be overcome. Below are some of the present challenges and how a tokenized future could look like.
What are the challenges associated with Tokenization?
1. Lack of Tokenization standards and legal infrastructure
Tokenization is not simply the creation of a token — any Solidity developer can do it. Instead, it’s about the design of the whole system, including understanding the various rights and issues we’ve talked about previously.
How do tokenization standards cater for these issues:
- Incentives (claim rights, ownership rights, governance)
- Privileges of users and system admins (who operate the token contracts)
- Life-cycle management of an asset (issuance, payouts, withdrawal)
- Security management
- Integration of KYC/AML requirements across different jurisdictions
- Integration with exchanges
- Interoperability between different public chains
In the case of cross-chain interoperability, we do see different chains with different nascent characteristics. For instance, Ethereum has scalability issues but provides for more complex Turing-complete smart contracts. How about other public blockchain networks like Stellar or IOST or Zilliqa?
How can tokenized assets (in the form of tokens) be interoperable across these different chains?
2. Digital identity that’s globally and legally-recognized
From a regulatory point of view, it is a regulatory nightmare for assets to be issued and transferred across citizens of different legal jurisdictions.
Suppose I am an EU resident looking to tokenize my real estate and the token only imbues claim rights. How do I transfer this token to U.S persons, whilst taking into account their identity, KYC/AML issues, U.S regulations, taxes and all the other issues?
How can I reasonably and easily deal with a verified, attested U.S person in a legally-compliant way for both our national jurisdictions?
3. Tokenization does not mean instant liquidity
Liquidity is the biggest challenge in the security token space and it does not happen organically. History has given us various examples of financial markets and instruments that have not yet achieved significant levels of liquidity. Helping to create liquidity through allowing institutional investors or accredited retail investors — through custodian solutions will be key. Of course, the underlying asset must be useful.
How do we introduce long-term, sustainable solutions for large institutional investors — the market makers — to create and maintain liquidity?
What does a tokenized future look like?
I’m generally bullish on a tokenized future: a fairer, more equitable world with lower barrier to entry and capital requirements for individuals or businesses.
Through capturing value in tokenized assets, we can re-create all the sophistication of the existing financial and operational world we live in, with far less operational costs and complexities. When combining tokenization with reasonably complex business logic enabled by smart contracts, we can represent complex business interactions faithfully and more efficiently.
There will be interoperability, through standardization.
ERC 20 for token standards, as an example
If the ecosystem for global assets becomes interoperable, it means we can hold ownership claims to a commercial building, early-stage equity, corporate bonds, a T-bill, a single-family residence, and a decentralized network on the same platform.
Different assets can reference each other contractually and interact in an automated way. It means an increased liquidity for all (tokenized) asset classes.
ERC 725 for Identity, as another
Fabian Vogelstellar — creator of the ERC 20 standard — is leading the front for a unique decentralized identity for “humans, groups, objects and machines”. Quoting directly from the ERC 725 Github itself, “ This identity can hold keys to sign actions (transactions, documents, logins, access, etc), and claims, which are attested from third parties (issuers) and self-attested (#ERC735), as well as a proxy function to act directly on the blockchain”.
The future of tokenization is not here (yet), but it will be sooner than we know
We are optimistic and bullish for the future of tokenization and tokenized securities. There are many elements of the envisioned tokenized future that we observe today:
1. Governments are increasingly partnering with private companies to create infrastructural solutions
One such example is the collaboration between NASDAQ, Monetary Authority of Singapore (Singapore’s Central Bank) and Singapore Exchange (Singapore’s main stock exchange) to develop Delivery versus Payment capabilities for settlement of tokenized assets across different blockchain platforms to improve operational efficiency and reduce settlement risks.
2. Projects have recognized the need for compliance, and are creating solutions that target automated compliance and AML/KYC
We have touched about the need to meld real-world legal requirements into the blockchain space. There are various projects that have been doing these globally:
- Harbor: A compliance platform and protocol to ensure tokenized securities comply with existing securities laws at issuance and on every trade, everywhere across the globe.
- Rate3 Network: A protocol that handles asset-tokenization and identity management across both Ethereum and Stellar blockchains.
- Polymath: A security token platform on which regulatory-compliant tokens can be built
I do notice more blockchain projects building tokenization solutions targeted at different asset classes, different ways of modeling structured finance through issuing both debt and equity tokens, for instance. More importantly, these solutions know that working directly with regulatory authorities, collaborating with central banks and other projects will help to improve the overall ecosystem.
Ensuring the legally-compliant design of the whole system is key.
3. “Paths of least resistance” will help everyone relate existing real examples to upcoming tokenization projects
Real estate have always been quoted as an example for tokenization projects. This is due to the structure of real estate investment trusts (REITs), that one could relate more easily to tokenized structures.
Tokenized real estate is not REITs, but there are various principles we can use to help us understand, relate and think better: property rights, economics for REITs for instance.
Not everything will be tokenized, but those that can be will be.