When someone thinks of cryptocurrency, the first things that come to mind are usually Bitcoin, NFTs, meme coins, or yield farming. Despite the public attention and large sums of money directed toward these applications of the technology, many in the financial sector believe that the most compelling use case is something less widely known — tokenization.
Tokenization is the process of converting an off-chain asset to a token, which becomes the on-chain representation of that asset. Tokenization can be used to fractionalize illiquid assets such as real estate or simply to allow the for the asset to be traded, transferred, or leveraged on the blockchain.
While tokenization is still a new concept, there are a growing number of banks, hedge funds, and governments starting to take notice. In November 2022, J.P. Morgan, DBS Bank and SBI Digital Asset Holdings used on-chain protocols to exchange tokenized government bonds. Following suit, Israel recently announced their intention to begin testing tokenized government bonds as well.
These programs may simply be the tip of the iceberg — there is widespread belief that tokenization may soon disrupt real estate, stock trading, and global commodity markets. But why would traditional financial systems be upended and replaced with tokenization? Let’s take a look at some of the reasons tokenization is viewed as one of the most promising use cases for the blockchain.
Disruption of traditional securities markets
All marketplaces have one goal in common — to become more efficient. Despite this, security markets still rely on an archaic network of banks, brokers, transfer agents, clearing houses, market makers, and more. While many aspects of the process have been digitized and streamlined, the underlying structure remains unchanged from what has been in place for decades. Because of all the moving parts, fees are often high and the transfer of funds in and out of the brokerage can take several days. This is why many, including Blackrock CEO Larry Fink, believe that tokenization is the next logical step for marketplaces to take.
At a recent event, Fink stated that “the next generation for markets, the next generation for securities, will be tokenization of securities.” He went on to say that tokenization can provide “instantaneous settlement” and “reduced fees” by leveraging the blockchain’s distributing ledger system. In addition, the open nature of the blockchain means that trades are transparent, trustless, and the need for intermediaries is largely eliminated.
Fractionalization and digitization of real estate
Buying, selling or transferring real estate requires the need of middlemen, title companies, and lawyers to manage paperwork or act as an escrow between you and a buyer. The system used to buy and sell real estate is largely unchanged from decades ago, relying on a series of manual processes that incur fees at each step.
Tokenization can be used to easily fractionalize, securitize, and trade traditionally illiquid assets such as real estate. Turning a real estate asset or development project into easily marketable securities is traditionally only achievable through high-fee brokerages or other investment portals. Tokenization makes this process far easier — fractional real estate securities can be issued on a public blockchain instead, meaning lower minimum investments, access to a global base of investors, and the ability to create a secondary market using smart contracts.
The emerging Tokenized Asset market is currently only valuated at roughly $0.6 billion, but due largely to the potential shown by tokenized real estate, many in the financial sector are bullish on tokenization as a disruptive force. Boston Consulting Group (BCG) is estimating asset tokenization will grow by 2500% by 2030, and the World Economic Forum estimates that tokenized markets could “potentially be worth as much as $24 trillion by 2027”.
The tokenization of “everything”
Tokenization is not limited to stocks and real estate. Virtually anything can be tokenized — natural resources, art, collectibles, currencies, and even carbon credits. This means that a digital marketplace consisting of virtually every asset imaginable, all existing on a single network, is a distinct possibility.
In fact, S&P Global executives have stated “we think the tokenization of everything is going to happen.” The ability to trade any asset in a shared digital space would fundamentally change the way global commodity markets work. Precious metals, energy resources, and agricultural products can all be traded on the blockchain’s distributed digital ledger through tokenization, with instant transfers and settlement anywhere in the world.
Leveraging smart contracts
When assets are tokenized, they exist as on-chain tokens utilizing existing standards such as ERC-20. Put simply, they can interact with smart contracts and DeFi protocols like any native crypto asset. Many crypto-savvy readers may be familiar with loan protocols, staking contracts, perpetual futures trading, and decentralized liquidity pools. When traditional assets are tokenized, they can interact with these protocols — creating brand new investment strategies and streamlining complex transactions.
This is far from a hypothetical use case — as part of the Monetary Authority of Singapore’s Project Guardian, borrow/lend smart contracts utilizing on-chain verification were used to carry out foreign exchange transactions without the need for intermediaries. In one transaction, 10.4 million JPY (roughly $70,000) was transferred with a transaction fee of only $0.03 USD.
Closing thoughts
Key players around the globe are all in agreement — asset tokenization is the future of marketplaces. While some firm’s estimations are loftier than others, it is important to view how these firms are forming their estimates. The World Economic Forum notes that if only 10% of the world’s GDP is tokenized, its market cap would climb to $24 trillion. The Boston Consulting Group agrees with the WEF, noting that the value of tokenized assets could surpass $16 trillion by 2030 if even a fraction of the world’s GDP is tokenized.
The varying projections each firm has comes down to a matter of opinion. Yet, there is widespread belief that adoption will happen; the only point of disagreement is how quickly it will happen. As the world becomes increasingly digital, it stands to reason that traditional systems will look to transition to digitally-native infrastructures. With tokenization, you can transform anything into a trustless, instantaneous, liquid, and fractional asset.
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