Lets start with Example:
Imagine you own a valuable piece of real estate, such as a commercial property, that you would like to sell. Traditionally, finding a buyer who is willing to invest a significant amount of money upfront can be challenging. However, with tokenization, you can transform the ownership of this property into digital tokens that can be easily traded and shared among multiple investors.
One more Good example can be:
Lets assume You want to sell the famous painting Mona Lisa. You would need to find a seller who wants to shell out millions of dollars for it. Clearly, this reduces the number of people who have enough liquid cash worthy of buying it. But if we tokenize the painting. Then we can have multiple people with whom the ownership of that painting be shared.
Tokenization is the process of transforming ownerships and rights of particular assets into a digital form. By tokenization, you can transform indivisible assets into token forms.
We implement tokens using smart contracts in the blockchain, also known as token contracts. These contracts are computer programs that help verify the business rules and help transfer values from one user’s wallet to the next.
There are two basic ways to transfer values using a smart contract.
- First is the UTXO model. They introduced it by implementing the bitcoin technology, and many cryptocurrencies use this model. UTXO works by determining the amount of digital currency left in a user’s account after a successful cryptocurrency transaction.
- Then we have the Account-based model, which is used by Ethereum and Hyperledger fabric. When an order takes place, the nodes that are the network’s validators debit the amount from the sender’s account and credit it to the receiver’s account
To ensure that you get the best perks of investing your efforts into the development of tokenized asset, tokens are broadly divided into two basis:
- Tangible Assets – The term represents a set of assets that holds some monetary value and is available usually in a physical form.
- Fungible Assets – These digital assets are created such that every token is equivalent to the next. Meaning, one bitcoin is equal to one bitcoin and is interchangeable with one bitcoin only.
- Non-Fungible Assets – They are designed as unique and can’t be interchangeable.
- Currency Tokens – These tokens represent currencies in digital form.
- Utility Tokens – The term refers to a digital token that is issued to support funding for the development of cryptocurrency and can be later employed for purchasing a particular product or service offered by the issuer of the cryptocurrency.
- Security Tokens –Security tokens, one of the cryptocurrency trends, is basically the digital representation of traditional securities.
We have seen what tokenization is and the underlying technology. But it is crucial to understand its advantages as it will help us realize the reasons for its growth. So, here are its advantages in simple terms.
- Assets Divisibility and More Liquidity
One of the significant benefits of tokenization in the blockchain is that it opens up the underlying assets to a broad audience. The divisibility of assets helps to achieve it. We can now take part in investments that have a high investment threshold. Thus, removing the liquid premium of hard-to-sell assets like prime real estate and artworks.
Tokenization also provides a broader geographic reach as blockchain is inherently global in nature. Anyone with a computer web browser can interact and keep track of the asset from any part of the world.
Asset divisibility also comes with the benefit of shared ownership. You can have a vacation home with 15 other people and agree on who will use the house during a specific time.
2. Faster and Cheaper transactions
We can bypass all the intermediaries involved in a transaction with cryptocurrency tokens. Let us understand it with an example if we tokenize the deed of a house and put it on the blockchain. Then interested parties can directly buy the deed with cryptocurrency, and the smart contract will transfer the deed to the new owner after a successful transaction.
The process eliminates the need for a lawyer, banks, an escrow account, and even brokerage commissions. The process is simply cheap and efficient. Moreover, crypto tokens are on the blockchain network that means we can trade them 24/7 all around the globe.
In a blockchain, all of the transactions are transparent and available to any computer interacting with the chain. That means you can dig up the previous owner history of an asset, thus increasing trust among potential buyers. Moreover, blockchain tokens also benefit from being immutable as all of the transactions are verified by the nodes.
All of this provides a level of trust that most traditional solutions cannot match.
Major concern is how security tokens-backed assets will be managed. For example, maybe thousands of foreign investors collectively own a tokenized hotel. There remains a big question on who will manage the hotel.
While most countries are implementing laws to encourage the growth of blockchain-based projects. However, some countries are taking strict actions against them, for example. The Securities and Exchange Commission (SEC) can classify certain tokens as securities in the USA. Without a doubt, it will invite a large amount of external scrutiny.