Is there any connection between the NFT tweet by Jack Dorsey and tokenized securities? See how crypto tokens are reshaping the global economy.

There was a time when buying and managing assets — whether real estate or other investments like bonds or art — was a difficult challenge. Investment and asset management have typically required a considerable initial cost because of the many intermediaries and time-consuming stages involved. Due to a lack of financial resources, the bulk of the world’s population has been unable to enter this arena.

Digitalizing ownership rights and doing business has never been easier thanks to tokenization. NFTs are becoming increasingly popular, as evidenced by the recent US$6.6 million sales of a Donald Trump NFT by digital artist Beeple and the National Basketball Association’s recent decision to allow fans to purchase NFT video clips of their favorite teams. These developments have opened up new markets and made blockchain-managed ownership of collectibles and other unique assets possible.

We’ll look at:

• What exactly is tokenization?
• How does tokenization work?
• Tokens of different types
• Tokens that may rot
• Tokens that are not fungible
• The advantages of tokenization on the blockchain
• Tokenization’s underlying technology
• Challenges that still need to be overcome, as well as
• Tokenization’s Future

1. What is tokenization?

A token is a digital representation of a real or virtual item that can be exchanged for other digital assets. Tokenization removes geographical obstacles and middlemen while allowing for fractional ownership of assets, opening up the market to small investors. Tokenization is now possible for almost any asset, including artwork, gold, and real estate.

It’s no secret that the token economy is reshaping the way we invest in assets, and businesses are increasingly looking to it to open up new markets and boost sales. The worldwide tokenization industry is expected to expand at a compound annual growth rate of 19.5 percent from US$1.9 billion in 2020 to US$4.8 billion by 2025.

Tokenization has become a standard practice in the virtual gaming sector. NBA Top Shot, a crypto-collectibles enterprise that lets fans exchange numbered replicas of particular, fully licensed, and tokenized video highlights, was notably endorsed by the National Basketball Association. Recent sales of an NFT of LeBron James doing a slam exceeded US$200,000.

In the precious metals industry, tokenization is becoming more popular. A gold tokenization initiative backed by the Royal Mint of Great Britain, Royal Mint Gold (RMG) aims to make gold more accessible to the general public.

It’s also possible to tokenize currencies via stablecoins, which are digital tokens backed by a fiat currency like the dollar.

2. The Process of Tokenization

In the blockchain industry, tokenization is rising, particularly in 2021. There is nothing new about the idea of tokenization. Financial institutions first promoted tokenization in the 1970s as a data security measure.

When it came to sensitive client information, these companies employed a mix of letters and numbers. As a result of tokenization, financial institutions could secure consumers’ private information, such as credit card numbers and personal data.

As an example, consider Apple Pay. Customers’ credit card information is replaced with a token by Apple. You don’t even realize what’s going on behind the hood. Tokenization is also commonly used for voter registration and healthcare data.

Tokenization is the payment industry refers to replacing cloud-sensitive data with digital tokens. Tokens may represent anything from a stake in a company’s stock to voting right in a democratic election on the blockchain.

Assume you own a $10 million farm. As a result of tokenization, you may split up the farm’s ownership and offer it to a wider group of investors. You may, however, establish a digital token called “FARM” instead of distributing the farm’s ownership shares in the usual manner. Suppose each FARM token is worth $10,000, or 0.1 percent of the farm’s value. Investors may now buy your FARM tokens, each of which represents a tiny portion of ownership. A real illustration of how asset tokenization works come from Elevated Returns, which sold tokens worth $18 million at the St. Regis Aspen Resort.

3. Types of Tokens

Most crypto tokens fall under the categories of “utility” or “security” tokens.

In addition to being known as utility tokens, they are sometimes referred to as app coins or user tokens. Crowdfunding tokens are those handed out during a project’s crowd sale. Utility tokens are a currency that may be redeemed in the future. The value of these tokens is not tied to any external asset. Companies make them for a particular reason. They cannot be traded on an exchange. Filecoin and Brave’s Basic Attention Token are examples of utility tokens (BAT).

It is possible to buy and sell security tokens, which reflect the legal ownership of an asset. The most common method of distributing them to investors is via a security token sale (STO). One of the most common uses of security tokens is to represent ownership in a corporation, such as in governance tokens.

We might think of the FARM tokens in our farm example as a kind of security token. They are traded for a stake in your farm. tZero is a well-known security token.

Another approach to categorizing tokens is based on whether or not they may be exchanged for other tokens.

Fungibility refers to the ability to exchange one thing for another of the same kind and value. There is no intrinsic value to fiat money. Say you borrow $100 from a buddy and want to pay him back. Paying back the exact note you borrowed isn’t necessary. An alternative $100 bill, or 10 separate $10 notes, may be given to him. You have paid off your debt until they all have the same worth.

In other words, fungible tokens are tokens that can be traded easily for one another. They have intrinsic worth and may be traded freely on the open market without causing a rift in the community. In this respect, most cryptocurrencies, including bitcoin, ether, XRP, and so on, are fungible tokens.

In contrast, non-fungible tokens (NFTs) are meant to have a specific value and are not interchangeable. Cryptographically unique and nondivisible, each NFT is like a picture in that it can never be duplicated or substituted for any other NFT.

A secondhand automobile is an example of a non-fungible object in the real world. Your buddy is likely to expect the same vehicle back to borrow a car from the same person who gave you $100. It is also necessary that the vehicle you return be undamaged. There is no easy way to swap this secondhand automobile for another since it is indivisible. The value of your friend’s used automobile is non-fungible since it is one of a kind.

This interest was sparked by CryptoKitties, a collection of digital cats that are cryptographically unique and whose origin, ownership, or legitimacy is recorded on a blockchain. Because each CryptoKitty has a distinct appearance and value, it would be impossible to split or swap it for other CryptoKitties. It’s been alleged that a CryptoKitty, a purple cat with buck teeth, went for almost $170,000 at one point. However, there are other CryptoKitties available for less than US$10.

NFTs are becoming increasingly popular in the arts, sports, music, and fashion industries. Twitter CEO Jack Dorsey, worth an estimated $1 billion, is getting in on the action by tokenizing and auctioning off his very first tweet.

4. Advantages of blockchain-based tokenization

Other advantages of tokenizing assets, outside NFT’s money-making potential for artists and other content providers, include:

a. The number of intermediaries will be reduced.

Consider a stock market sale of your company’s equity. Working with underwriters and other third parties, such as securities custodians, brokerages, and registrars is necessary. The transaction becomes more complicated and expensive as each intermediary is added.

Tokenization eliminates the intermediaries, allowing business owners to access finance more quickly and cheaply. The issue of tokens is quick, and the assets are cheap. Also, since actual assets back tokens, they are less dangerous than ICOs (ICOs).

b. Faster business transactions

Smart contracts embedded in the blockchain complete tokenization. In other words, transactions that would normally take days or weeks may now be completed in hours or minutes.

c. Divisibility — and reduced entrance barriers for investors

It is not feasible to divide NFTs into smaller bits due to their nondivisible nature, but tokenization of other assets makes it viable. The asset becomes a profitable investment choice because of this feature’s liquidity in the market.

Tokenization works well with non-NFT artwork. Tokenizing a Picasso artwork for $200 million with 10 million tokens is an impressive thought. As a result, the investment required for this endeavor has been lowered to $20 per token. This makes Picasso’s art more widely available to the general public rather than only to museums and the world’s wealthiest collectors. The owner of an asset will have more options to sell their product because of the reduced entry barriers provided by the blockchain.

d. The immutability

On a blockchain, all data is immutable and irreversible. An immutable blockchain record cannot be tampered with or fabricated.

Tokenization relies on immutability to keep track of an asset’s origin and history. You may track the token’s history from its issue date through its ownership changes and the prices at which it was traded. This feature considerably reduces investment fraud and theft.

5. Tokenization’s underlying technology

Smart contracts are used to implement tokenization. On the blockchain, these contracts serve as a means for parties to agree. In tokenization, a smart contract eliminates intermediaries and other go-betweens so that a person may acquire your token and obtain shares of your property.

For the time being, Ethereum is the most widely utilized blockchain platform for the tokenization process. The Ethereum blockchain is the most extensively utilized in the token sector and powers the second most valued cryptocurrency, ether. Decentralized finance (DeFi) and ERC-20 tokens have helped to make the Ethereum blockchain process more transactions per day than the Bitcoin blockchain, according to statistics from crypto research company Messari.

Consequently, competitors to the Ethereum blockchain, such as Polkadot, Hedera Hashgraph, Cardano, and Flow — have been gaining users as a result of congestion and high gas prices on the Ethereum network.

a. ERC-20 tokens: the standard for token issuance in the crypto industry

For Ethereum-based tokens, the ERC-20 token is the gold standard. Ethereum smart contracts employ the same technological standard to build tokens on the Ethereum blockchain, and it specifies rules for assets to follow.

Like Litecoin and Bitcoin, ERC-20 may be seen as a digital currency. It’s a digital asset that can be transmitted, received, and exchanged on the blockchain. On the other hand, these tokens are issued through the Ethereum network rather than functioning on their blockchain. For example, BAT and OmiseGo are both ERC-20-compliant cryptocurrencies that use the standard (OMG).

There are six different ways in which the ERC-20 token may be used. These are some examples:

This is known as the “total supply function for a given project’s economics.”

Transferring tokens from one user’s wallet to another is possible via this feature. For ICOs, ERC-20 coins are a popular choice because of this feature (ICOs)

After the first distribution, token holders may use the transferFrom function to trade one token for another.

This function tracks token balances in each user’s wallet.

The approve function ensures a steady supply of tokens and wards off illicit behavior.

To ensure that transactions are genuine before they are included in the blockchain, we use the allowance function.

Several token standards are based on the Ethereum standard. These are some examples:

b. ERC-223 Tokens

With ERC-223 tokens, a major issue with ERC-20 tokens may be resolved, namely token losses during a transfer. Using ERC-223, each transaction is treated as an Ether transaction – it’s a unique event. A major benefit of the ERC-223 standard over the ERC-20 is that the same transfer function may be used for wallet addresses and smart contracts. This transfer function successfully eliminates erroneous transfers and loss of money. The ERC-223 standard effectively overcomes this issue by offering the same function for money delivered to wallets and smart contracts.

c. ERC-721 Tokens

As a result of Ethereum-based NFT collectible CryptoKitties’ success, the ERC-721 tokens gained first notoriety.

ERC-721 differs from previous ERC standards in that it makes it simple for developers to design NFTs. Put another way, a token might have a different value than another inside the same ecosystem or platform, yet they can still be traded.

d. ERC-777 and ERC-820 Tokens

An improvement was also made to the ERC-20 token standard by creating the ERC-777 tokens. In addition to addressing the asset transfer fault that ERC-223 tokens improve on, it also varies in transaction management.

First, you need to familiarize yourself with the ERC-820 standard. On the Ethereum network, a central register for smart contracts is set up in the latter case. Every smart contract address can be “examined,” which means anyone may see what functionalities it supports.

ERC-777 makes smart contract functionalities more easily verifiable by using the same registry as ERC-820. Instead of employing the same “transfer” and “approve” operations as in the ERC-20 standard, it introduces a new set of functions in this standard. Instead, it sends ETH via the “send” function.

Depending on a project’s token economics, ERC-777 also employs a standard for destroying and minting tokens.

6. Issues and challenges of tokenization

Tokenization still has several unresolved issues and possible roadblocks. 

a. Uncertainty in the regulation

Asset tokenization on blockchains is fraught with regulatory ambiguity. Because blockchain technology has no national boundaries, it necessitates cross-government cooperation. This would enable authorities to establish a legal framework for tokenization that covers all technology elements.

The regulations and standards that govern security compliance in today’s world vary widely from country to country. As a result, an asset considered security in one nation might be considered a utility token in another. Token holders are left perplexed by the many classifications, making it difficult to comply.

b. Uncertainty in operations

Any universal rules do not govern the creation and management of digital tokens. Tokens need to be generally acknowledged, valuable, and readily purchased and traded for a connection between the market and interoperability across networks. The government’s involvement and collaboration with the blockchain sector may be necessary to overcome this obstacle.

c. Scams and hacking

An economy based on tokens is vulnerable to scams. In the first place, as token storage systems continue to evolve and hackers become more adept, they might be compromised.

There’s also the issue of fraud to contend with. Several users of the NFT marketplaces Rarible and OpenSea have observed a “Pest Supply” dealer selling Banksy-signature NFTs. Many people were drawn to the trader’s items because of real Banksy’s fondness for pop-up sales. Later, it was determined that the merchant was a con artist. The person had reaped almost $1 million in earnings, with 453 ETH in its primary wallet address and another 443 ETH in another wallet address.

d. Small investors are exposed to more risk.

Despite the recent spike in sales, NFTs are still relatively new. NFTs, such as NBA’s Top Shot NFT video clips of pro basketball players, are selling for around US$100 and are most likely going to smaller buyers, whereas the NFT version of Twitter CEO Jack Dorsey’s first tweet sold for US$2.5 million to a rich bidder. As with baseball trading cards, some people may be purchasing NFTs as a hobby or a collection. Other people may be jumping on the NFT bandwagon to make money off of the trend. Even if the situation may alter, Despite the hoopla, there is a chance prices might fall, leaving investors with enormous losses.

7. How a future ‘token economy’ may look like

A “token economy” might allow the financial system to accept conventional illiquid assets and significantly higher transaction volumes. Transactions are less expensive and faster to complete because of this.

Tokenization enables lower-income investors to participate in markets previously unavailable to them. However, there are still dangers associated with investing.

Tokenization of real estate is a chance to increase market liquidity. Buildings, by their very nature, are immobile. While REITs were created to help the market by providing some liquidity, they have also become riddled with fraud. Better, more transparent, and simpler implementation of real estate asset trade is possible with tokenization. However, if digital fractional ownership is anything like purchasing a timeshare in the real world, the returns are questionable.

Another area where further tokenization is planned is digital art. When you can verify ownership and authenticity of a physical work of art, it’s worth its weight in gold. When it comes to showcasing and monetizing their work, artists like Beeple — a Wisconsin-based graphic designer — are benefiting from tokenization, making it simpler for them to do so. In 2018, the worldwide art market was valued at around US$67.4 billion, with the majority of the market held by a small number of wealthy people. However, despite Christie’s engagement in the digital art sector, their influence is dwindling, and tokenization may further diminish the authority of art gatekeepers like galleries and major collectors.

Blockchain-based virtual worlds have also increased in popularity, with members being able to buy land and other assets in the virtual world. Multiplayer online role-playing game Decentraland started selling land in its virtual environment in 2018. In the end, the firm’s LAND NFTs were the most traded NFTs of the year.