Tokenization as the path to increasing assets liquidity

It is clear that the democratization of investment and trade, which is happening in the crypto industry, leads to a sharp increase in the attractiveness of assets. The irrefutable fact is that the cost of a share of a public company is always higher than that of a private one, given the same level of profitability.

The world is full of assets – shares, real estate, precious metals, intellectual property rights etc. Many of the assets are difficult to deliver, and it may be hard to divide them and assign ownership rights to them. The legal processes for transfer of ownership rights are complex – and they thus suggest the involvement of trusted participants.

Considering the existing problems with traditional assets trading, such as paper based accounting, poor integrations between accounting systems, limited functionality of asset management software and outmode payment and accounting infrastructure, digital evolution for real assets accounting seems reasonable and well-timed.

It can be said that blockchain industry created a fashion for extremely simple, convenient systems, where within 20 minutes you can get money on the exchange, trade, and withdraw capital. However the key challenge for the new generation systems that involve tokenizing real-world assets will be to ensure that the processes comply to regulation.

Today we are at the stage when tokenization is being considered as an option by newly founded companies – for example, when choosing a method for accounting for assets, preference goes to the tokenization on a blockchain, rather than to the older and traditional methods. This is a simpler choice for younger companies, since their staff aren’t already locked into one system or the other – while the value streams and client numbers are only starting to rise.

Important innovations

Prior to deal with how to transfer real asset into a digital token let’s consider the ‘token’ term itself. One way or another, in blockchain startups a term appeared that has migrated from the security management process. Balances on accounts in blockchain began to be called tokens, due to the fact that they were items to be simply and safely transmitted. In essence, tokenization is the process of transforming the storage and management of an asset, when each asset is assigned a digital counterpart.

Tokenization introduces the range of important innovations. The first one is that assets are managed directly by the owner instead of managing assets through issuing orders. The difference in approaches is easily explained by the example of the difference between the banking system and Bitcoin. Here, in the case of a bank account, the client sends an instruction to a bank where it is executed by someone, and the client identifies themselves through their login and password. In the case of bitcoin, the transaction initiator uses their digital signature, which in itself is a sufficient condition for the transaction to be executed. Obviously, nothing prevents the use of the same mechanism for traditional assets management. Certainly, this will require a change in infrastructure, but will bring many benefits. It will reduce costs, and increase the speed and security of trades.

Another one innovation can be explained via asset management infrastructure that directly or indirectly includes the following components: a depository, an exchange, a payment system, and a wallet. Tokenization assumes that all the asset management infrastructure components will be far more integrated. And the use of blockchain technology will allow decentralizing the entire infrastructure, distributing the storage and processing functions between all the parties involved. As a result, it is possible for us to outline three tokenization principal domains:

  1. Using cryptography to manage accounts
  2. Interaction of system components through open API
  3. Decentralization of audit and decision-making

In terms of the system functionality, plug-in modules for business logiс and smart contracts will appear; in terms of security – the possibility of real-time transparent audit with access to results for all parties, as well as guaranteed synchronization of data between participants of the trading processes; in terms of management – the opportunity for joint management of assets that do not require trust; in terms of speed – calculations within a few seconds, not days; and finally, in terms of convenience – the ability for any software to work with any trading platform.

More digital value

Tokenization allows you to increase the speed, security and convenience of operations as well as to reduce the need for intermediaries. Among them is the addition of properties of assets that are not initially inherent. For example: the ability to prove the history of ownership, the opportunity to divide assets into the smallest fractions, and the ability to integrate principles of management into the asset itself (e.g. involving multiple owners of a property in the question of its repair). In addition, a tokenized asset will be more valuable than a physical equivalent, and this can be demonstrated by the following example.

Would you take a pill that you saw on the counter in the pharmacy? Of course not, you don’t know anything about it! But what if this particular pill is in a package with instructions and details from the leading manufacturer of medicinal products? And, in addition to the packaging, you have a prescription from your doctor? And if, (imagine this possibility), you could independently test the chemical composition of the pill and make sure that it coincides with what is written on the packaging and with the prescription of your doctor? Or (moving to 2049), you could verify that the chemical composition of the tablet is suitable for DNA and is it confirmed by clinical studies. Would this pill be much more valuable to you? Undeniably. And its value increases depending on how much information about it you have. Interestingly, the actual properties of the pill did not change at any same time!

Obstructions to progress

Very often people associate tokenization simply with the creation of a token on a public blockchain. Besides problems with regulation (especially KYC/AML), the gap between the tokenization of the asset and the release of a token on the blockchain is approximately the same as keeping accountancy information in QuickBooks as opposed to keeping the details on paper. Blockchain itself only provides the function of storing information about the asset, with limited capacity to carry out transactions.

Any complete tokenization system will include:

  • The privileges of users and system administrators management
  • Life-cycle management of an asset (issuance, withdrawal, redemption, limits, fees etc.)
  • Security management
  • Integration of KYC, AML and scoring systems
  • Integration with payment gateways
  • Integration with depositories and custodians
  • Mobile and Web apps
  • Exchange modules or integration with external exchanges

It is likely that in the future each organization that manages some asset will own its own tokenization system – just like now it has its own accounting system. Proper framework makes it possible to reduce time to market, total cost of ownership and integration risks. The only challenge now is the lack of standardized approaches to tokenization.

The formalized tokenization processes will help to develop a unified approach to the digitization of assets, which in turn will accelerate and simplify the creation of a fully automated digital economy. Having best practices standardized that will reduce time and efforts’ loss as well as integration and deployment risks; strengthen a security level; make TCO predictable.

Firmly believing in the importance of the tokenization processes and already engaged for three years in similar projects, Distributed Lab has started developing an open framework for creating industrial tokenization platforms, called TokenD. The framework incorporates the technology and best practices for designing all the components needed to create an integrated infrastructure. It includes a description of security standards, architecture, wireframes, quality standards and even open-source code for system modules. Some of the materials are already available on the site tokend.org. Distributed Lab helps to create turn key solutions based on this framework. The ultimate goal is to build a framework that can be used easily and via any organization, the same way as WordPress is used to create web-sites.

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