Tokenization: A complete guide

• Tokenization allows nearly any assets to be tracked in a transparent and highly tamper resistant way.

• Beyond its benefits of increased liquidity and greater accessibility, tokenization allows for fractional ownership of previously indivisible assets.

• From art and collectibles to corporate bonds and commodities, a variety of assets are being tokenized on blockchain networks today.

Tokenization refers to the process of representing real-world assets (RWA) on the blockchain using cryptocurrency tokens. 

Fine art, company stocks, and even intangible assets like intellectual property are just some examples of what things can exist on the blockchain through tokenization. 

In the current financial landscape, poor liquidity and accessibility are prevalent issues with certain types of assets. 

Real estate assets like commercial property, for example, are traditionally regarded as illiquid. In other words, it’s difficult for owners to sell up their properties quickly for cash. The process can take months to finalize, and that’s assuming there are willing buyers in the market to begin with.

Additionally, investing in commercial real estate generally remains an exclusive privilege reserved for financial institutions or ultra high net-worth individuals. Prices can range in the hundreds of millions, excluding all but the wealthiest of investors. 

Among many other benefits, tokenization aims to address these problems.

While tokenization may sound complex, the concept has roots in traditional financial practices like securitization. This involves aggregating similar assets into a single tradable security. 

Tokenization extends the concept to a much wider range of tangible assets and non-physical assets. 

Furthermore, issuers are not limited in the number of tokens they can issue for each real-world asset. A person or company may decide to mint tens of thousands of tokens representing a single building. This divisibility allows for fractionalized ownership, where multiple parties can purchase and own small pieces of a single item. 

This has the potential to dramatically reduce the cost per unit or share, making big-ticket items more accessible to a larger market of potential buyers.

Smart contracts and token standards

Smart contracts and specific token standards are key building blocks that allow blockchain developers to tokenize assets.

Smart contracts are software programs that automatically execute the terms of an agreement when predetermined conditions are met. They can be thought of as “if this, then that '' computer programs. 

The ability to automatically execute predetermined rules is what makes smart contracts an integral component of tokenization.

You can learn even more with our article, What is a smart contract?

Token standards set out standardized functions and features that tokens must adhere to in order to be compatible with a Layer 1 blockchain’s broader ecosystem of assets and decentralized services. 

Ethereum (ETH) and Solana (SOL) are just some examples of popular Layer 1 blockchains that each feature their own token standards.

It is the combination of smart contracts and carefully designed token standards which allow developers to represent physical objects, legal rights, and financial products like investment funds on-chain. 

Ethereum’s ERC-1400 and ERC-3643 token standards are among the most commonly used to quickly deploy blockchain-based tokens linked to real-world assets. 

Tokens launched using these standards differ significantly from other types of cryptocurrencies like:

• Bitcoin (BTC)

• XRP (XRP)

Using the ERC-3643 standard, for example, developers can implement specific transfer rules to meet current regulatory requirements. Token issuers also maintain full control over each token during its lifecycle, no matter who owns it. 

How to tokenize a real-world asset

While the tokenization process can vary from platform to platform, there are four fundamental steps that most developers usually follow.  

1. Select an RWA to tokenize

2. Choose a blockchain platform to issue the tokens on

3. Define the token’s properties

4. Mint on-chain

After deciding which real-world asset to tokenize, the process begins by creating smart contracts on blockchain platforms such as Ethereum (ETH), Solana (SOL), or Avalanche (AVAX). 

These smart contracts outline the crypto token's properties, answering questions such as: 

• How many tokens will be issued initially, and how many can be issued later?

• What asset/form of value do the tokens represent?

• Will the tokens be fungible or non-fungible?

• What dynamic regulations must the tokens, their issuance process, and their holders adhere to?

• Can the tokens be traded on the open market?

• Will the tokens also represent governance rights for their underlying asset?

• Will the tokens accrue dividends? If so, how will they be distributed?

• Can the tokens be redeemed for their underlying asset? If so, how is delivery of the asset handled?

Once minted on-chain (created and verified on a blockchain network), some RWA-backed tokens may be subject to ongoing monitoring to manage distribution and ensure their compliance with regulations.

This responsibility may fall on the issuer or a third-party such as an exchange or bank. 

Blackrock’s tokenized BUIDL money market fund is one example of a regulated, traditional financial product based on the blockchain that involves several trusted intermediaries. 

Depending on the type of RWA-backed token and its eligibility requirements, trading may be available via decentralized crypto exchanges such as Uniswap (UNI), specialized platforms such as Archax, or via banks like BNY Mellon. 

As new platforms and services emerge, it’s becoming increasingly easier to deploy these new types of digital assets. 

For example, Centrifuge (CFG) employs liquidity pools where issuers can quickly tokenize their real-world assets and post them as collateral to receive crowd-sourced capital. 

In return, people who provide liquidity, expect to receive a return on their investment based on whatever assets the token issuer purchases using the pooled funds (U.S. Treasuries, real estate, etc).

Tokenization aims to improve several areas associated with asset management, trading, and ownership. Some of its key advantages include: 

• Democratization of investments: By lowering minimum investment thresholds through fractional ownership, tokenization can make it possible for small investors to participate in markets previously reserved for high-net-worth individuals or institutional investors. This may increase accessibility and help promote financial inclusion.
• Increased liquidity: Tokenization can convert illiquid assets, such as real estate, into fractional shares that can be bought and sold via blockchain-native exchanges more easily. Creating more accessible financial markets for illiquid assets might help to reduce certain friction points that are typically associated with buying and selling these assets. These include high transaction costs and inefficient pricing (i.e., wide bid-ask spreads).
• Global access: Crypto exchanges like Kraken, as well as decentralized finance (DeFi) and non-fungible token (NFT) marketplaces including Jupiter (JUP) and Blur (BLUR), facilitate 24/7 trading across global markets. This allows for around-the-clock trading for people all over the world, breaking down geographical barriers and enabling broader participation.
• Improved transparency and security: Each transaction is recorded by the blockchain network, ensuring transparency and immutability. This may help to reduce fraud risk and make it easier for investors to verify ownership rights and track the history of assets.
• Cost efficiency: Industry proponents have claimed that tokenization streamlines the process of buying and selling traditional assets by eliminating many of the intermediaries involved in these transactions, such as brokers and banks. They argue this can significantly reduce transaction costs and fees, making investments more cost-effective for both issuers and investors.
• Faster transactions: The use of smart contracts and blockchain technology can help to accelerate the settlement process. Transactions that would typically take days to clear using fiat currencies in the traditional financial system may be completed in minutes or even seconds using digital tokens (depending on the blockchain used and network congestion levels).
• Access to a wider range of assets: Tokenization can be applied to a wide variety of assets. From art and collectables to intellectual property, tokenization opens up new asset classes to traders, offering opportunities for portfolio diversification.

Some crypto analysts expect a sharp expansion of the tokenization market over the next five years, with 21.co projecting it to reach $10 trillion by 2030. 

Several early use cases and implementations of tokenization platforms include: 

• Art and collectables: The use of NFTs for art and collectables has exploded in popularity, with platforms like OpenSea and Kraken’s NFT marketplace facilitating 24/7 digital collectible trading. One famous instance is Beeple's "Everydays - The First 5000 Days" NFT sold for $69 million at Christie's auction house, representing a significant moment for tokenized art.
• Intellectual property: Myco allows creators to tokenize and monetize their intellectual property and earn crypto by watching content, offering a new revenue stream for artists and creators.
• In-game assets: In-game assets used in GameFi protocols or metaverse projects, like Axie Infinity (AXS) and Gala Games (GALA), can be represented as tokenized assets. 
• Corporate bonds: EV car company EGO in partnership with Mimo Capital AG recently announced the tokenization of its corporate bonds. The result is a significantly more transparent and efficient way to trade bonds without involving costly intermediaries.
• Commodities: HSBC Bank is among the early financial institutions that have begun experimenting with tokenizing gold and other commodities on the blockchain.
• Government securities: Ondo Finance and Backed Finance are two examples of blockchain-based platforms that have already issued tokenized U.S. Treasury Bills.

Future use cases for tokenization could potentially include sectors such as healthcare for patient data and medical records, energy for trading renewable credits, and education for credentials and certificates, offering new avenues for blockchain application and integration.

Despite its benefits, the tokenization market faces several challenges: 

• Regulatory hurdles: The regulatory environment for tokenized assets is still evolving. Legal frameworks vary by jurisdiction and asset class, creating complexity for issuers looking to tokenize financial assets and make them available to investors in certain geographies.
• Interoperability: The lack of standardization across different blockchain platforms can lead to interoperability issues. This makes it challenging for tokenized assets on one blockchain to be recognized or traded on another, potentially limiting their liquidity and appeal.
• Market adoption: While the concept of tokenization is gaining traction, widespread adoption across industries and asset classes is still in its early stages. Convincing traditional markets, investors and governments to embrace blockchain technology and understand the value of tokenized assets remains an ongoing challenge.
• Security concerns: Smart contract bugs, exploits, and vulnerabilities can pose significant risks. The increasing value and visibility of tokenized assets make this sector a target for hackers and scammers. Ensuring the security and legitimacy of tokenized assets and the platforms that manage them is crucial to maintaining investor trust. 

In summary, many believe tokenization has the potential to democratize access to investment opportunities, streamline transactions and create a more transparent and efficient financial system. 

However, realizing this potential will likely require continued innovation, supportive regulation and increased collaboration between the blockchain community and traditional financial institutions.

Kraken allows you to buy, sell and trade several cryptocurrencies that are leading the tokenization movement.

If you're interested in exploring the expanding universe of tokenized assets, including cryptocurrencies and NFTs, Kraken is your go to place to take part in the action.

Get started with Kraken to be a part of the tokenization movement today.