What is Tokenization?
Coinbase Institute: Insights Series
Tokenization is the process of creating a digital version of real-world assets on a blockchain. Tokens can represent many different types of assets, both financial and non-financial: cash, gold, stocks and bonds, royalties, art, real estate, and more. Essentially, tokenization allows people to buy, sell, and manage these assets more efficiently, using blockchain technology to reduce costs, speed up transactions, and increase transparency.
How it Works
Blockchains are distributed ledgers that contain an immutable record of transactions. They can also store software called smart contracts, which can be programmed with specific rules for creating, issuing, and trading tokenized assets. These methods allow parties to transact directly peer to peer. The code ensures that transactions are accurate and efficient, while keeping transaction data permanent and visible on the blockchain.
Tokenization, while nascent, has already led to applications transacting trillions of dollars of assets onchain each month. Demand for tokenized versions of cash has driven hundreds of billions of new purchases of Treasury bills, and tokenization of assets as varied as gold, real estate, diamonds, and art are cropping up globally.
Use Cases and Significance
Tokenization can bring significant benefits to many types of assets, including:
Risk Reduction: Tokenized assets make it possible to settle trades immediately, without the risk of one party not fulfilling their part of the deal. Autonomous smart contracts can settle trades, or send assets back to the original sender in the case of failed settlement. By decreasing the number of intermediaries, the technology minimizes the need for trust in other parties. This makes transactions safer and reduces the need for regulatory oversight of multiple different players.
Transparency: Public blockchains provide significantly more transparency into market structure and activity than is available in current financial markets. Providing a real-time representation of the location and status of all assets can help reveal and mitigate risk.
Interoperability and Open Access: Open-source and open-access blockchains allow anyone to participate. This means that small and newly formed companies can interact on an even playing field with established firms, increasing competition and innovation.
Liquidity: Tokenization can also allow markets to become more efficient and liquid. Currently, the purchase of a gold ETF with money held in a savings account will take multiple days to settle. But onchain assets can be effectively converted for each other—tokenized deposits for tokenized gold, in this example—dramatically reducing this timeframe.
Cost and Efficiency: Blockchains allow for automation in areas where traditional financial systems rely on manual operations or private processes. This innovation allows for cheaper costs and greater efficiency for all parties.
Conclusion
Tokenization has the potential to unlock important benefits for economies and financial systems. But the simple fact that assets have been put on a blockchain should not drive regulation. Treating on- and off-chain assets differently would threaten many of tokenization’s important benefits while also creating opportunities for regulatory arbitrage, particularly in cases where tax treatment differs or tokenized assets have more restrictive underlying frameworks. Regulators should aim to prevent arbitrage by harmonizing rules not only across jurisdictions, but across technologies—and in this case, across ledgers.
Building on this basic principle, it makes sense that, within the universe of tokenized assets, different types of assets will have different regulatory requirements. For example, issuers of stablecoins and other pegged-value tokens should likely be required to show proof of reserves and sufficient capital requirements. For tokenized tangible assets, such as real estate or artwork, considerations of physical custody, insurance, and intellectual property will come into play. These will have to be tackled asset class by asset class, not because of any fundamental property of blockchains, but rather because of the nature of the assets themselves.
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