What is Tokenization?

Tokenization leverages blockchain technology to improve upon inefficiencies in the traditional finance market including the illiquidity of physical assets and the high cost of securitization.

The market for tokenized real world assets (RWAs) onchain is forecasted to reach upwards of $16 trillion by 2030.

What are the benefits of tokenization?

Tokenization is a powerful blockchain use case that will increase the liquidity, composability, and transparency of nearly all valuable physical assets and securities. 

The Capital Efficiency Case for Mass Adoption of Tokenization

Assets with identical cash flow distributions that would otherwise have the same value, differ by up to 25% in market value when comparing liquid and illiquid assets. In fact, when the illiquidity horizon is 30 years (such as with large real-estate developments, industrial plants, or mining rights), the difference in the relative valuation between the two assets can be as much as 43 percent. 

For this reason, the most capital efficient primitives will be adopted by the market over the long term. Today, securitization is widely used to increase capital flow, but tokenization is beginning to show clear benefits over securities.

Tokenization on public blockchains such as Ethereum allow for novel access to untapped liquidity pools and lucrative new financial primitives being developed by the rapidly-growing decentralized finance (DeFi) industry. Blockchain connects retail investors and the balance sheets of large corporations alike by providing new sources for yield. 

Corporations currently seek out large institutional purchasers of assets such as carbon-credits, while blockchains allow the seamless transfer of these industry-specific assets within a global marketplace to other institutional or retail investors. This $1.16 trillion market still faces the same liquidity and composability issues as other traditional assets.

The total value of physical assets is upwards of $520 trillion. Of these, the largest components are traditionally illiquid assets such as natural resources, real estate, and infrastructure. 

What are the composability benefits of blockchain tokenization?

Financial markets are heavily siloed by asset types, geography, industry, and regulations leading to inefficient markets. 

Blockchain technology enables instantaneous, global settlement of composable tokenized assets within these distinct, siloed markets. There are currently trillions of dollars in capital inefficient markets that stand to be disrupted by the innovation of blockchain. 

Securitization has high costs from underwriting, transacting, and legal proceedings. Tokenization offers a far cheaper, digital, and more scalable solution through smart contract based validation and execution. 

The Ethereum blockchain’s computational language, EVM, contains the dominant amount of capital and composability. Digital assets on Ethereum natively integrate with thousands of dapps and DeFi protocols. 

Private blockchains are currently in use by JPMorgan and Blackrock for the interchange of assets. Private (permissioned) blockchains are secure, enterprise grade blockchains with shared infrastructure for the exchange of assets and resources within a closed pool of partners. Public (permissionless) blockchains like Ethereum are open for public participation. 

JPMorgan and Blackrock’s foray into tokenized collateral settlements on the permissioned Tokenized Collateral Network (TCN) indicates a shift towards a more composable solution for physical asset management within corporations. JPMorgan Onyx’s initiative to tokenize collateral infuses traditional assets with greater composability within their permissioned ecosystem and unlocks new pools of liquidity. 

What are the transparency benefits of blockchain tokenization?

Blockchain technology's transparency benefits are well-documented, providing institutions with a robust and immutable ledger system that ensures trust, security, and operational efficiency in financial transactions.

Maintaining and propagating accurate and up-to-date records between centralized, siloed marketplaces can be difficult and resource intensive. Financial products lacking transparency in asset health, quality, and history lead to capital inefficiencies. 

The 2008 financial crisis was propagated by the obfuscation of low quality mortgages buried deep within AAA-rated bonds. The lack of transparency surrounding the individual assets in MBSs made it impossible to evaluate health or quality of the security, leading to high risk investments. The transparency of permissioned and permissionless blockchains lends to preventing similar catastrophes from happening in the future.

Using blockchain reduces overhead costs for transacting parties by eliminating redundant transaction data and validating transactions on a common ledger. Transparency in financial and procurement functions can help drive costs down by 11% for corporations and provide insight into customer and client asset history. 

What are the most popular use cases for Tokenization?

There are many different use cases for tokenizing real world assets such as stablecoins, credit, bonds, and more.

Private Credit and Collateral

JPMorgan’s Onyx, an Ethereum based permissioned blockchain, has processed close to $700 billion in short-term loan transactions and has been revolutionizing interbank settlement with entities from around the world. Their partnership with Blackrock and Barclays marks the first collateral settlement for a live client over-the-counter (OTC) derivative transaction. 

By tokenizing assets on the Tokenized Collateral Network, institutions are able to interface with blockchain settlement technology to transfer ownership of digital assets as collateral, unlock new pools of liquidity, and take advantage of token transaction programmability and immutability.

Bringing private credit onchain provides a line of credit in the form of stable currencies to emerging markets plagued with currency debasement. Lenders are able to collect stable yield from a previously untapped market. With the private credit market sitting at ~$1.5 trillion and expected to grow to $2.3 trillion by 2027, building solutions that leverage tokenized collateral is a highly lucrative opportunity. 

Treasury and Bond Market

In 2021, Franklin Templeton launched the first tokenized US mutual fund on the Stellar network. Tokenizing bond and treasury funds allowed Franklin Templeton to earn fees for injecting liquidity into the web3 ecosystem via US treasuries. Their early entry advantage made them a juggernaut in the blockchain treasury market with over $300 million in assets under management in their tokenized money market fund.  

Tokenizing treasuries and bonds onchain is the gold standard of real world asset tokenization. The stability of tokenized United States debt reduces trading volatility within web3 markets and is a safe haven for onchain investors. The existence of stable, high yield bearing assets onchain also provides a good benchmark to track the health of DeFi markets. Tokenizing bonds increases their composability and liquidity. 

Fiat Currency

Within less than a decade of operation, Circle is approaching annual profits of $1 billion by issuing a tokenized version of the U.S. Dollar. Circle’s product, USDC, is an onchain token backed by dollars and treasuries held by Circle.

Stablecoins are a superior Dollar, capable of digital programmability and composability within DeFi protocols. Stablecoins also provide stability to refugees of war and inflation instantaneously across the world. 

Public Equity

Demand for the onchain expansion of the hundred trillion dollar public equity market is immense. Tokenization of public equity brings stocks and securities onchain in the form of digital assets. The ability to seamlessly transact tokenized public equity without intermediaries, long processing times, or borders is an undeniable advantage over traditional securitization. 

Tokenization of public equity has been difficult due to heightened government regulations and scrutiny. Once regulations are made clear, the business opportunity will be unmistakable. 

Real Estate

Losing the title to your property could result in significant financial and legal complications. Such antiquated processes are ripe for disruption in the digital age. 

High quality, prime mortgages have been a highly sought after investment vehicle for institutional and retail investors. The introduction of mortgage-backed securities (MBS) provided investors with a means to invest in these fixed income assets without direct exposure to any one mortgage or involvement in the mortgage process at all. Tokenizing mortgages, either directly or through securitization, provides liquidity to the housing market and transparency to investors.

The real-estate crowdfunding company HoneyBricks has taken a unique approach in this field, offering fractional ownership in multi-family real estate that pays yield derived from rent.

How to Choose a Blockchain Infrastructure Partner

When tokenizing assets it is important to decide between deploying on a permissioned or permissionless blockchain. Permissioned blockchains excel at providing shared infrastructure for corporations looking to share assets and resources within a closed pool of partners. Permissionless blockchains allow for public participation and typically enjoy greater decentralization and liquidity. 

Once an asset class has been identified for tokenization, an in depth analysis must be conducted to verify legality and regulations surrounding tokenization and accurately appraise economic value of the assets. 

The development of permissioned blockchain requires an infrastructure partner with enterprise grade blockchain architecture and/or existing hardware for node deployment. Though less demanding, deploying on a public blockchain still relies on RPC infrastructure, blockchain specific SDKs, and tooling available through enterprise grade infrastructure providers. 

Real world asset tokenization requires high quality, real-time data to satisfy smart contract (onchain logic) functionality. Oracle providers play a crucial role in the sustainment of onchain assets and is one of many factors to consider when choosing a blockchain infrastructure partner.