What is tokenization: Benefits and use cases

The advent of blockchain brought with it more than cryptocurrencies, web3, decentralized finance (DeFi) non-fungible tokens (NFTs), and the metaverse. It also allowed physical items like gold and houses to be put on Bitcoin and Ethereum. Here, we look at what is tokenization, its benefits, its risks, and where it can be used in the real world.

What is tokenization in the blockchain space?

Simply put, tokenization is the process of converting ownership rights of real-world assets into blockchain-based tokens. The tokens can represent full or partial ownership of the tokenized commodity. The tokens are tradable on a blockchain.

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What is a simple example of tokenization? Let�s say you want to tokenize a house with 10 rooms. You can decide to offer a token that represents the ownership of the whole house or you can decide to offer several tokens with each representing ownership of a single room.

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When tokens provide partial ownership of the house, each person who owns the token owns a section of the house.

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Another example is when a $20,000 gold bar is tokenized into 1,000 tokens making it easy for multiple people to own part of the gold bar without worrying about how to store the physical gold bar.

How does tokenization work?

The tokenization process starts at the issuance stage where the owner of the physical item decides to issue ownership on the blockchain. This is done with the help of experienced blockchain companies.

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Next is securing both the physical and digital versions of the asset or commodity. Custodial services can be used to secure the physical assets while smart contracts can help guarantee the security of blockchain tokens. Smart contracts also help track the movement of the tokens on the blockchain.

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Addressing the issuance and security/custody part opens up the tokens for trading on centralized and decentralized exchanges. 

What is tokenization: Benefits

• Decentralizes access - Tokenization decentralizes an asset's ownership and access without compromising the asset's security and authenticity. Tangible and hard-to-move assets like gold have been left for the rich due to their high upfront costs. With tokenization, they can be fractionalized making them affordable.

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• Enhances the liquidity of assets - Things like real estate, precious metals, and energy sources are highly illiquid. It takes a lot of time to turn them into cash equivalents. Tokenization increases their liquidity. Tokenization also removes intermediaries making trading of these assets less cumbersome, lengthy, and costly.

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• Improves transparency - Data stored on the blockchain is largely unchangeable. As such, tokenization improves the transparency of transactions thus boosting the confidence of investors.

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• Linking the physical and virtual worlds - Tokenization helps unite the physical and virtual worlds. This allows entities to own a piece of a physical item without worrying about things like the paperwork and location.

What is tokenization: Risks

• Security risks - Although tokenization has a lot of advantages as we have seen above, it�s also prone to security risks just like other blockchain projects. Some of the risks include hacks and smart contract code exploits.

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• Regulations - Regulations around virtual assets are a gray area in most countries, including the United States. Countries are in a dilemma on whether to create new laws to govern the space including tokenized assets or use existing finance laws to govern digital assets.

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• The liquidity dilemma - What if the tokenized asset fails to gain marketwide adoption? Will tokenization have increased the liquidity of the asset? Most of the benefits of tokenization are realized when the targeted audience embraces the tokenized asset.

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• Linking the digital with the physical - There�s still some complexity around how to manage physical items using blockchain technology through tokenization. This introduces operational challenges since issuers and investors are required to embrace new infrastructure to manage blockchain-based assets.

What is tokenization: Use cases

• Real estate - Real estate is among the sectors poised to benefit fully from tokenization. Tokenization in the real estate sector helps investors to trade shares of different properties with ease.

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• Bonds - Bonds can be tokenized and functions like settlements and interest payments automated using blockchain technology.

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• Other tokenization use cases - Other things that can benefit from tokenization include carbon credits, precious metals, agricultural products, and energy sources.

Conclusion

In our above discussion on what is tokenization, it�s evident that it's the process of merging the traditional space with blockchain technology. The process helps increase physical assets� liquidity and also removes geographical barriers allowing the assets to be owned or traded by entities across the world.

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Tokenization isn�t always a smooth path as it inherits the risks found in the crypto/blockchain sector like hacks and smart contract code exploits.