Tokenization 101: What is tokenization?

Cryptocurrency Mar 1, 2022

Overview

People in crypto often use the word “token” without knowing what it means exactly. Most would agree that BTC is not a token while UNI (DeFi exchange UniSwap’s native token) is a token. So which assets you see on CoinMarketCap, CoinGecko or any other platforms are tokens and which are not? What’s the difference?

Since the presumed pseudonymous Satoshi Nakamoto developed Bitcoin in 2008, blockchain technology has gone from being a promising concept to being the future of technology. In this evolution, blockchain technology has created new models for business, and tokenization is one of the concepts that has been popularized by blockchain. In this series of articles, we are going to take a deep dive into tokenization and correlate it with the currently popular terms.

What is tokenization?

The idea of tokenization existed long before blockchain technology. For instance, casino chips are used to represent money; game tokens represent your access to play games in The Rec Room; banknotes authenticate your ownership towards the amount of asset. These are all different forms of tokens.

Tokenization, by definition, is the process of creating tokens as a medium of data. Tokens are often numbers and letters that represent highly sensitive data. Tokenization in the digital world was first attempted by TrustCommerce in 2001 to protect the sensitive credit card details of its users. Blockchain then magnifies the usefulness of tokens exponentially.

In the blockchain ecosystem, tokens are assets that allow information and value to be transferred, stored, and verified in an efficient and secure manner. These crypto tokens can take many forms and can be programmed with unique characteristics that expand their use cases. Depending on their use cases, crypto tokens can be security tokens, utility tokens, or governance tokens. Non-Fungible Tokens (NFTs) are also a form of the most common kind of tokens in the blockchain system. More information on NFTs can be found here.

The benefits of tokenization

Crypto tokens provide a lot of benefits that can be generalized into the following main categories.

Transparency: Crypto tokens live on a blockchain that runs on an open-source code. Users can view the provenance and transactions easily. Information stored on a blockchain is immutable. The immutability and transparency of tokens help guarantee the authenticity of each token’s history. These qualities enable crypto tokens to achieve a level of reliability that most other assets can’t match.

Liquidity attraction: Tokenized assets can be made available to a much larger audience. And because blockchain, especially DeFi, lowers or even removes the access barriers associated with an investment that are traditionally only accessible to the rich few, tokenization increases the market liquidity for things like fine art and real estate dramatically.

Fewer to no intermediaries: Blockchain technology allows the owner of the asset and its buyer to contact each other directly, thus eliminating the involvement of intermediaries. This significantly reduces the costs that would normally be spent on third-party services. Moreover, it usually may take hours or even days to transfer assets and conduct related transactions, but thanks to the blockchain this process can now be completed within a few seconds.

The risks of tokenization

Despite the benefits and growing interest in asset tokenization (crypto tokens), there are challenges and barriers in the way of tokenization. Regulatory issues, among the others, are the most concerning risk associated with tokenization at the current stage.

Crypto tokens often share common characteristics with financial securities but are not subject to the same regulations as traditional securities. This presents challenges to both regulators and blockchain businesses trying to balance innovation and compliance.

However, the current situation that crypto tokens face is not uncommon. It is in fact quite normal for any new technology or global trend. In history, many technologies have overcome hurdles to prosper and see mainstream use. However, this is not a given for crypto tokens, so it would be irrational to assume crypto tokens would overcome all the challenges.  

A mature regulatory environment will need joined force from all stakeholders including regulators, politicians, industry leaders, and even developers. In the end, courts need defined rules to arbitrate cases in the blockchain environment and cases where the blockchain environment and traditional world overlap, and investors want defined protections and the ability to seek recourse in situations that cannot yet be fully codified in smart contracts.

Read more on the Tokenization series.

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