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May 28, 2021

Asset Tokenization: A Guide for Financial Institutions and Fintechs

By: Algorand

Bitcoin was the first use case of blockchain, but the reach of this innovative technology is immense as it doesn’t boil down to a money system only. Blockchain can do a lot of things, but its game-changing potential has to do with its ability to tokenize everything, including digital and physical assets.

While the impact of blockchain and its ability to tokenize assets is not fully perceived at the moment, this will become the norm in the years to come, as major players of traditional finance are gradually adopting the technology.

In this guide, you will learn about asset tokenization and the role it will play in the future of finance. You will also discover a list of tokenized assets operating on the Algorand blockchain. 

What is Tokenization?

Tokenization will revolutionize the way we invest and trade assets, but what is it, and what does it promise? 

Tokenization refers to the issuance of blockchain tokens representing real tradable assets, whether it’s about company shares, commodities, art, real estate, and money, among others (and yes, “among others” can refer to everything).

Thus, blockchain can transform many industries and the way investors interact with businesses and brokerage firms. Thanks to its decentralization feature, blockchain can enable the creation of borderless networks where investors, businesses, and communities can interact with each other without a central authority.

Tokenization is poised to become the next big thing in the financial markets because it provides the following benefits:

  • Liquidity – By converting real-world assets to blockchain tokens, issuers can secure greater liquidity. For example, private securities are typically illiquid, which affects the trading process on secondary markets. Thanks to tokenization, this problem can be addressed to give investors more freedom to implement various strategies on scarcer assets.
  • Fractional ownership – One of the most important features of tokenization is the ability to own fractions of an asset. For example, as an investor, you might be interested in getting exposure to the real estate market by owning property in the best region. However, you might not hold enough funds to buy a single property, let alone create a real estate portfolio. If every property would be converted into multiple tokens, you could own a portion of it or shares of multiple properties and thus benefit from their potential price gains. By holding a token or several of them, you hold the definitive proof that you are the owner of a share of that property.
  • Faster and cheaper transactions – Modern blockchains enable fast and low-cost transactions, and this relates to the tokenized assets as well. For example, Algorand relies on a consensus mechanism called Pure Proof of Stake, which was invented by MIT professor Silvio Micali. The algorithm ensures that the network has high throughput and low fees. This could speed up the adoption of tokenization as the main approach to deal with real-world assets.
  • Transparency – Blockchain has become one of the most important technologies thanks to its unique attributes, including immutability and transparency. Once a blockchain transaction has achieved finality, it cannot be reversed, canceled, or tampered with in any way. The good news is that Algorand ensures that transaction finality is reached in less than 5 seconds. This allows all network participants to monitor data almost in real-time and be sure about the authenticity of transactions. 
  • Convenience – Several decades ago, the main form of communication between investors, brokers, and market makers was done by phone. There were no online accounts and no advanced charting options right in your pocket. Today, everyone can get exposure to stocks by buying shares or speculate on their price via derivatives through online platforms. The internet has transformed the way we invest, but blockchain can do even more by making the investment process more convenient and accessible.

Tokenized Assets to Transform Financial Market Infrastructures

Cryptocurrencies have experienced an impressive evolution, but their underlying technology is getting to traditional markets as well. The most likely scenario is that tokenized assets will become the essential mechanism through which investors will get exposure to various markets, including equities, commodities, real estate, and art. The benefits are too evident to be ignored, and many traditional finance players are already rolling out tokenization services.  

For example, SIX Swiss Exchange – the principal stock exchange in Switzerland – is developing a proprietary blockchain platform to tokenize traditional securities, such as company shares. The new platform is run by SIX Digital Exchange (SDX).

SIX CEO Jos Dijsselhof commented:

“This is the beginning of a new era for capital markets infrastructures. For us it is abundantly clear that much of what is going on in the digital space is here to stay and will define the future of our industry. The financial industry now needs to bridge the gap between traditional financial services and digital communities.”

Thanks to the tokenization of assets, financial markets will become more active, fair, and transparent. The emerging trend can reach every part of all peripheries of traditional finance, including venture capital.

During a World Economic Forum (WEF) panel organized last year, participants concluded that we’re advancing from isolated token assets to a whole token economy, with tokenization being capable of enhancing infrastructures without causing systemic financial risks.

This may be indeed the beginning of a new era for financial markets, but there are several challenges to be addressed until wider adoption is reached, especially when it comes to tokenizing stocks or real estate:

  • There are still no standards and regulatory clarity – While cryptocurrency can theoretically exist without any regulatory supervision, the so-called security tokens are meant to represent real-world assets, and thus they automatically fall under the purview of regulators. Unfortunately, there is no general consensus on which major rules should be implemented to enable the tokenization and trading of digital assets representing equities and other traditional assets.
    Thankfully, the European Union (EU) is very supportive of blockchain, but it doesn’t focus too much on tokenization, even though it’s working on a new law for cryptoassets. Elsewhere, the US Securities and Exchanges Commission (SEC) issued a statement at the end of 2020, saying that it encourages tokenization but within the current regulatory boundaries. Sooner than later, major regulators will be forced to align their regulatory frameworks to adjust to the increasing demand for tokenized assets.
  • There is no digital identity that is recognized internationally – The other major challenge has to do with the difficulty of transferring tokenized assets across citizens of different jurisdictions. For example, how can a US resident transfer his token representing real estate to a citizen from an EU member country? This issue hinders the creation of borderless tokenization platforms with a global reach.

Considering the major regulatory challenges, the wider adoption of tokenized assets is expected to be gradual, though regulators won’t be able to withstand the new trend but rather lead it in a certain direction.

Tokenized Assets versus Traditional Assets

Tokenized assets are much faster, flexible, secure, and convenient compared to traditional assets, and the Algorand infrastructure takes these attributes to the superlative.

Some types of traditional assets are illiquid by their nature, e.g. real estate, art, or private equity. On the other end, tokenized assets can ensure liquidity and greater access to a broad range of investors.

When it comes to traditional assets, including equities, fixed-income (bonds), real estate, commodities, and art, their blockchain-based digital representations could automate processes, reduce costs, bring more liquidity, and ensure a better user experience when it comes to investing and managing these assets. All in all, there is a big difference between traditional assets and their tokenized versions, and the latter are the clear winners.

Algorand enables the tokenization of all types of assets by facilitating the creation of fungible tokens (which can be used for tokenizing commodities and bonds), non-fungible tokens (which work best for art, real estate, and some precious metals), as well as security tokens (they are ideal for equities).

Examples of Tokenized Assets

The Algorand platform has already been implemented for tokenization use cases, which helped businesses and organizations streamline processes.

Businesses and other entities can tokenize any type of assets through Algorand Standard Assets (ASA) within minutes. Tokenizing through ASA means that you benefit from Algorand’s Layer-1 blockchain, andan unforkable network with high throughput and unbreakable security.

Here are some examples of real-world assets that have been tokenized with Algorand:

  • Private equity – BridgeTower Capital announced a partnership with Algorand to issue a BridgeTower Capital tokenized digital security that will allow investors to get exposure to the company’s portfolio through digital securities in the form of tokens built on Algorand.
  • Commodities – Australian tech firm Meld Gold has built a platform for trading tokenized gold in the form of ASAs. Meld users can buy both physical and digital gold. Thanks to Algorand, Meld’s platform offers several key benefits, including increased efficiency, transparency, liquidity, security, and better pricing. Meld has also used Algorand to tokenize silver.
  • Real estate – Vesta Equity, a global home equity marketplace, said that it would use Algorand’s Layer-1 to build a solution to facilitate residential property financing and investing. Vesta’s blockchain-based platform will connect property investors to homeowners and provide the needed tools to trade seamlessly. The solution enables homeowners to keep debt-free while retaining their full residential rights.
  • Stocks Microequity Stock Exchange (MESE) is a product by the International Blockchain Monetary Reserve (IBMR). It uses Algorand to tokenize tech stocks by issuing fractions of shares called microequities. Each token represents 1/10,000th of a stock. Currently, MESE supports Apple, Amazon, Google, Twitter, Tesla, Microsoft, and Netflix.

Algorand can also be used to tokenize art and memorabilia through non-fungible tokens (NFTs), which have been making headlines since the start of the year. Algorand’s NFT technology has been successfully used by SIAE (Società Italiana degli Autori ed Editori), the largest copyright collecting agency in Italy. The agency issued 4 million NFTs representing the rights of its more than 95,000 member authors. It took SIAE only several hours to tokenize the copyrights at the lowest cost possible. If the agency went for another major blockchain supporting NFTs, it would have done it in days.

Algorand’s Layer-1 is fast, secure, and transparent, which makes the best infrastructure to tokenize financial assets. As of today, Algorand processes over 1 million transactions per day, and the network supports over 4.5 million assets.

Thanks to its unique features, Algorand is poised to lead the tokenization trend.

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