How tokenization transfers physical assets to the blockchain

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How tokenization transfers physical assets to the blockchain

Tokenization is the process of transferring rights to an asset to a digital token on the blockchain. Financial intermediaries and specialists are very interested in the issue of moving physical assets to the blockchain in order to use the capabilities of Bitcoin technologies, while preserving the characteristics of the asset.

Why do we need tokenization of “real” assets

Our world is full of various assets: stocks, real estate, gold, carbon credits, oil. Many of them are difficult to translate physically, so buyers and sellers prefer to trade documents representing these assets. However, this is a rather difficult and difficult process to track. As one of the possible solutions, it is proposed to switch to a digital system similar to Bitcoin, but tied to an asset.

Most commodity exchanges have already switched to electronic transactions and standardized agreements, but they incur high costs and rely mainly on trusted participants. Now financial companies and startups are working on creating systems that will be the next stage in this evolution: tokenized assets. But why do we need a digital token representing a physical asset, and how can it be created?

Imagine that Jane is a $ 15 million diamonds wholesaler. Diamonds are difficult to send to customers, as this requires a security system to ensure there is no fraud in the supply chain. Joe does not mind investing several thousand dollars in diamonds, but he does not want to deal with the problem of their physical receipt. Ideally, Joe would prefer to own a small portion of diamonds, determining his position in this market.

Jane does not want to waste time searching for Joe and selling diamonds; She just wants to find an easy way to split her diamond stock and sell it in parts. Joe wants to be able to sell his equity right in diamonds. Such an opportunity to make all participants happy is a kind of promise of blockchain tokens representing physical assets, as well as the opportunity to democratize ownership of interesting categories of assets.

There are many ways to put physical assets on the blockchain. The challenge is to achieve the safety, speed and ease of transferring bitcoins connected to physical assets. This is a new form of the old model: “securitization” (turning a set of assets into securities), and in some cases – tokenization of securitized assets.

What types of assets can be placed on the blockchain?

Intangible assets

There is a type of asset that lawyers call intangible. They exist only thanks to the law, a physical object is absent. Examples of intangible assets are patents, carbon credits, trademarks, copyright, and the like. Non-physical intangible assets are easier to combine with blockchain-based systems.

It is easier to tokenize intangible assets than physical objects, since there are fewer problems with regard to storage and dispatch.

Fungible assets

Lawyers share interchangeable and non-interchangeable assets. An interchangeable asset is an asset that can be replaced by another identical entity. For example, wheat, gold or water. Interchangeable assets are much easier to convert to tokens, as they can be divided into smaller units, like bitcoin.

Tokenization of interchangeable assets does not require an abstract layer. To tokenize non-interchangeable assets, such a layer is necessary. For example, a company that groups assets and offers them a package. This method is used for securitization of mortgage loans, when a set of loans with unique characteristics is combined into a group with approximately the same characteristics.

It is usually easier to tokenize interchangeable assets, since a common set of tokens is tied to a common set of interchangeable components of an asset (for example, 10 kg of gold).

Transfer of ownership versus transfers of limited rights

There are many types of asset transfers and many types of asset rights. In some cases, only limited rights associated with the asset are transferred. For example, a loan to use land for a limited period of time instead of transferring ownership of land.

Blockchain projects in total can be divided into those that imply tokenization of partial rights, for example, licensing music, and those that imply tokenization of all property rights, for example, the sale of real estate.

Ensuring Token Interaction

In a digital system like Bitcoin, there is always interaction. Transactions are subject to the rules of the software product, there are no exceptions. Gold bars can be stolen, houses burned, music can be unlicensed, and diamonds can not be delivered. People do not always obey the rules. Therefore, the main problem of any system involving the tokenization of physical assets is to ensure that digital tokens are attached to a physical asset.

Legal models

1. Licensing
Music licensing is highly dependent on documentation and trust. So, musicians believe that they are given accurate information about the sales of their music. Since streaming video and digital downloads significantly reduce the physical sales of musical works, music becomes the first candidate for tokenization. If the right to possess music were represented on the blockchain, many participants in the creation of music could have their own shares set electronically. Ideally, to listen to any of their works, “unlocking” and payment would be necessary, which would then be distributed among the established holders.

An example of content token ownership and licensing is SingularDTV.

2. Trading systems
Take a group of companies wishing to trade oil with each other. Under normal conditions, they will exchange documents and will keep their own sales records. If they switched to a blockchain-based system, they could reduce paper work and provide more reliable accounting. Currently, many consortia are working on this goal. In fact, they do not seek to tokenize real assets directly, but want to use a blockchain-based system to facilitate trading in physical assets. This is a hybrid of the old documentation approach and the new blockchain approach. Tokens have value only in the context of a contract system that includes all past and future participants.

An example of such tokenization is the IBM-Natixis-Trafigura oil trading project. There are also tokenization schemes implying limited use of property, for example, Slock.it.

3. Payments
Imagine a reproduction of a famous artist. Reproductions can be tokenized by transferring ownership of them to a company that has a constantly open offer to pay tokens for each reproduction or part of the cost of the reproduction. Physical delivery of reproductions can be done at the specified address. Thus, buyers receive an easily transported token, and third-party markets receive the ability to translate reproductions in parts. In the future, for the artist this can become a source of financing, and for ordinary people – a way to participate in the art market.

This model is based on the fact that the company – the owner of the work of art – must constantly offer payments.

An example of such a model is Tether.

4. Storage and smart contracts
Imagine a repository of gold. Gold is owned by Goldowner Inc, and the vault is owned by Vault Inc. Vault Inc has an impeccable reputation and third-party auditors confirming that gold is in storage.

Goldowner Inc can offer people a digital token representing the right to own gold, or through a smart contract with Vault Inc, maintain a public register outside the blockchain linking the equity property right to gold with tokens. For each token sold, Goldowner Inc transfers the ownership of Vault Inc, which owns it as the owner of the token. Vault Inc guarantees gold payments to anyone who can prove ownership with a digital signature.

Why do you need to tokenize gold? One of the advantages is that buyers of tokens will know that only they received this token, while buyers of a paper certificate cannot be sure of this.

Two examples of gold tokenization are startups Vaultoro and Orebits.

Intersection with world laws

Quite often, the sale of equity ownership of assets (without government permission) is prohibited by law. Due to the default global nature of the blockchain, this can be a problem for organizations involved in tokenization, or operators of sites where tokens are sold. These problems are especially complex because they involve conflicting laws (such as a Chinese seller and an American buyer).

Digital tokens are tied to real assets and ultimately relate to a real entity that the regulator can track. This makes it difficult to avoid regulation.

Centralization problem

One of the main advantages of Bitcoin over non-blockchain systems is that it is decentralized. However, physical assets usually have one or more owners.

Many asset-based token models involve an open offer of payments by the holding company of physical assets. If the holder of the central asset fails, the whole model may fail.

Are legal changes necessary

Some types of physical assets cannot be transferred to the blockchain without the adoption of certain legislative changes. In some countries, there are rules requiring assets to be transferred in a specific form or registered in a specific way, which is not suitable for a token-based system.

Tokenization of real assets is a very serious problem that needs innovative solutions that go beyond technology. In some cases, this requires a legal platform, in others, a combination of existing legal rules, new business structures and new digital token systems.

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