Tokenization is a popular topic among cryptocurrency enthusiasts, but its current status and the technical and regulatory issues it faces are not well understood.

Tokenization is a hot topic both in the crypto world and in traditional finance, with ongoing talks of Central Bank Digital Currencies and now even a possible digital dollar. The term “blockchain” has been a popular buzzword in the financial industry for a while now, and the concept is being explored by startups, established institutions, and governments alike. Blockchain technology can be used in a centralized or decentralized manner.

Some people have raised questions about tokens from technological, financial, and regulatory standpoints. Here is a deep look into tokenization, how it will impact the financial markets, and what challenges it currently faces on its way to mainstream adoption.

What is tokenization?

Digitizing assets and making them available on a distributed ledger is called tokenization. The concept of a virtual currency that can’t be tampered with has been made possible by blockchain technology. Blockchain technology ensures that transaction and balance records can’t be retroactively altered.

What is being tokenized, the technology used, and the purpose of the token all affect the form that this process takes. The type of blockchain technology that can be used depends on the variables that have been mentioned. The process of tokenization on a decentralized ledger can help to verify ownership quickly and without the need for trust, but this same process can also present a challenge in terms of performance and compatibility.

Related: Tokenization, Explained

Essentially, digital tokens are a way to indicate ownership of an asset, and can be incredibly useful for exchanging or transferring partial or full ownership. This increases liquidity and allows for greater access to these assets.

The potential for tokenization extends far beyond just financial applications and has the potential to revolutionize and improve many different industries. Tokenization is a new concept that is quickly becoming popular in the financial technology world.

Tokenization is here

Cryptocurrency advocates often make claims about the current capabilities of cryptocurrencies and blockchain technology that are not backed up by evidence. While blockchain has enormous potential, crypto assets are relatively new and make up a small part of the overall financial markets.

The idea of replacing the fiat currency system with Bitcoin is one that excites many enthusiasts, but Bitcoin would not be able to handle adoption on such a large scale due to technological constraints when it comes to processing transactions.

Tokenization has made it possible to use crypto as a currency or global payment system. What was once a theory is now reality. It can be used both privately on a small scale and does not require a high capacity. The concept of a national or global cryptocurrency-based monetary system is not possible because assets can exist on separate blockchains.

Although the concept of tokenization existed before Ethereum, it was not widely known until Ethereum. Most platforms now allow assets to be tokenized, including EOS, Tron, Neo, and Waves. Blockchain technology is used by both private and public institutions, but it is used more frequently by larger organizations.

Nonfungible tokens: From CryptoKitties to real estate

Nonfungible tokens (NFTs) are a popular application of tokenization. Each token or set of tokens in NFT systems have different values. NFTs have recently become very popular in the cryptocurrency industry because of games like CryptoKitties that allow users to collect digital items. Virtual land is also becoming big in the industry.

NFTs can be used to own in-game items. The system allows for in-game items to be exchanged outside of the game and even through smart contracts. This ensures that once the item is passed in-game, funds are released, and fraud is eliminated. Ensuring in-game ownership is assured even if game servers malfunction or get hacked is another interesting application.

NFTs have become popular among the crypto and gaming community and are now extending to traditional finance. This provides liquidity to nonliquid asset classes such as real estate. It allows people to raise funds for property investments using a tokenized asset as collateral for a loan. This makes it easier for individuals to invest in property without having to put down a large amount of money upfront.

Stablecoins

Another application of tokenization is stablecoins. Tether is a tokenized fiat currency that exists in different iterations, including USDT. It was first issued on the Bitcoin blockchain through the Omni Layer protocol. Other examples of coins that have been backed by different entities include USD Coin (USDC), StableUSD (USDS), and WUSD (WUSD). There have also been coins backed by gold, like PAX Gold (PAXG).

The goal of stablecoins is to allow users to take advantage of the benefits of blockchain technology without having to worry about the volatility often associated with cryptocurrencies. They are usually given out by a government in order to represent currency, and can be redeemed for an equivalent amount of that currency. Other stablecoin projects like Saga’s SGA coin and Celo also exist and aim to bring more stability by issuing tokens that are custom-backed by a basket of different fiat currencies rather than just one economy. Keren Orian Nadel, Saga’s Managing Director, told Cointelegraph:

The SGA stablecoin model begins by tying its value to a trusted basket of currencies, which is the same way the value of the IMF’s Special Drawing Rights (SDR) is determined. However, the SGA is designed to eventually become an independent currency with its own value, separate from the SDR.

Security tokens

In 2018, cryptocurrency prices were volatile and there was speculation about initial coin offerings. ICOs are a fund raising mechanism that are similar to initial public offerings.

Initial coin offerings (ICOs) have made equity investment accessible to a wider range of people and have provided funding for projects like Ethereum and EOS. However, the positive outcomes of early projects have caused an influx of lower quality projects and scams. Since ICOs have lost their popularity, security token offerings have taken their place.

Security tokens are basically tokenized company shares. Examples of popular STOs include Nexo are Robinhood. Antoni Trenchev, a managing partner and co-founder at Nexo, told Cointelegraph:

” With a blockchain-based STO, it’s easier and cheaper to list than on a traditional exchange. This also allows a wider range of people to participate and to acquire the tokens after the STO, including those without access to traditional financial services. This system also allows for settlements to be completed immediately, which can be essential for people who need access to liquid funds during a crisis.

DeFi, DApps and crypto synthetic assets

Tokenization is the process of converting a physical asset into a digital token. This process has led to the emergence of smart contracts and has brought many advantages to the field, such as increased security and transparency. Smart contracts allow two parties to agree to and execute a contract automatically, without the need for a third-party intermediary. This makes new concepts like decentralized finance and decentralized applications possible. These NFTs can be traded in a trustless environment using smart contracts.

Cryptocurrency-based synthetic assets are becoming more popular because they expose users to a variety of different assets, like commodities and stocks, without having to leave the cryptocurrency sphere. In March 2020, Synthetix, an exchange that allows users to trade in these assets, was the second most popular DeFi application, according to a recent report by DappRadar. Jon Jordan, the communications director of DappRadar, told Cointelegraph:

The user base for Synthetix is still relatively small, but it has been growing steadily. This is especially apparent during periods of high crypto price volatility, as one would expect with any sort of trading product.

Tokenization hits traditional finance: Tokenized securities and CBDCs

Institutions are increasingly using tokenization to protect data. Projects that are backed by stablecoins or that use tokenized securities are becoming increasingly popular.

Although Societe Generale’s efforts have demonstrated that it is possible to tokenize securities on a decentralized blockchain while remaining fully compliant, private blockchain technology is still the preferred choice when it comes to security tokenization. In spite of this, there are many examples of this happening, such as The World Bank and the Commonwealth Bank of Australia issuing a blockchain-based security token called Bond-i. The Central Bank of China has also recently created digital versions of 20 billion Chinese yuan ($2.8 billion) worth of bonds using blockchain technology.

CBDCs have also been making headlines. From the digital dollar advocated by the former CFTC Chairman J. Christopher Giancarlo is extremely popular for the recent experiment program by the Bank of France. China has been working on the concept of a digital yuan since 2005 with the hope of launching its own digital currency.

Many commercial banks are beginning to use stablecoins as a way to settle transactions and payments. Projects like JPMorgan’s JPM Coin, Signet, and Wells Fargo’s Digital Cash are examples of this. Although blockchain technology is decentralized, most financial institutions work with centralized and permissioned technology. However, Guido Santos, founder and chief technology officer of Genesis Studio, believes this trend may change with time. He told Cointelegraph:

As regulations and KYT/AML/CFT compliance become more stringent, blockchains that preserve the confidentiality and protect the privacy of their users will become increasingly attractive.” Blockchain technology will be initially adopted by those who can control it, but eventually it will become more open to the public. As regulations related to anti-money laundering and countering the financing of terrorism become stricter, blockchains that preserve user confidentiality and privacy will become more attractive. A few companies, like Santander, are testing out Ethereum, but most companies are still focused on using Hyperledger and Corda.