Source: Dev3

Perhaps one of the most important use cases of blockchain technology is tokenization. Blockchain has opened up a realm of opportunities we never thought was possible. It is safe to say tokenization is the core pillar on which blockchain itself operates. Through tokenization, anything can be brought on-chain and they’ll be permanently recorded.

In this article, we’ll be taking an in-depth look at what tokenization truly is and the mechanism behind it.

Outline:

What is tokenization?

The mechanism behind tokenization

Types of assets that can be tokenized

Fractionalization

Benefits of tokenization

Challenges with tokenization

What is Tokenization?

In layman’s terms, tokenization is simply “converting” physical items into digital assets and before you ask, no magic is required to do this transformation.

The digital assets are basically representations of the underlying physical items and they are recorded on the blockchain. The physical assets are not literally brought on the blockchain, rather digital certificates of the assets are issued on the blockchain as tokens. These tokens can also mean ownership rights or certificates of the underlying assets. Tokenization enables the safety of sensitive data as they’ll be stored on the blockchain.

The Mechanism Behind Tokenization

As I mentioned earlier, tokenization doesn’t imply putting the physical item on the blockchain (assuming that was even possible). Some technologies make tokenization possible.

Blockchain technology: Tokenization is greatly aided by blockchain technology, which offers a decentralized, transparent, and safe platform for representing physical assets. Any data recorded on the blockchain is immutable and is distributed among various nodes, so there is a low risk of tampering.

Smart contracts: A smart contract is a self-executing set of codes that is triggered when predetermined conditions are met. Once conditions for a certain action are specified in a smart contract, tokens can be created & issued and tokenized assets can be transferred from one party to another.

Types of Assets that can be Tokenized on the Blockchain

Currency: stablecoins best fit into this category because they are digital assets that are tied to the value of physical currencies. CBDCs are also a good example because they are simply digital versions of national legal tenders.

Art: before now, art was only considered as a physical item until the emergence of NFTs. Technology has made it possible for physical artworks to be digitally represented on the blockchain so fractions of it can be traded.

Real estate: commercial and residential real estate can be tokenized on the blockchain, people can buy these virtual real estates and even rent them out.

Music: there are platforms built on the concept of MusicFi, which allows songs to be tokenized and traded.

Identities & Data: instead of exposing sensitive personal data, blockchain allows tokenization of these data and users’ identities to prevent unauthorized access.

Stocks, bonds, shares: Company stocks, bonds, and shares can be tokenized on the blockchain. Tokenized stocks and bonds are representations of traditional exchange-traded funds (ETFs).

Fashion items: Big fashion brands like Nike, and Adidas are now tokenizing fashion items like clothing and accessories. The tokenized fashion items are represented as NFTs and can easily traded.

Precious metals: Derivatives of precious metals like gold, and silver can be tokenized and issued as synthetic assets (synths) on the blockchain. Learn more about synthetic assets here

Certificates: Credentials and important documents can be tokenized for safekeeping on the blockchain.

In-game assets: items purchased or gotten as a reward in video games can be tokenized.

Social media profiles: you must be familiar with the concept of SocialFi. Social media profiles can be tokenized and traded like every fungible token.

Fractionalization (Fractional Ownership)

Fractionalization is the breaking of assets into smaller units that can be traded. An example of this is what Ubuntu Tribe is building with GIFT by tokenizing and fractionalizing gold so that real gold can be afforded by all. Read more about GIFT in my past article.

Fractionalization makes it possible to own assets that would normally be expensive to afford, by owning fractions of it along with other people.

Benefits of Tokenization

Accessibility: when assets are tokenized, it makes it easier for more people to invest in them as there are no physical constraints. Marketplaces and exchanges where these tokenized assets are traded are open 24/7, so there is also no time constraint.

Reduce the need for parties: one gospel that blockchain preaches is the elimination of the over-reliance on centralized third parties.

Improved transparency: blockchain is an open system so every transaction carried out on it is transparent for everyone to see.

Liquidity provision: tokenized assets provide liquidity for investors who are looking for other investment options.

Lower barrier to entry

Challenges of Tokenization

Security concerns: With smart contracts, there is always the risk of little vulnerabilities being used to exploit the entire network, even if blockchain technology is considered a tamper-proof and secure environment. According to the 2023 Cyvers Web3 security report published earlier this year, smart contract vulnerabilities were the reason for 50% of the total hacks that happened in 2022 even though half of these smart contracts were properly audited.

This year alone, there have been multiple smart contract hacks that have led to the loss of millions of users' funds.

Market volatility: tokenized assets like cryptocurrencies can experience high price volatility due to various unforeseen circumstances. So it is often regarded as a risky investment that can lead to losses, as much as it can lead to profits.

Lack of true privacy: although blockchain promotes anonymity, its transparent nature leaves little room for privacy. Recently, new technologies have made it possible to deanonymize the identities behind wallet addresses, so, suffice it to say, there is hardly room left for privacy.

Regulatory concerns: The legal ecosystem around tokenized assets is still developing and regulations may differ between regions and for certain crypto companies based on their offerings. Businesses and investors find it difficult to navigate this uncertainty since compliance standards are subject to modification or clarification. For instance, the issue of whether certain cryptocurrencies should be regarded as securities or not.

In conclusion, tokenization came into the limelight as blockchain became more popular but the idea of it has always been around for a while now. As the world is becoming more digital, tokenization will keep gaining attention and will be greatly appreciated.

What other types of assets or items can be tokenized on the blockchain? Which did I miss?