The first application of blockchain technology may have been in currencies but people are becoming increasingly aware that a secure distributed ledger system of this kind could in fact potentially support all economic activity one day. Today startups around the world are feverishly building new frameworks for migrating ever more spheres of financial and economic activity to distributed ledger technology. Many believe that the next stage in this process is the conversion of capital markets to token networks as it is becoming increasingly apparent that the management of securities of any kind, from stocks and bonds to real estate, could be brought into the age of information through tokenization.1 There is currently great interest by financial intermediaries and technologists in figuring out how to move real-world assets onto blockchains to gain the advantages of distributed ledgers while keeping the characteristics of the asset.
The conversion of capital markets to token networks would create many efficiencies. It could take the somewhat elite world of high finance and make it accessible to any and all; creating new opportunities for investors and new sources of equity for organizations. Our capital markets of various kinds today hold trillions of dollars of assets that are being used far from their potential; locked up by high transaction costs, low transparency, layers of middlemen and bureaucracy. The tokenization of this system could radically improve the efficiency of transaction processing by removing the layers of bureaucracy created by centralization. It could unlock vast amounts of currently locked up fix capital. It could create a quantum leap in transparency, opening up capital market data to advanced analytics in unimaginable new ways. Likewise distributed ledgers are tamper-proof making them less susceptible to fraud.
Our world is full of different forms of assets: oil, basic foodstuff, stocks, carbon credits, real estate, gold, etc. Many of these assets are difficult to subdivide or physically move around, so buyers and sellers instead trade pieces of paper that represent ownership of part or all of those assets. However this existing system composed of paper and lengthy legal agreements is cumbersome, assets are difficult to transfer and can be hard to track. Tokenization of securities is the process of converting rights to an asset into a digital token on a blockchain.2 Any asset that is currently traded on a capital market as a security, such as commodities, shares, bonds, or various forms of derivatives could be tokenized by linking them to a blockchain register. Indeed any asset at all could be securitized by linking it to a digital token. This might include any form of property, such as a house, it might include loans or mortgages, all of these could be converted into security tokens and traded on markets.
The most obvious use of this system is the raising of initial funding for a new project. Already huge amounts of funds have been diverted from traditional forms of venture capital in to directly funding projects through ICOs. Many industry observers believe that mainstream companies will one-day issue shares through ICOs, either in place of or in addition to traditional public offerings. ICOs are a good example of where we are heading as we shift more of capital markets onto the blockchain. They illustrate the capacity to open up these markets to the many, as venture capital has gone from the domain of a few investors to being accessible to anyone on the planet with an internet connection and a few dollars. They illustrate the direct peer-to-peer nature of token economies. But what we have seen so far is really just the tip of the iceberg as what has happened to venture capitalism could literally happen to all of capitalism – as all capital could be tokenized. A number of platforms are currently in operation or being built to do exactly this.
LAToken is one such platform. LAToken is an asset tokenization platform that allows users to convert tangible assets such as real estate or precious artworks into tokens, thereby making them sellable in fractions.3 You can tokenize your asset on their platform and sell it in fractions to investors, investors may then sell the tokens on a secondary market and you can buy back the asset later on or sell it on the settlement date. Imagine an artwork by a famous artist with 100 copies. The art prints could be tokenized by having ownership held by a company that has a standing offer to the public to redeem tokens for either a single art print or a fraction of one copy. In this way, buyers could obtain an easy-to-transfer token and a secondary market could transact in fractions of the art prints. This could potentially be a source of financing for the artist and a way for the broader public to participate in the art market that is currently inaccessible to most. Likewise, commodities could be converted into security tokens and traded. Imagine a group of companies that want to trade aluminum with one another. Normally they’d exchange paperwork and keep their own lists of trades. If they could move to a blockchain-based system for trading their aluminum, they could potentially reduce paperwork and have more robust record-keeping.
One of the fascinating aspects of distributed ledger networks is that they can enable people to securitize their own assets. Tokenization is an extension of the more traditional process of securitization, which is the conversion of an illiquid asset into a record that can be traded to increase liquidity. Whereas previously the creation of securities was the domain of large highly regulated centralized organizations, blockchain networks can automate this process and make it accessible to all. People and organizations of any kind could securitize any asset that they own, they simply lock it on the blockchain and receive liquidity in return, when the liquid capital is returned the illiquid asset is unfrozen. Sweetbridge is one token platform that is essentially enabling people to be their own banks when it comes to loans. This is done through creating a blockchain network where people can register and lock up their own assets as collateral against which they can borrow money at low-interest rates or even no interests rates at all. Users are essentially lending themselves money without a credit check because they are lending it against their own assets they have locked up.4
What is happening is that when you lock an asset into the network, the network grows in value and gives you the tokens equal to that growth in its value which you can then exchange for other tokens of fiat currency. Because you are creating the currency and not renting it from somebody else you don’t need to pay much interest on it or even no interest at all. Where this gets exciting is not in developed economies it is in places where you have a highly ineffective and inefficient formal economic system and a high level of informality, such as the developing nations of Africa and Asia. In these environments, interest rates tend to be very high and loans tend to be very difficult and yet these are the roots of the supply chains of the world. This is where the food is grown, where the minerals come from. In these frontier markets it can be really tough to get financing of any kind and if you do it’s very expensive; it may be 10 to 20 percent. With a security token platform like that of Sweetbridge, no credit rating would be needed, you just lock up some asset and get liquidity in return at a low-interest rate. This can be revolutionary, making a massive difference, not just for global trade but in the lives of the most vulnerable.5
Real Estate is another asset class that is set to move to token networks in the coming years. The stock of real estate assets is enormous, it is the biggest asset class in the world, valued at well over 200 trillion dollars. At just 1.4 trillion in transactions every year most of this market sits stagnant and does not really trade. Real estate is a very illiquid market and one of the least transparent, buying and selling property especially on the global market across borders is full of frictions, middlemen, and lengthy procedures. You can hold a piece of a corporate or a government debt in a bond, but it is very difficult to hold a piece of property and there is a lot of friction to trading property. While at the same time for many assets in real estate people will pay up to 20% more for one that is liquid versus one that is not; so tokenizing these assets could release huge amounts of untapped or underused resources.
Atlant is one platform that is working to tokenize real estate.6 It does this by linking the property to a special purpose vehicle(SPV) which is then converted into tokens. The property is purchased and transferred to the SPV, the SPV is split into many shares that can then be traded on the platform with almost no friction. Now a person sitting in Taiwan can at the click of a button invest in the creation of a new factory in Poland or a section of an office space in Mexico City. Likewise, through this tokenization of property, the physical asset can be split up into extremely small units of equity that make the whole market greatly more liquid. Say for example you have a shopping center, the platform can tokenize it by dividing it into a million centimeters of floor space. People can then exchange those small units or rent the property they own out.
In all of this conversation around the tokenization of real-world assets remains one big elephant in the room, which is the question of how exactly do you put assets on the blockchain. The linkage between the information software layer of the blockchain network and the physical real-world asset is of course of critical significance and in many cases remains an unanswered question as to how exactly that linkage is secured, so in the next module we will pick up on this very topic.