Tokenization of real-world assets: Is a digital transformation underway?

Tokenization of real-world assets: It’s quite a mouthful, but what does it mean? The short answer is that it’s digital proof of ownership of an asset, represented by a token (or tokens) on a blockchain.

What is asset tokenization?

Asset tokenization is the process of converting rights to a physical or digital asset into a digital token on a blockchain. The tokenization process can produce either fungible tokens that are readily exchanged, or non-fungible tokens (NFTs) that each represent unique assets. The nature of the asset and the desired use case typically determine the type of token that is minted.

Theoretically, many types of real-world assets could be tokenized. A few possibilities include:

• Real estate—Residential and commercial properties, undeveloped land
• Commodities—Oil, agricultural products, and precious metals like gold
• Art and collectibles—Digital art, paintings, sculptures, and rare items
• Financial instruments—Bonds, stocks, and other traditional securities
• Insurance policies and loans—Any type of insurance or traditional loan
• Intellectual property—Royalties from music, patents, and trademarks
• Luxury goods—High-end watches, jewelry, and vintage cars
• Wines and spirits—Rare wines, tequila, and whiskey casks
• Natural resources—Water rights, timber, mines, extracted minerals, and mineral rights
• Industrial infrastructure—Bridges, roads, and industrial-scale energy projects
• Transportation assets—Ships, airplanes, and freight containers
• Agricultural assets—Crops, livestock, and farmland
• Renewable energy infrastructure—Solar panels, wind turbines, and hydropower facilities
• Health care assets—Medical equipment and medical facilities
• Telecommunications infrastructure—Cell towers and fiber-optic networks

An asset can be tokenized in a way that confers ownership, or a token may be created to mirror the price or performance of a real-world asset (in a way similar to an exchange-traded fund [ETF] that tracks, say, a stock or commodity index). Asset tokenization enables direct ownership or rights to the asset, while the mirror structure uses blockchain tokens that track the asset without conferring ownership. Mirror structures are commonly used when direct tokenization is impractical or legally restricted.

Pros of tokenizing assets

Fractional ownership. An asset that’s tokenized can be easily divided into fractions—tokens—with many owners.

Enhanced accessibility. Fractional ownership through tokenization can make owning different types of assets accessible to many more people in varying financial circumstances. Tokenization may also expand global availability.

Potentially increased liquidity. Tokenizing an asset with fractional ownership might make it easier to buy, sell, and trade that asset.

Greater transparency. Blockchain technology makes the same information available to everyone, increasing the transparency associated with tokenized assets.

Reduced transaction costs. Buying tokenized assets could someday lessen the need for intermediaries such as real estate brokers and insurance agents, bringing down the associated transaction expenses.

Faster transaction speeds. Purchasing an asset that’s tokenized may be much faster than purchasing the same asset via traditional methods—perhaps in near real time, much as the stock market operates today.

Portfolio diversification opportunity. Like other types of alternative investments, tokenized assets could add a layer of so-called “noncorrelated diversification,” which can enhance the risk-adjusted return profile of your portfolio.

Asset programmability. Blockchain-based smart contracts enable programmable features—such as automated compliance checks, dividend distributions, and governance—that may enhance the programmability of traditional assets.

Cons of tokenizing assets

Legal recognition. Existing legal systems may not recognize tokenized asset ownership or digital ownership rights, potentially leading to problems with enforcing ownership or transferring rights.

Regulatory uncertainty. The laws and regulations that govern tokenized assets are uncertain at best and rapidly evolving. Understanding and complying with applicable laws can be challenging. For example, tokenized assets may not be eligible for the same protections normally associated with investing in traditional financial securities.

Complexity. Asset tokenization is complex, which may create steep learning curves or entry barriers for many market participants.

Price volatility. Tokenized assets, especially those traded on secondary markets, can experience significant price fluctuations and potentially generate losses for investors.

Valuation difficulties. Accurately valuing a tokenized asset can be challenging, particularly if it’s a unique or rare item such as a collectible.

Tax complexity. Tax rules for tokenized assets can be unclear, with requirements varying across jurisdictions. Selling or trading tokenized assets can create significant tax reporting challenges.

Custodial risks. Securely holding and managing tokenized assets requires robust storage solutions. Tokens may be lost, stolen, or otherwise mismanaged.

Incompatibility with traditional systems. Integrating tokenized assets with existing financial and legal systems can be challenging or simply impossible.

Other technical challenges. Blockchains, smart contracts, and other Web3 systems may be vulnerable to security risks and technological failures.