by Ras Vasilisin, Founder & CEO at Virtuse Exchange

Alike to alchemy, where scientists convert base substances into different elements like gold, tokenization involves the conversion of rights to an asset, such as ownership of a commodity, equity or real estate, into a digital token.

These digital tokens are transacted on the Ethereum blockchain, where they then become ERC20 tokens that can be traded on secondary markets. This makes it easier, faster and cheaper to invest in assets by removing geographic restrictions, the majority of fees by cutting out middlemen, as well as minimum transaction amounts.

Tokenization also brings new benefits like increased liquidity, security and automation; makes assets more easily fungible; and transactions can also be made almost instantly, 24/7. So what are the best uses of tokenization? Here we discuss three.

Tokenizing commodities

Commodity exchanges have mostly stopped using physical paper and have instead shifted to electronic transactions and standardized agreements. Yet the overhead of these systems is enormous and they generally rely on trusted participants.

So startups and financial companies around the world are now racing to develop new systems for the next phase of this evolution: tokenizing commodities. But why would someone want a digital token that represents a physical asset, and how can that be done?

Let’s imagine a vault of gold. The gold within the vault is owned by GoldInvestor Inc., and the vault itself is owned by Custodian & Co. Custodian & Co. has a sterling reputation and third-party auditors who verify the amount of gold in the vault.

GoldInvestor Inc. could offer a digital token to the public that represents ownership of the gold, and through a smart contract with Custodian & Co. could maintain a public off-chain registry that relates fractional interest in the gold with the tokens.

For every token sold, GoldInvestor Inc. transfers ownership to Custodian & Co., who holds it on behalf of the token owner. Custodian & Co. guarantees redemption of gold by anyone who can prove ownership through a digital signature.

GoldInvestor Inc. can take advantage of the fact that Custodian and Co. is trusted and audited, where owners of the tokens rely on Custodian & Co’s representations and not on GoldInvestor Inc. (even though GoldInvestor Inc. is the token issuer).

Obviously, there are many risks in the above example that wouldn’t exist if the gold was a digital item that could be transferred electronically. Gold has a physical embodiment that requires physical storage (which also costs money).

So why tokenize gold? One advantage is that buyers of the tokens would know that they’re the only person who has received the token, whereas a buyer of a paper certificate has no way of knowing that the same certificate hasn’t been sold to multiple people.

Tokenizing art

Let’s now imagine a piece of art by a famous artist with 1000 prints. 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, if the redeemed tokens are less than a certain threshold, a fraction of the assessed value of the art print.

Physical delivery of the prints could be made at a certain location, or shipped to a specified address. This way, buyers could obtain an easy-to-transfer token and third-party markets 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.

The above model relies on the company holding the art to continue to offer redemptions. An obvious risk for token holders is that the company will no longer honor its commitment to exchanging the digital tokens for the real-world goods in its possession. Another issue would be how the company holding the artwork will be compensated for storage costs. Tokenizing real estate assets

A tokenized real estate asset is a building or property that issues tokens (digital shares) when someone invests in it with cryptocurrency.

Suppose there’s a $300,000 apartment. Tokenization can transform this apartment into 300,000 tokens (the number is totally arbitrary, we could have issued 3 million tokens), where each token represents a 0.001% share of the apartment. We can then issue the token on a platform supporting smart contracts, for example on Ethereum, so the tokens can be freely bought and sold by people on different exchanges.

When you buy one token, you own 0.001% of the asset. If you buy 150,000 tokens, you own 50% of the asset. And if you were to buy all 300,000 tokens, you then own 100% of the asset. But obviously you’re not becoming a legal owner of the property.

Because Blockchain is an immutable public ledger it ensures that once you buy tokens, nobody can “erase” your ownership, even if it’s not registered in a government-run registry. So we can take an asset, tokenize it, and create a digital representation of it that lives on the Blockchain.

Final words

As real-world assets increasingly become tokenized they’ll become more accessible, and there will be greater ease of trade and increased efficiency. The tokenization of assets provides asset managers with the opportunity to diversify investment opportunities in both traditional financial markets and emerging cryptocurrency markets.

Tokenizing real-world assets is a challenging problem requiring innovative solutions that go beyond technology. In some cases this will require legal reform, and in other cases it will involve clever combinations of existing legal rules, new business structures, and new digitization standards.

Digital tokens can be to assets what bank accounts are to money and the year 2017 was just the beginning. As many people and countries begin to appreciate digital tokens backed by real assets, it’s clear that many assets will become tokenized. A good example is what’s happening now, where some governments are starting to create cryptocurrencies backed by oil, fiat, or other assets.

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