Tokenization is the process of converting fractional-ownership rights to an asset into a digital token on a blockchain. There is great interest by financial intermediaries and technologists around the world in figuring out how to move real-world assets onto blockchains to gain the advantages of Bitcoin while keeping the characteristics of the asset.[1]

There are many proposed methods for taking real-world assets and "putting them on a blockchain." The goal is to achieve the security, speed and ease of transfer of Bitcoin, combined with real-world assets. This is a new form of an old concept: "securitization" (turning a set of assets into a security), and in some cases the tokenization is of securitized assets.

Intangible AssetsEdit

Examples of intangible assets include patents, brand names, copyrights, etc. There can be problems, but intangible assets are often easier to tokenize than physical objects because there are fewer concerns regarding storage and shipment.

Fungible AssetsEdit

Fungible assets are typically easier to tokenize because the general set of tokens are linked to a general set of interchangeable asset components, say, 10 tons of wheat.

Transfers of Ownership vs. Transfer of Limited RightsEdit

There are many kinds of transfers of assets and many types of asset rights. Sometimes only limited rights connected to an asset are transferred, such as a lease to use land for a limited time rather than a transfer of land ownership.

Blockchain projects can generally be divided into those that involve tokenizing partial rights, like music licensing, and those that involve tokenizing full ownership, e.g. selling real estate.

The Key Legal Issue: Ensuring Token ConsistencyEdit

Imagine a token that represents a fractional interest in a set of gold bars in a vault. If a gold bar is taken from the vault, how will that be reflected in the digital token?

If the buyer of a token can't be sure that the token is properly linked to the real-world asset, then the value of the token will fall or become zero (if no one has faith in it).

Legal ModelsEdit

1. LicensingEdit

Music licensing relies heavily on paperwork and trust. Tokenization of music ownership could allow new business models such as investing in music creation by the public. If a new band could sell 20 percent of their new song to fans, what would that do to the creation of music? How would that affect intermediaries?

2. Trading SystemsEdit

There are many consortiums sprouting up that aim to replace paper trading systems with blockchain trading systems. They generally don't aim to tokenize real-world assets directly, but rather to use a blockchain system to enable trading of real-world assets.

3. RedemptionEdit

Imagine an art print 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. This 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.

4. Vaults & Smart ContractsEdit

Imagine a vault of gold. The gold is owned by "Goldowner Inc." and the vault is owned by "Vault Inc." Vault Inc. has a sterling reputation and third-party auditors who verify the amount of gold in its vault.

Goldowner Inc. could offer a digital token to the public that represents ownership of the gold and through a smart contract with Vault Inc. maintain a public off-chain registry that relates fractional interest in the gold with the tokens. For every token sold, Goldowner Inc. transfers ownership to Vault Inc., who holds it on behalf of the token owner. Vault Inc. guarantees redemption of gold by anyone who can prove ownership through a digital signature.

Intersection With Global Securities LawsEdit

Selling a fractional interest in an asset to the public (without permission from the government) is often prohibited by securities laws. Given the global-by-default nature of blockchains, this can pose a problem for the entities involved in the tokenization, or the operators of marketplaces where these tokens are traded. These issues are particularly complicated because they often involve overlapping jurisdictions (e.g., a Chinese seller and American buyer).

The legal angle needs to be investigated carefully.

The Centralization IssueEdit

One of the main advantages to Bitcoin over non-blockchain systems is that it's decentralized. But real-world assets generally have a single owner, or a small group of owners.

Many of the models for asset-backed tokens involve an open offer for redemption by a company that holds the real-world asset. The entire token can fail if the central asset holder fails.

Legal Changes Needed?Edit

Tokenizing real-world assets is a challenging problem that requires 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 digital token systems, such as sidechains[2].

See alsoEdit