What is tokenization?

Of all the Web3 developments and concepts I’ve written about here, tokenization is one of the most exciting and potentially transformative. I know I said something similar in my last article about smart contracts, but tokenization goes hand in hand with smart contracts. Smart contracts can only govern things on the blockchain, and these things are tokens. Nevertheless, tokenization has profound implications in regards to ownership, which implies implications to aspects of private property in general… and when an aspect of our day-to-day reality as enormous as private property and ownership is modified, we are talking about something truly game-changing. So, what is tokenization? In this article, we will explore that question, how tokenization works and why it matters before exploring different forms of tokenization, the status of tokenization rollout and implementation currently, and finally, the implications tokenization poses for the future of web3, enterprise, and our daily lives.

One of the best definitions of tokenizations I have found comes from the NASDAQ (weirdly): “Tokenization is the process of converting an asset or the ownership rights of an asset to a unique unit called [a] token.” In simple terms, it is essentially creating a file on a computer that corresponds to the ownership of some asset - but instead of that file being located on your computer, the file lives on the blockchain. There, the file securely and transparently verifies the ownership of an asset in a completely trustworthy, decentralized way. In this sense, the token itself does not really have any value, but it is a proxy for the asset - whatever that asset is. Think of a token as a receipt that is universally trusted, universally recognized, and never gets lost. When an asset (digital or real-world) is tokenized, the ownership of the item is exactingly clear and recorded, and should that asset ever be sold, transferred, traded, or passed down in an inheritance, the movement of the token is visible and verified on the blockchain, and thus the transferred ownership is essentially indisputable. (I say ‘essentially’ because anything can be challenged in court, but the ironclad authority of ownership via tokenization has the same legal weight as a contract, will, or any other legally binding agreement.)

Through tokenization, diverse assets (represented as programmable digital tokens on a blockchain) enable interoperability, divisibility, automation, and security. Tokenization enhances the efficiency of transactions, enables fractional ownership (comparable to the way a co-ownership allows multiple distinct parties to co-own real estate property, sports cars, or planes), offers global accessibility, reduces costs, and integrates regulatory compliance. This process bridges the gap between physical and digital assets, empowering smart contracts to automate processes, increase transparency, and revolutionize industries by offering the benefits of blockchain technology to real-world assets. In fact, tokenization is a critical and necessary component in the effective functioning of smart contracts on blockchain platforms, whether the related assets are real-world or digital.

WHY THIS MATTERS

In the litany of Web3 technologies, a technical description of tokenization may sound like a description of a vehicle’s carburettor after you’ve read a description of its shock system. Technical jargon may make it unclear how this technology is distinct from the other types I’ve discussed. So go with me for a moment here (I promise it will be worth it).

Imagine a few scenarios:

• You own your car outright… but what happens if you lose the title or someone steals it? Who owns it, then? How do you verify your ownership? (There is an answer to this question, but the point of the question is: Do you know how the ownership is verified?)

• What about the things in your house? The bicycle in your shed, the desk your computer rests on, the chair you’re sitting in right now, the shirt on your back, the gum in your mouth: you know you own it, but how can you prove it? Do you keep all the receipts? If you give away a book or a couch or an exercise bench, how does the person you gave it to prove they own it?

• If you went to your neighbor's house, you inherently know and never question that everything in their house is theirs and not yours. But again, how do you prove that?

The point is that certain aspects of the nature of ownership - and how it’s verified - are a little fuzzier than we collectively imagine. The world functions in a more or less sustainable way in regards to how we relate to the concept of ownership, but it clearly has limitations. With real-world assets whose ownership is contested or needs verification, there are legal processes and documents whose purpose is to pin this down: wills, contracts, inventories, etc. But as the questions above hopefully illuminate, those documents are not comprehensive to all real-world assets.

Tokenization allows for transparent, unambiguous identification of ownership and access to real-world and digital assets with unprecedented clarity. But even beyond that - and here’s where we get into the game-change - it enables new forms of ownership that can offer the average person access to tools and techniques of wealth cultivation previously only accessible to the hyper-wealthy.

How? To answer that question, let’s first take a look at the different forms of tokenization currently available and what each of them can do.

Forms of Tokenization

Below is a table listing a variety of the types of tokens out there. (This list is not exhaustive as there are a number of payment processes and other utilitarian forms of tokenization.)

Making Your Assets Work For You

So, how does tokenization spur a new type of ownership? To answer that, we’ll look at the tokenization of real-world assets. Imagine a hyper-wealthy person: some tech or social media zillionaire with a personal wealth valued at over a hundred million dollars. Do they have all of that as cash in a bank account somewhere? Unlikely. More likely, it is spread out in an array of cash/liquid assets, ownership stakes in various companies, real-estate property, art holdings, private jets, you name it.

Let’s look a little more closely at some of those assets. The price of a private jet can range from $2,000,000 to $100,000,000; we’ll say this one cost $10,000,000. But how often does this person fly? If they use the jet 10 days a month, that means they aren’t using it 20 days a month. What happens to it during those 20 days? Does it sit in a hangar? No. They rent it out. So, their (expensive) real-world asset itself becomes an income stream, which, over time, will pay for itself. Now, let’s look at their art holdings. Say this zillionaire owns a painting valued at $100,000,000. What do they do with it? Hang it on the wall in their kitchen? Maybe, but that’s not all they do with it: they use it as collateral to pursue loans for businesses or acquire other assets. And even if they don’t, the painting as an asset likely is gaining in value over time, meaning that as an asset, it is either passively or actively (or both) generating new wealth.

The takeaway is that the wealthy are able to use the value of their assets to either make money directly, leverage the asset’s value to borrow or make money, or hold the asset as its worth continues to grow. Up to this point, this type of wealth cultivation has been primarily available to the hyper-wealthy, because it’s only assets of extreme value that are able to have their value liquid without having to sell it off.

Tokenization can change this paradigm.

Imagine creating a token for the things you have in your home right now. Your computer, your phone, your chair, your microwave oven, your television, your washing machine, your Roomba vacuum, your power drill, your jet ski, your lawnmower. Imagine being able to rent them out, like an Airbnb, or you could pursue a micro-loan using a handful of assets as collateral.

There is an innate bias towards newness, and this makes sense, but it may also be a byproduct of never having had an alternative. Musical purists used to only listen to (and buy) vinyl records because of their opinions on the sound quality. Maybe they’re right, maybe they’re wrong. But how many people listen to vinyl records compared to how many people listen to a Bluetooth speaker playing music on Spotify? So, on first thought, you may think, ‘Who would want to use my old power drill?’ Ask yourself this: Do you think the group of people who need a power drill but can’t afford one is smaller or larger than the group of people with $200 to spend on a new drill? This may seem like a narrow or niche example, but apply the concept to the enormous array of everyday items you own but rarely use or think about.

Our history with our assets follows this path: we buy them, we own and use them until we’re done with them, and then they sit in our home until they break or we give them away. Tokenization allows the average person to add new functionality and utility to the items they have already purchased, including methods to re-extract their value with the same strategy previously only applicable to extreme-value items owned by the extremely wealthy. Obviously, this type of paradigm shift would require infrastructure and wide adoption for it to take hold at the level described here - but the same could be said about the power of the personal computer as a tool to offer economic opportunity to the average person, and look at our world today. The use of (and average understanding of) blockchain will need to grow for this adoption to be possible, but it gains momentum every day. Should these trends continue, the economic and financial ramifications of this are staggering.

How’s that for a game-changer?

Hopefully, this explainer has shed light on the incredible impact that tokenization can have on the ownership of real-world and digital assets. The outcomes of tokenization laid out above are not guaranteed - after all, electric cars were first developed in the 1800s but didn’t start gaining traction until the last decade - but technological barriers are collapsing faster than ever before, and the economic incentives for a growing percentage of the population tilt towards increased adoption of tokenization. Like any form of innovation, there are upsides and downsides, as well as unexpected consequences. I don’t believe tokenization is an answer to all the world’s problems or that there won’t be growing pains and difficulties posed by the presence of this technology. But will it change the world?

Future articles will explore aspects of tokenization more fully (including deep dives on real-world and digital asset tokenization, decentralized autonomous organizations (DAOs), data tokenization and how smart contract oracles fit into the puzzle, as well as an overall exploration of the good and the bad of tokenization), but for now, hopefully, your web3 literacy has grown on another exciting, powerful tool in the web3 arsenal.

(If you’d like to learn more about where tokenization stands currently, as well as what may be holding it back from fully coming into its own, check out our article HERE.)

Further Reading

Digital Assets:

Real World Assets:

Governance:

Personal Data: