Digital Assets and Tokenization
The value of digital assets is well over 1,500 billion US dollars – and this is just the beginning. The tokenization of assets opens a new chapter in digitization
The digital representation of assets and ownership claims as so-called tokensopens up new markets for financing companies and projects.
In recent years, cryptocurrencies have developed into an asset class of their own, which has now also arrived in the regulated financial market.
Over $19 billion has now gone into funding crypto projects via Initial Coin Offerings (ICOs), making them a serious alternative to traditional venture funding.
New application areas of tokenization such as Non Fungible Tokens “NFTs” (US$25 billion trading volume) and Decentralized Finance “DeFi” (US$239 billion Total Value Locked) are developing very dynamically.
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Tokenization Digitizes Assets
Assets to be tokenized range from vouchers, customer bonuses, art, access to services and tickets to company shares
Until the emergence of Bitcoin in 2009, it was very difficult or even impossible to secure digital assets against arbitrary copying. This fact changed with the advent of Bitcoin and blockchain technology.
With the help of the blockchain, digital value units, so-called tokens, can be easily created on the Ethereum blockchain, for example, and protected against copying. This allows tokens to take on financial values, and their properties can be designed very flexibly.
Tokenization brings a disruptive alternative to the financial system as we know it today. It can be assumed that tokenization will fundamentally change existing financial structures, at least at the technical level.
Advantages of Tokenization
Tokenization offers great design possibilities, low costs and high flexibility in the digital representation of assets.
Through the digital representation of an asset, its ownership can be divided at will and transferred to other owners very easily, quickly and cheaply. For previously illiquid assets such as real estate, art or classic cars, new markets are emerging and buyers and sellers can come together.
Initial Coin Offerings Are an Early-Stage Digital Investment Tool
Initital Coin Offerings(ICOs) are used for early stage funding for a startup’s crypto project – similar to an IPO where shares are issued and sold.
The project usually describes its plan in a white paper – analogous to a securities prospectus.
Funds are raised by issuing digital tokens. The tokens are generated by a smart contract on a mostly existing blockchain.
Investors who believe in the project receive the tokens by exchanging them for mostly established cryptocurrencies. Subsequently, the tokens are traded on the secondary market of crypto exchanges.
Contrary to the anology to stocks, tokens from ICOs do not involve shares in the company, but rather access opportunities to the services of the crypto project.
The first ICO took place in 2013 by Mastercoin on the Bitcoin network.
Today, Ethereum is the most important platform for issuing tokens
Fundraising for the launch of Ethereum in 2014 raised $18.3 million through the sale of 50 million Ether at US$0.31 each. As of 4th April 2022, the price of Ether was $2,864 and the total market capitalization was $345 billion. The number of nodes in the Ethereum network is 5860.
The volume of ICOs increased sharply, especially in 2017, reaching a peak of over $6 billion in the first quarter of 2018. This significantly exceeded the comparable volume of traditional early-stage investment instruments, and token-based financing had established itself as a new option. However, in 2018, with the bear market and increasing regulation, ICO volumes declined again.
Decentralized Finance Replaces Banks and Stock Exchanges With Computer Programs
Decentralized financial services (“DeFi”) have emerged in recent years based on the Ethereum platform.
DeFi replaces previously required intermediaries in the financial system such as banks and exchanges with a new blockchain-based transaction infrastructure. This infrastructure is public and can be used without permission, so users of DeFi only need a digital wallet.
Due to the openness and standardization of common platforms, non-discrimination, initially little regulation, and global electronic direct access, many types of decentralized financial applications (“Dapps”) and a vast ecosystem have emerged and continue to emerge.
Compared to siloed applications for specific vendors that have prevailed to date, Dapps are interoperable.
Users can borrow, lend, invest, insure, trade and manage digital assets in a variety of ways with Dapps.
Digital assets can be exchanged quickly and globally on a peer-to-peer basis. DeFi’s total volume now stands at $239 billion (Total Value Locked) and further strong growth is expected.
There Are Several Types of Tokens
From payment, value storage and asset to venture capital financing
Security tokens have a security-like character and represent a digital property claim and associated value expectations. Similar to the issuance of stocks, security tokens are subject to regulatory requirements.
Utility tokens can be used in a similar way to crowdfunding to finance the development of products or services. Utility tokens are usually issued in exchange for fiat money or cryptocurrencies and represent a claim on the services or products being developed.
Large Companies Use Tokenization
World-class companies give tokenization the confidence it needs
J.P. Morgan uses tokenization for internal bank clearing
The largest U.S. bank, J.P. Morgan, launched its own token called “JPM Coin” in 2019.
The token uses Ethereum’s ERC-20 standard and is an in-bank settlement token that is pegged to the U.S. dollar.
The token is intended to make (cross-border) payments between customers faster and cheaper, provided that customers exchange their FIAT funds for the token.
Facebook Designs Payment Tokens For Over 1 Billion Global Users
Meta’s “Diem” project, originally called “Libra,” was an attempt launched in 2019 by a major player to create a so-called stablecoin.
Libra was to be offered as a token for payment to a very large audience via existing, globally distributed applications such as Facebook.
The implications of Libra would have been enormous, as a global and stable-value means of payment for over 1 billion Facebook users would have emerged without central bank control in competition with the state’s monopoly on money under the rules of a company-driven private association.
With Libra, it would also have been expected that Facebook would have been interested in transaction-based insights about users.
U.S. regulators stopped the project as planned, and despite some changes, the project was eventually terminated.
Central Banks Plan Digital Currencies
9 out of 10 central banks are currently discussing introducing a digital central bank money, called Central Bank Digital Currency (CDBC).
About half of the central banks are already conducting concrete experiments or developments in this regard. A key driver of this is previously prevalent private stablecoins and previous limitations and inefficiencies in today’s payment systems.
The central features of a CDBC, similar to paper money, should be the payment function and value storage function. The digital tokens would correspond 1:1 to the paper monetary units.
The architecture (see above) envisions a centrally controlled blockchain, so electronic payment service providers need regulated access.
How is Tokenization Implemented Technically?
Well-developed digital platform infrastructure and increasing standardization help with realization
Blockchain technology is mostly used to realize tokenization. A blockchain consists of programs, called nodes, that organize themselves into a decentralized network, each mapping the transaction history of the network.
The blockchain creates a non-modifiable digital database of token transfers. The database is usually organized publicly accessible on the Internet across different computers.
Ethereum is an important example of a blockchain. It can not only transfer assets, but also map different types of tokens that represent the assets.
The ERC-20 standard on the Ethereum blockchain is the most widely used for (utility) tokenization projects worldwide. ERC-20 provides basic functions needed to control the supply of tokens and transfer them on the Ethereum blockchain.
The established ERC-721 standard provides the foundation for NFT on the Ethereum blockchain. NFTs are issued, managed and made transferable through a smart contract. Each NFT instance is assigned a globally unique identifier.
Furthermore, the ERC-1400 standard targets security tokens. Security tokens represent shares in an asset or company. To meet regulatory requirements, the standard allows the use of the token to be restricted based on identity or jurisdiction.
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What Is to Be Considered Legally?
Increasing regulation creates clear rules for the crypto economy
An inseparable, legally secure link must be created between a (tangible) asset and a digital token. Corresponding legal agreements must be deposited in the terms and conditions for a token.
Depending on the asset, different constructs can create a link between a token and an asset. So far, mainly subordinated profit participation rights have been tokenized in Germany. Profit participation rights are securities that can be issued by companies to obtain capital in return for a yield payment for a certain term.
The billion-dollar market created by tokenization is increasingly regulated, which enables legally secure application based on clear rules and establishes trust in the traditional economy as well. Thus, tokenization is gaining importance for more and more companies.
In Germany, the main regulations enacted in recent years are: the Crypto Custody Act and the introduction of electronic securities and a supervised crypto securities registry. This particularly affects the issuing and signing of security tokens, whereby KYC processes must be integrated.
“Markets in Crypto Assets” (MICA) is the upcoming regulation for tokens, crypto assets and token issuances in the EU, which is still under discussion. Entry into force is expected in 2023. Entry into force is expected in 2023.
MICA will only allow transfers to wallets if the owner is known beyond doubt, in order to prevent money laundering. Thus, wallets hosted on exchanges would be preferred because exchanges must identify customers.
As far as DeFi services are concerned, MICA could cause difficulties for European providers by considering that the creators of the smart contracts that automatically settle DeFi services should be considered as financial intermediaries. Due to the associated liability, the EU location would become unattractive for these companies.
MICA regulation also affects stablecoins, which they wanted to put a stop to in light of the expected threat from Libra. This makes a Euro stablecoin very unlikely and DeFi will continue to rely on US dollar based stablecoins like Tether.
Numerous projects and activities are driving the development of digtal assets. With cryptocurrencies slowly establishing themselves in the banking industry, we expect digital assets to make a breakthrough in finance in the next three to five years.
51nodes and Digital Assets
Let long-time experienced blockchain professionals help you tokenize
The future economy will be digital, collaborative and decentralized. That is why we support companies in the implementation of blockchain projects. Since 2017, we have been successfully helping our clients create digital assets using tokenization. In the process, we coordinate all the necessary subject matter experts.
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