In this “What is Tokenization?” article, we’ll do a deep dive into the process of tokenization. Also, we’ll explore various benefits of replacing sensitive data with on-chain representations and some of the applications of this technology. Plus, we’ll discuss some of the most widely-used tokens, data tokenization, and token standards.
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What is a Token?
Before we address the question of “what is tokenization?”, let’s first take a look at tokens. A token is essentially a dataset that represents another dataset of high-value information. On their own, tokens have no real intrinsic value. However, when tokens represent real-world assets, commodities, and data, they can be worth as much as the original asset.
An example of this in the analog world is in a game of poker. Poker chips are tokens that represent stacks of cash. It’s much easier to move tokens around a table than vast sums of money. The benefit is that nobody loses money if the chips are stolen or lost. Tokens can act as placeholders that are redeemable for the value they represent. Moreover, anyone can remove valuable data from their environment and replace it with a token on the blockchain.
What is Tokenization?
So, what is tokenization? The process of tokenization refers to representing any real-world asset on-chain with crypto assets. Also, tokenization facilitates the transfer, storage, and verification of data transparently and securely.
Tokenization has been an essential part of the crypto industry for several years. The ability to mint utility tokens, governance tokens, and non-fungible tokens (NFTs) enables crypto projects to harness the security of an established blockchain without creating an entirely new chain. Furthermore, token standards such as the ERC-20 standard allow a broad range of tokens to follow the same set of rules while varying greatly in their utility. Tokens play a crucial role in crypto derivatives, on-chain governance, staking, and more.
That said, just about any real-world asset can be tokenized and tracked on the blockchain. However, the idea of tokenization is evolving to meet real-world use cases. Examples of this include tokenizing data, proof of ownership, securities, and financial instruments. Accordingly, the technology responsible for tokenization is rapidly evolving to meet the needs of a shifting paradigm.
Moreover, the tokenization of complex financial instruments and assets enables issuers to program unique characteristics of assets in a format that is accessible around the clock. In addition, these tokens can dramatically improve efficiency and transparency in traditional markets.
The concept of tokenization is not exclusive to blockchain technology. Early iterations existed in the 1970s in the financial sector to protect clients’ personal data. Firms often convert information such as credit card details and social security numbers into strings of alphanumeric characters using various cryptographic functions. This results in the creation of unique tokens that represent individual pieces of client data. However, in blockchain terms, tokenization offers much broader utility to a wide range of applications in various industries.
Tokens and Tokenization – Different Types
Now that we’ve considered the “what is tokenization?” question, let’s take a closer look at some of the different types of tokens available. Below, we’ll discuss some of the most prominent tokens and how they benefit investors.
Utility tokens are among the most common types of tokens. They often have a specific function within a crypto application or ecosystem. However, many utility tokens have multiple functions. For example, a decentralized exchange (DEX) could offer a utility token that represents a share in the platform (with the price of the token theoretically representing the perceived value of the platform) while also giving holders discounted trading fees.
Other common utilities include access to token launches, preferential treatment, and discounts. Furthermore, utility tokens can serve as promotional tools for new projects. An example of this would be airdrops. Airdrops of utility tokens are a popular way to incentivize new users.
Many DeFi protocols use a native token to attract users in various ways. One popular type of DeFi token is the governance token. When a DeFi protocol uses an on-chain voting mechanism for protocol updates, a governance token often plays an essential role in casting votes. Furthermore, many DeFi lending protocols use a native token as rewards for liquidity mining and yield farming.
Data tokenization is the process of taking sensitive data of any type and exchanging it for “tokens” on the blockchain. It’s possible to tokenize just about anything on the blockchain. However, most tokenization occurs with assets, commodities, and data.
Data tokenization can represent data in a common format. Whereas encrypted data can be deciphered or reversed, there is no mathematical relationship between the tokens and the tokenized data. Also, data tokenization allows businesses to store data securely outside of a central database.
Security tokens are crypto assets that represent a securities offering in the traditional finance world. Securities are fungible, tradable financial instruments that mimic the price of assets such as stocks, bonds, and options. Also, securities can be tied to a share in a company. As such, security tokens can be seen as an investment in the long-term growth of a company. In addition, security tokens can be regulated just like securities in traditional markets.
Equity-backed security tokens such as those provided by the Tokeny T-REX service harness the transparency of public blockchains to offer a highly compliant tokenized equity solution. Tokenizing equities in this way enhances the user experience for equity investors. Plus, the platform uses a digital identity whitelisting process for maximum security.
Furthermore, T-REX uses a gasless model for tokenizing equities on the Ethereum blockchain. Accordingly, the process is fast, cost-effective, and free of many processes that would traditionally hinder adoption. Plus, it provides transparent proof of ownership for a broad range of assets.
Non-Fungible Tokens (NFTs)
Non-fungible tokens (NFTs) represent unique assets on the blockchain and are, therefore, not fungible. However, fungible assets are interchangeable. For example, one BTC in your pocket is worth the same as one BTC in somebody else’s. The same goes for Ethereum and fiat currencies, such as the U.S. dollar, to name a few. Moreover, these assets can be swapped for one another.
However, NFTs can be completely unique. This is particularly useful for things like art, music, and crypto gaming, as NFTs can represent transparent ownership of individual pieces of work or in-game items. Also, NFTs provide a transparent ownership history so that potential investors can track every transaction.
This type of tokenization lends itself to complex forms of investment and fractional ownership of assets. Also, NFTs are already being used for things like real estate, certification, and social media posts. Furthermore, NFTs can help to prevent fraud and counterfeiting in various industries across each step of the supply chain.
Before tokenizing an asset on the blockchain, it’s important to consider the various token standards available. Each blockchain has its own set of token standards. However, many of these are similar to the common token standards established by the Ethereum development community.
Token standards make it so that anyone can create a cryptocurrency with a uniform set of rules and parameters. For example, the ERC-20 token standard requires a token to have a specific set of events and methods. Anyone must be able to find the total amount of tokens available on the network and the token balance of a particular account. As a result, anyone can send an ERC-20 token to just about any Ethereum wallet.
Other common token standards include the ERC-721 and ERC-1155 NFT standards. The ERC-721 standard makes it possible to mint multiple unique assets from a single contract address. Also, the ERC-1155 standard makes it straightforward to sell multiple unique or rare assets in batches. This is particularly useful for NFT art and crypto gaming. Moreover, token standards enable assets and applications to be composable and compatible with multiple applications.
What are the Benefits of Tokenization?
Tokenization helps to draw additional liquidity to markets. For example, PAX Gold (PAXG) is an ERC-20 token that is backed by one fine troy ounce (t oz) of a 400 oz London Good Delivery gold bar. Not only does PAXG track the price of gold, but token holders gain physical ownership of gold.
Also, this gold is held securely in a vault, meaning that token holders benefit from the highest security while avoiding many of the risks associated with physical gold ownership. Furthermore, tokenization benefits investors and token issuers by facilitating compliance automation and standardized administration processes. This could be particularly useful for things like securities. Moreover, tokenized securities facilitate the frictionless, compliant transfer of ownership in a way that would not be possible without the use of blockchain. Plus, data tokenization is among the most secure ways to protect personal information.
The tokenization of traditional assets allows them to reach larger audiences. Also, this additional liquidity helps to remove the “liquidity premium” associated with investments such as art and real estate. Furthermore, tokenization facilitates fractional ownership. Accordingly, investors have more opportunities than ever before to gain exposure to assets that have historically been reserved for the wealthiest investors.
Transaction Cost and Speed
Tokenization also benefits investors by removing intermediaries that are common in traditional asset management. As such, investors can save money on unnecessary fees and costs. In addition, token trading and management often occur in real-time rather than within the opening hours of stock exchanges.
The use of public blockchains enables transparent ownership of assets, cryptographically-verifiable provenance, and transaction traceability. All public blockchain transactions are automatically recorded into a distributed ledger that cannot be manipulated. As such, crypto tokens can offer higher reliability than many other digital assets.
Deep Dive: What is Tokenization? – Summary
Tokens are crypto-based representations of an asset. Tokenization is a method of converting anything of value into a token that can be used with a cryptocurrency application. These tokens can represent physical assets such as gold and commodities or intangible items like licenses, voting rights, and proof of ownership.
Tokenizing assets helps to increase transparency while drawing additional liquidity to markets. Also, tokenization offers compliant investment vehicles that lower the entry barrier for a new wave of investors. Plus, data tokenization removes many of the constraints of traditional data security methods.
The use of blockchain is becoming increasingly prominent sector-wide. From art, music, and crypto gaming platforms to Web3 browsers, blockchain in supply chain, insurance, and real estate, blockchain is becoming a staple in business practices globally! As such, there has never been a better time to learn a new skill in an emerging industry.