How Does Tokenization Work? A Beginner’s Guide to Tokenized Assets

How Does Tokenization Work? A Beginner’s Guide to Tokenized Assets

The emergence of blockchain technology has birthed the tokenization of assets, enabling the digitization of real-world and digital assets. Read on to learn what tokenization is, how it works, what its most promising use cases are, and discover a list of real-world examples. 

What is Tokenization in Blockchain?

Tokenization in blockchain is the process of transforming the value of an asset, such as a share in a company or a painting, into a token that “lives” on a blockchain

There are two types of tokenized assets: tangible and intangible assets

Assets like artworks, gold, and real estate are examples of tangible assets while content licensing, ownership rights, or voting rights are classified as intangible assets. 

Tokenization, however, didn’t start with blockchain technology. 

The financial services industry has been applying some form of tokenization to help protect their clients’ confidential information. Typically, the process involves the modification of sensitive data – such as personal identifiable details, credit card numbers, and even social security numbers – into secure alphanumeric characters that are then processed cryptographically to create a unique token. Albeit traditional, this method has some resemblance to how blockchain tokenization occurs.

Today, tokenization in blockchain provides a process to tokenize assets in a more secure and flexible way. This has further boosted the utilization of digital tokens across various industries.

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How Does Tokenization Work?

Now that you have an idea of what tokenization is, let’s take a look at how tokenization works in practice. 

Traditionally, the process of transferring an asset has been quite cumbersome as it involves a lot of paperwork and legal agreements that can end up being hard to track. However, with blockchain-enabled tokenization, assets can be digitally transferred in a process that is much faster and more efficient. 

Tokenization in blockchain is mostly divided into three asset categories that can be converted to digital tokens: intangible, fungible, and non-fungible. 

Intangible Assets

These are assets that exist purely based on legal precedents and have no physical objects as a representation. Copyrights and patents are examples of intangible assets. 

When looking to tokenize an intangible asset, it’s imperative that the real world transfer model of the asset and that of the blockchain network remain the same. Intangible assets are easy to tokenize as long as there are no shipping or storage concerns. However, jurisdictional differences can pose a challenge when it comes to transferring tokens that are a representation of intangible assets.

Fungible Assets

Fungible assets are assets that are interchangeable. For example, the US dollar (and other fiat currencies) are considered fungible assets. 

Fungible assets can easily be converted into tokens as they can be divided into smaller units with one token serving as a representative of a specific number of units of a fungible asset, such as the US dollar.

Non-Fungible Assets

Unlike fungible assets, non-fungible assets can’t be interchanged with the same asset as they are unique. 

Tokenization helps to break down non-fungible assets into digital shares that can be traded in a limited way or fully. Pieces of art or real estate are good examples of non-fungible assets that can be converted to digital tokens. 

An artwork, for instance, can be digitally converted to a token by incorporating an immutable digital signature. The digital signature becomes the artwork’s representation while maintaining its uniqueness. Additionally, the token can be broken down into smaller sub-tokens that one can sign digitally and even sell as shares of the real artwork in the form of fractional NFTs, for example.

Next, let’s take a look at the benefits of tokenization.

Benefits of Tokenization

Tokenization comes with a myriad of benefits. Here are the most impactful ones. 

Higher Liquidity and Accessibility

Tokenized assets can become widely popularized to a bigger audience. This in turn, increases market liquidity and eliminates the liquidity premium typically linked to investment assets that are traditionally more time-consuming or difficult to sell. 

In addition, tokenized assets can easily be exchanged online, thus allowing investors to own a fraction of the token’s underlying asset. This way, a tokenized asset doesn’t just contribute to the liquidity in existing markets but also offers a wider range of investment opportunities to investors.

Faster and Cheaper Transactions

Tokenization helps eliminate intermediaries since transactions are processed on-chain and/or using smart contracts. The automated process also helps reduce the administrative burden, which results in transactions that are much faster and more cost-effective.

Transparency and Immutability

Another benefit of tokenization is transparency and immutability thanks to the utilization of blockchain technology. Transactions on the blockchain are recorded in a transparent manner and can typically not be altered. This enables anyone (or specific parties) to see the ownership as well as transfer history of the tokenized asset. 

Tokenization Use Cases

It’s still early days for blockchain-powered asset tokenization but a handful of tokenization use cases have already emerged. 

Tokenization in Real Estate

Real estate tokenization can help streamline the investing process for investors by eliminating intermediaries, enabling buyers and sellers to interact with each other directly. Moreover, fractionalization can open up the real estate market to more investors by enabling them to purchase fractional ownership in properties. 

Tokenization of Precious Metals

Tokenization can help lower the entry barrier for the precious metals market, enabling more investors to gain exposure to metals like gold and silver simply by purchasing a digital token representing a certain amount of value in a specific precious metal. 

Tokenization in the Art Market

As the rise of NFTs has shown us, the tokenization of physical and digital art is another compelling use case. Turning an expensive piece of art into a set number of digital tokens representing shares in the artwork enables more collectors to take part in the art market while creating new monetization models for creatives.  

Real-World Examples of Tokenization

Arguably the best real-world best example of tokenization is NFTs in the art market. Hundred of thousands of artworks are being tokenization and sold as NFTs to collectors around the globe, enabling artists to get paid (sometimes handsomely) for their craft. ‘The Merge,’ for example, is one of the most expensive NFTs, selling for $91.8 million.

Fractional investing in the real estate market has also emerged as a popular market for tokenization. Platforms such as RealT and SolidBlock enable investors to buy fractional ownership in real estate properties in the form of digital tokens.

Even though the full potential of tokenization is yet to be realized, the use cases in several sectors suggest that tokenization is not only a mere concept but a technology that, if fully embraced, can bring immense change.