I wanted to talk to you today about a concept in digital currency which we bump into a lot, but can require a bit of explanation. That is the idea of tokenisation. This is a fundamentally disruptive idea (sorry, there’s that word again, but it’s true — the fortunate thing is, the disruption is largely at the institutional stage, with relatively little impact on you as the user).

If you like, tokenisation is the disruption of money

So to appreciate this, we have to first understand exactly what money is.

Money can be understood in many ways, such as a store of wealth and value, and a way of accounting for things. Day to day though, money is our means of exchange — and this makes it very different from other forms of wealth such as property, or jewellery, or other kinds of assets like bullion or stocks.

But the money we use every day used to be pegged to the value of scarce resources, most often gold. Because gold was scarce there were issues in storing it and transporting it safely, so eventually an industry called banking emerged, which guarded the money and issued paper promises to circulate in its stead, far easier in everyday life, and everyone understood and believed in the valuable resource represented by the piece of paper.

However for many years now the gold standard has been removed in most developed economies, and now the value of money comes from the policies of the reserve banking industries, combined with the network effects of global usage — one pound sterling is worth one pound sterling, or about 1 and a third US dollars, because we all accept and agree that this is so.

We call this fiat money: something (like a bank note) made legal tender by a government decree. Many reserve banks still have gold bullion, but their currencies float independently of the gold price, and it’s a matter of policy rather than preciousness, exactly what the banknotes in your wallet are worth.

Of course, the world has other assets, with real intrinsic value — in addition to precious metals, there are fuel resources, property, works of art, rare gems… even crop yields in the foods we depend on. But these are not easy to trade and exchange, to physically transfer or to subdivide. We say they are “illiquid” — their value cannot easily flow, from one bearer or location to another.

It would be impractical or costly to transact with such things in real life.

But what if we could unlock that value, if we could fractionalize it, transparently and securely?

Blockchain-based tokenized assets are the answer. We have technology emerging now which enables us to quantify, divide and trade in tokens of real-world assets, on an immutable and censorship-resistant public ledger.

Tokens which denote real-world assets — similar to the promise printed on fiat banknotes, but actually backed by something real. They are like shares of ownership, in something physical.

These are ‘security tokens’, and blockchain-based tokens are similar to traditional securities like stocks, which are traded digitally in the world financial markets every day.

There is some similarity to the process of securitization, where financiers bundle and slice fractional ownership of various assets — this has existed for hundreds of years, and is not without its problems.

But before the transparency of direct, on-chain tokenization, securities could get completely separated from their connection with the real world — as in the 2008 financial crisis, when trillions of dollars worth of collateralized mortgage loans were securitized, and were then bought and sold from one institution to another, completely disconnected from their real underlying risk profile — the risk of a mortgage holder being unable to make their repayment.

We all know how that ended up.

Therefore the key challenge for any system that involves tokenizing real-world assets is to ensure that the digital token stays directly connected to the real-world asset.

This is where the immutable, tamper-evident technology of the blockchain makes the difference, employing distributed ledger technology with smart contracts, to directly quantify ownership and allocations in real-time.

Of course, this will in many cases need to be combined with robust off-chain due diligence, to create a total system of real-world asset tokenization. Industries like real estate have complex legal procedures of their own to adhere to. But it’s the intersection of the two which makes things really interesting.

That’s because, so much of the world’s worth is tied up in illiquid, static assets.

If we could tokenize it all and unlock it, just imagine the transformation. The world’s total stock of financial assets, real estate, and physical assets is currently worth more than $400 trillion. Real estate alone is valued at $217 trillion — all stuck, in fixed, non-liquid assets.

Right now to invest in any of that real estate is expensive, completely excluding access for most of the world’s population. Even if you have deposit funds of around 20%, it can take months to contract and secure loans for the rest (and this assumes you have an A1 credit rating — otherwise forget about it). Then bear in mind that the average transaction costs just to buy any property is around 10%, so it would cost close to $21.7 trillion simply to liquidate the entire global real estate asset marketplace!

After that you are invested in a really illiquid asset — even it’s earning you income from letting and appreciation, you can’t get any of the value out until you sell the whole thing.

So the potential of asset tokenization, to free that value, cannot be overstated. It will cause an instant redistribution of power in the world, as liquidity increases… and trade increases.

And this can apply to ANY asset, not just real estate.

Consider for example equity in private companies:

A share of a stock traded on a public stock exchange is valued more highly than a share in an identical private company because it’s easier to trade the public stock. There are more market participants, greater volume, smaller spreads — and less price impact.

This liquidity premium (which could also be described as an illiquidity discount), can be as much as 30%! Simply tokenizing these kinds of assets will make a big difference, and will make investment fairer and more transparent.

But think about all the other assets in the world, which are even more illiquid — yet contain so much value.

Imagine if an indigenous tribe could fractionalize returns on fuel mining on their ancestral homeland, a land forever secured in their name by a public smart contract. What if they could trade access to mining corporations, in exchange for a return on investment of the resources extracted, and development of the infrastructure they need in their community, like medical centres or schools?

Imagine a student band with a small but loyal fan following, who want to spend time creating and recording their own original music, instead of playing covers of popular hits for tourists and wedding parties.

What if, instead of selling their souls and their artistic integrity to a record company, they could tokenize their music, their own art: If their fans could own a share in the creative output of the band, and receive unique perks, such as special gigs and recordings unique to their community? How about iIf all of that value went directly to the musicians, instead of to a centralized platform, which calls itself ‘peer to peer’, but ultimately controls the relationship and the transaction?

Or, imagine the value contained in the livestock herd of a nomadic family group, who have never owned land of their own — but have cultivated their rare breed stock for generations.

What if they could tokenize that livestock itself, and release capital to send some of its young people to university, to study breeding and veterinary techniques, to improve the herd further and bring long-term security to the lifestyle of their people, without sacrificing their tribal lifestyle and acquiring real estate of their own?

The potential extends far beyond the measurable book value of tangible assets. And it’s only when you start to realize how massive the reach is, that the mind-blowing extent of the potential disruption becomes apparent

So, our brave new tokenised world could look very different to the one we presently live in

For example, we’ve been talking about ‘the sharing economy’ for more than a decade, but it has all been an illusion, based around centralized corporations which control the platforms and take a big slice of the profits. Decentralized ledgers redefine sharing, so the very concept of ownership is going to need a shake-up.

Instead of getting a loan to buy a house, it might make sense to buy a basket of real estate tokens, in properties around the world — it’s better to diversify, in a volatile marketplace.

Or if I own my house, perhaps you could buy a few shares in it, so I can release capital to invest in something else or for living expenses? I could tokenize my house, and instead of making mortgage payments, I’d make payments to the network of token holders.

And tokenization will create new ways to organize and act collectively. Perhaps a community of small donors will acquire a piece of art for their local museum through a token sale, even though none of them could afford to buy the painting individually. The difference between this and current crowdfunding models is that the token holders will retain real fractional ownership. Of course, we’re going to need new contract law to accompany all this, loads of off-chain work to be done — but the asset ownership will be clear and transparent on the blockchain itself, for anybody to inspect.

When I talk about tokenization and shared ownership, I don’t mean some kind of communist and collectivism — but true control, over how assets are allocated and distributed. By removing “middlemen” and embedding both execution and legality within smart contract code, tokens make it easier and cheaper to divide assets into fractions and lower the cost global transfers of ownership.

Ownership of tokens will be complex because present law makes a distinction between assets that are fungible and those that are not. A fungible item is one that can be replaced by another identical item, in the way that a dollar bill can — like crops, gold or oil. Fungible assets are much easier to convert to tokens because they can generally be broken down into smaller units (like grams of gold in a bullion bar), and a token can stand for a group of objects (e.g., a pile of gold)

It’s different for non-fungible things with variable intrinsic value — a token couldn’t easily stand for a set of individual objects, like a warehouse full of unique works of art.

But the processes and protocols will catch up eventually, and shift our mental picture of what owning something looks like and feels like.

Governance models will need to evolve. If a hundred people collectively own a property, who ensures that it is maintained and secured, and who has the right to live there? If 10 thousand people own fractions of the building, none of them can even monitor this in a way that would not exceed the costs of their investment.

So although the blockchain smart contract provides for the asset tokenization itself, new security solutions will need to be created off-chain to address the physical aspects of the assets involved.

But it will be worth it, because liquidity is the fundamental reward for unlocking all this value.

Rather than thinking in chunks and units, we will start to see value as something which can truly flow, from any owner to another, from any location to another, without barriers or friction — and without value leaking away to trusted institutions and third parties.

Then we will truly have a peer to peer exchange of value.

A successfully tokenized economy is all about inclusion. Indeed, it needs mass adoption to work — if a token is thinly traded, it going to stay relatively illiquid. But because the tokens are highly divisible and move digitally around the world, the potential market is truly global. More participants mean more market depth, and more trading for everyone.

No KYC or qualified investor status.

Indeed it is not limited to those who are included in traditional banking markets, who have typically recognised consumer credit scores, or who have assets in specific currencies. So many people fall through the cracks and are excluded, from the financial behaviors we easily take for granted. And the value they bring to the world, to their communities, is lost to the economy.

Further inclusion will take place if we can tokenize the value of unrecognised activities, such as home-making and childcare. Perhaps these tokens could be used by some of the poorest and most disempowered women in the world as collateral for micro-business loans… And a real opportunity to create change in their lives and communities.

The potential is incredible.

So, I’ve talked a lot about the ways tokenization could make the world a better place. However, the reality is that we have a long way to go, for all the infrastructure to come together to make this happen in the real world, with sufficient network effects... It might take years, or even decades, to be truly manifest.

But tokenisation is evolving. Today you can buy REITs, real estate investment trusts, in which you can take shares in a portfolio of property (which has been compiled and managed by a central company) — which demonstrates some of the potential. But it’s not transparent, you have no control, and the barriers to entry are high.

And you can gold using Digix tokens, an ethereum-based protocol, which is much closer to true digital asset tokenization. Digix uses a Proof of Asset protocol, to certify the chain of custody of the actual bullion, creating asset cards certifying the vendor, custodian, and auditor, written into the Ethereum blockchain, and the Digix-DAO is exploring new applications for this model going forward.

So we have much of the technological infrastructure in place, or at least emerging, to do what is needed — the blockchain is ready, fast internet is reaching more of the globe daily, and mobile connectivity is exploding — with the 5g revolution around the corner, scaling up the speed of the distributed ledger exponentially.

But whilst technology changes quickly — social institutions and regulatory frameworks do not. The tokenization of traditional assets represents one of the greatest challenges that the SEC and other global regulatory agencies are facing this decade. There is much to keep the lawyers busy for a long time.

Tokenizing real-world assets creates challenging problems requiring innovative solutions, which will need to 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 .

But with positive interest from the IMF, the G20, and regulators around the world, and governments themselves increasingly adopting blockchain solutions, we can see that the ground is shifting, the realities are responding. Some of the brightest minds are actively seeking creative solutions to all of these challenges, and disruptive change is most definitely coming.

It’s going to be very exciting. There’s so much more going on in this space than stressing about crypto prices… smart people are building, creating and thinking about amazing things.


Tokenising All Of The World… was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.