Why asset backed tokens will be mainstream
Everything you need to know about crypto securities.
Ethereum was the first smart contracts computing platform and its adoption as a facilitator for blockchain based crowdfunding has grown significantly over the past two years, leading to the current token sale or initial coin offering (ICO) phenomenon.
The most common types of tokens issued through these ICO’s are so called utility tokens in the form the ethereum ERC20 standard token. While many tokens do not provide any value or utility, (besides perhaps being a security) there will be some decentralized applications and protocols that will challenge and transform traditional industries. The valuation of utility tokens is currently very subjective or driven purely by speculative market forces, while the potential value of asset backed tokens is easier to rationalize.
What is an asset backed token (ABT)?
An asset backed token is a blockchain token that is connected to a tangible or intangible object that has economic value. There are fungible (often referred to as security tokens) and non-fungible asset backed tokens that can represent various real-world (physical) assets. Non-fungible means that one unit is not equal to another similar unit, two diamonds of equal dimensions are still not interchangeable. An asset backed token essentially digitizes an asset and records its associated information on a blockchain. For example, a real estate property could have a digital record, instead of a standard paper deed. A token that represented a specific property could be created, which would store information about the house, such as the deed, ownership/renter history, financing, geographic location, and anything else desired. The ABT could be easily transferred to another owner when the property was sold.
Types of ABT’s
While there a few different types of token models for asset backing, ERC721 is currently the most common non-fungible token (NFT). ERC721 will likely become increasingly popular throughout 2018 although the ERC821 NFT standard looks like it could be promising as well. But, the question remains, why would you want to tokenize a real world asset?
General benefits of ABT’s:
Asset backed tokens can provide many benefits including:
- Securitization of assets
- Ownership rights
- Decreased volatility of cryptoassets
- Definable intangible assets
Liquidity in the simplest terms is how quickly and easily something can be bought or sold based on the volume of trading activity in a market. Stocks and bonds can be sold almost immediately at a market price, while other assets like cars, real estate, or collectibles require much more time due to the lower volume of secondary market trading activity.
The primary reason that real world assets would want to be on the blockchain is to increase their liquidity. Real estate is a typical non-liquid asset that requires lots of time to sell. Ask anyone who has every sold their car or house, finding a buyer can take lots of time.
Liquidity is arguably more important than some realize, as it enables investors to enter and exit markets much more efficiently. This is incredibly valuable when considering how fast things can change. When the global financial market started to crash in 2008, if you could have sold your house or apartment instantly you might have saved (hundreds of) thousands of dollars. When liquidity is provided to a market it enhances the value of the underlying asset because it mitigates some of the risk that would be associated with not being able to quickly sell that asset.
Securitization of assets
Many assets require a primary owner of the underlying asset, not all assets allow for joint ownership and for those that do, it can be very difficult to obtain. Tokens increase the potential for fractional and shared ownership because tokens are divisible. A tokenized patent could be easily divided among the inventors and then the royalties could be distributed directly and proportional to each individual’s ownership. Beyonce’s hit song, “Single Ladies” could be tokenized and once downloaded or played, the royalties would be paid to Beyonce, her producers and whoever else owned a stake in creating the “Single Ladies” song. Of course Beyonce would receive the all the proceeds from her song sales because she is the Queen, but any other non-Beyonce song could easily be securitized on the blockchain.
Imagine having undeniable ownership of your assets. While this idea may not seem too revolutionary to those who live in advanced economies, those who live in more corrupt and less economically efficient countries know the realistic possibility of a government seizing their property simply because they don’t possess a property deed.
Even in countries like the U.S, Britain, and France the government is able to seize land for the public using the legal rights of eminent domain. U.S landowners on the Mexican border could have their land seized without compensation in order to build President Trump’s border wall. With digital asset ownership you’ll have undeniable proof that you own your property, which can’t be easily destroyed like a piece of paper. Ownership records cannot be altered by centralized authorities and a bank or government would not have ability to seize the digital ownership of your land, car, or equipment.
One of main challenges for cryptocurrencies becoming mainstream is price volatility. Cryptoassets are incredibly volatile and are likely to remain volatile until a rational and more liquid market develops. Asset backed tokens have the ability to take traditional assets, such as real estate, precious metals, intellectual property, and combine them with decentralized blockchain asset properties (efficient securitization, trustless transactions, etc). These new hybrid traditional-crypto assets will naturally be less volatile than current cryptoassets, helping the market stabilize.
Another important note is that assets connected to traditional markets only trade Monday through Friday.
Cryptoassets trade twenty-four hours a day, seven days a week, 52 weeks a year. The ability to open markets regardless of geographical location or arbitrary time differences will provide more trading opportunities for everyone around the world. Although it may make it harder to sleep at night.
Definable intangible assets
Conceptually it will be easier to back intangible assets because they already exist in digital formats and have no physical presence. Copyrights, trademarks, and patents can all have asset backed tokens that would allow for a more transparent system. Intangible assets are generally illiquid and have few secondary marketplaces. Having a tokenized version of these assets will provide more transferable ownership for intangible assets. Purchasing licensing rights to a song or patent will be fast and cheaper with definable tokens.
Precious metals and other commodities
Purchasing, owning, and storing gold or silver in large quantities is not an easy task. Most individuals that purchase precious metals do so using an exchange for speculative purposes. However, blockchain technology provides a more secure and stable way to transfer ownership of this asset. The gold and silver could be traded without an intermediary and ownership would be indisputable. If you wished to claim your gold or silver you could simply exchange your token for the physical metals. There are many projects aiming to create gold and other precious metal backed tokens, such as Digix and HelloGold.
Any commodity that is currently sold on an exchange can become a fungible asset backed token, whether it is oil, sugar, wheat, or even cattle. These commodities are already electronically exchanged through trusted intermediaries so tokenizing them would be relatively fast and easy.
Energy commodities such as crude oil and natural gas can be traded as asset backed tokens. Other renewable resources, such as wind, solar, and hydro energy will also have the potential to be tokenized and traded between nations or even individuals. A decentralized exchange that sells commodity backed tokens could drastically reduce costs as almost no overhead would be required because traders can bypass intermediaries.
Tokenized real estate has larger applications besides acting as deed to your house or apartment. Divisible and proportional ownership is one of the more interesting applications for real estate. The Burj Khalifa, the building Tom Cruise A.K.A Ethan Hunt scaled in the movie Mission Impossible: Ghost Protocol is one of the most expensive buildings ever built with a price tag of around USD 1.5 billion. The Burj Khalifa is currently owned by Emaar Properties, but partial ownership could allow say 150,000 people to own and share the revenues of the property with a small investment of USD 10,000. The ability to suddenly democratize property that was once unaffordable to millions of people is a powerful application of ABT’s.
A common question is how could that many people actively agree on property and business management decisions. Management decisions could be agreed upon based on proportional voting system or even delegated to other companies or individuals. A smart contract could further specify certain duties any owner must perform in order to receive profits or maintain legal custody of their Burj Khalifa token. While there are still major steps before this becomes a reality, democratizing ownership and equally distributing resources in a common and inevitable trend throughout history.
Art is another typically illiquid market where it is difficult to find immediate buyers and sellers. Therefore, it takes a lot of time to sell art, it usually has to be appraised (sometimes more than once) and even then the piece could be a forgery.
With ABT’s, an artist could have their own digital signature that they could use to sign all their artwork. This could eliminate all forgeries and allow people to verify any piece of artwork as decades or even centuries pass. Imagine if the artwork of Leonardo da Vinci had been an ABT and we had access to extensive records of when pieces were created, if the artists collaborated with others, and the artist-given titles. Maybe the Mona Lisa was actually titled “Woman in Love” and that’s why she’s smiling. Probably not, but the point is ABT’s would allow us to know that information.
Auction houses like Sotheby’s and Christie’s control much of the secondary art market, preventing the majority of people from the opportunity from having an ownership stake in rare artworks. Similar to our crowd ownership of the Burj Khalifa, expensive and famous pieces have the potential to be purchased and equally shared by museums or even by hundreds of individuals. Smart contracts can equally distribute royalties or specify dates that individual museums can display the co-owned art piece.
There will be historical collectibles, such as coins, toys, trading cards and comics that can be tokenized. There will also be new tokenized collectibles that have not yet been created. Virtual and augmented reality art will continue to grow in popularity, requiring a means to show ownership and a method in which to sell virtual pieces. Tokenization of virtual art seems like a very practical application for artists.
Some of the first applications following mainstream adoption of the internet was from gaming. Games like pong, online gambling, or other long forgotten computer games created the foundation for what is now a multi-billion dollar industry. Gaming has continued to develop and now has a separate multi-billion dollar industry solely based on virtually traded goods. Virtual goods such as costumes or other aesthetic features called “skins” are frequently sought after between online gamers. These virtual goods already have a digital presence so tokenization would be easy, conceptually frictionless, and will allow players to trade these goods on their own without the need for an exchange or intermediary.
WAX is an decentralized exchange aspiring to provide such a market for virtually traded goods. Virtual goods are currently a highly illiquid market, so the creation of a marketplace for them could provide much needed liquidity and potentially open up opportunity for investing. Augmented reality and virtual reality are able to utilize asset backed tokens to place objects or even RPG(role playing game) characters into their ecosystems that would be tradeable within the virtual or augmented realities.
Gaming amplified by virtual and augmented reality provides even more use cases for ABT’s. Decentraland, a virtual reality game utilizing blockchain technology, just completed their first virtual land auction for Genesis City of the Decentraland ecosystem. This land will eventually contain a marketplace for gamers to interact and trade virtual real estate. Augmented reality has similar opportunities to create digital/virtual real estate. Projects like Arcona offering individual digital land in their augmented ecosystem. Professional and recreational gamers will continue to merge the lines between virtual and traditional reality, in turn creating a large ecosystem for virtual goods.
Self-sovereignty is an exciting application of blockchain technology. While you probably don’t actively consider your identity as a traditional asset, it will be quantified as one in the future. Corporations, such as Facebook and Google already view their customers as assets of information that they can sell. Data breaches of people’s private identities, personal information, and national identification numbers happen all the time. In fact, according to a new report form Javelin Strategy & Research 15.4 million consumers in the U.S were victim to identity theft or fraud last year. A person’s identity and information will eventually become their most important asset and potentially the most profitable.
Estonia, a small country in eastern Europe, has already created a digital citizenship. Estonia’s digital citizenship offers an e-resident to establish a company online or manage documents and services online, all without ever needing to live in the country. This is just the beginning of what digitizing identities on the blockchain have the potential to accomplish.
Digital citizenship will offer the unique ability of trading tokenized identities. For example, if you moved from France to Hong Kong and now needed a new doctor. An asset backed token of your medical history could transfer all medical information to your new doctor. This would prevent other companies from storing people’s medical information on a centralized database and give everyone complete control of their own personal information. Users will potentially be able to transfer any personal information conveniently to individuals or institutions without having to risk it being lost, stolen, or manipulated by any other party.
We all have other important documents besides our identity that can be tokenized. Passports, birth certificates, and marriage certificates can all exist as asset backed tokens. Evernym, a company trying to create self sovereign digital identities on the blockchain has already partnered with the state of Illinois to put birth certificates on the blockchain. These are all very significant documents that are often lost or easily forged. Electronic passports already exist so taking it a step further and tokenizing them using the attributes of decentralized technology (open, trustless, censorship resistant) could provide users with more personal security and reduce the security risk from forged passports.
Venture Capital, Private Equity, and Hedge funds
These types of companies invest in other companies and assets that generally tend to be very illiquid. The only way to receive funds back in a VC or private equity (PE) firm is when a private company goes public or is acquired by another firm. Hedge funds tend to have a little more flexibility with their investments, but in recent years have started to invest in less liquid assets.
Further, these firms usually require investors commit to a certain amount of time (years or months) and there are generally restrictions on how and when someone can take their money out of an investment, PE, or VC fund. If these firms are able to invest in a hybrid of traditional and cryptoassets in the form of ABT’s then this would benefit them immensely and increase their liquidity. This seems like a miniscule benefit, but it’s actually game changing because it allows these types of firms to adapt to the market and mitigate risk by adjusting their portfolios, potentially save hundreds of millions of dollars. Hedge funds, such as Multicoin Capital and Polychain Capital have taken high liquid investment strategies while investing in cryptoassets and become very successful.
Companies such Overstock.com have already raised over USD 250 million for their security token and have also received SEC scrutiny. While this is currently a very grey area, eventually many large companies may choose to institute tokenized equity over traditional equity. Kodak, the once prosperous company that refuses to die, has also decided to launch their own token. While not all traditional companies will be able to effectively use a token, the allure of huge capital funding is certainly hard to resist.
Equity tokens would be slightly different than most other asset backed tokens in the sense that they would be fungible. It’s possible that once securitizing tokens is legally allowed many traditional companies will start to implement an asset backed token with equity rights. It’s also possible that projects and companies will never institute ABT’s with equity rights because they can raise capital while retaining all of the ownership in their company.
Challenges for ABTs to become mainstream
Laws and regulations
One glance at the news and it’s obvious that governments and financial regulators around the world have very inconsistent viewpoints on how to regulate cryptoassets. Some countries opt for complete bans like Qatar and China, while other countries allow for loose restrictions, such as Switzerland and Estonia. Because ABT’s are attached to real world securities or items they will be more familiar to governments compared to bitcoin and therefore easier to regulate compared to utility tokens.
However, regulators of long standing physical assets are extremely conservative and are taking tokenization of traditional assets as slow as possible. Regulators are still unsure about decentralized blockchain as a reliable ledger and are even more skeptical of combining real world assets with digital properties, especially amidst many ICO scams. Governments and regulatory bodies usually move slowly in uncharted waters and decentralized blockchain combined with tokenized assets is about as uncharted as it gets. The only reason regulators are even on the boat is because they realize the potential economic benefits of distributed ledger technology and don’t want to discourage innovation.
Government regulators are also concerned with protecting their citizens from participating in malicious projects that steal their money. Any single negative event about cryptoassets could result in a government completely banning or at least instituting strict regulations on all cryptoassets. The adoption and acceptance of asset backed tokens will take time and will gradually evolve as people and governments realize they can use them to become more efficient.
Cryptocurrency transactions are still very difficult for some people to grasp and ABT’s will have a high probability for user error when people first enter the market. Losing an ABT could have some severe consequences, just as losing the deed to your house or social security card. Knowledge about the best practices will be vital for people to gain confidence using a previously inconceivable model for managing assets. However, just as everyone has learned to use the internet, they will learn to use blockchain enabled technology throughout their daily lives. There will be growing pains, but once the market has matured these pains will subside and the true benefits will be realized by the masses.
Obviously blockchain technology is far from perfect and there are still a lot of technical issues, too many to get into. There will always be problems, bugs, and ideas that will have to be tested. ERC721 appears to be a good standard token for non-fungible assets, but the ERC821 standard or a new token standard may eventually be superior. Once industry standard practices have been developed, there will be an explosion of ABT’s in the market just as there has been an explosion of utility tokens.
Asset backed tokens have many use cases and capabilities that can provide economic and social benefits to many industries.
ABT’s will eventually be mainstream and in 2018 the crypto space may develop better defined token standards for non fungible items as well as some much need regulations. When I think about cryptoassets and asset backed tokens, I’m reminded of the old children’s story about the tortoise and the hare. Crypoassets as whole have been moving fast and sometimes recklessly while ABT’s represent the slow tortoise, moving slowly due to uncertain regulations, hesitant adoption, and a myriad of technical issues.
Eventually as the market matures, users will learn, regulation will create needed safeguards, and the other industries will utilize the benefits of ABT’s. I don’t know how long it will take, but just as the children’s story teaches, slow and steady wins the race.