Beyond the Buzz: Understanding the Significance of Tokenizing Real World Assets for Value Storage

In the cryptocurrency space, tokenization is the latest buzzword, which is attracting not just the Web3 natives but, more importantly, the giants of the traditional finance (TradFi) world. With all the innovation happening in finance over recent decades, the industry continues to follow the tradition in terms of intermediaries and limited availability in contrast to the current fast-paced digital world.

To match that up, companies are capitalizing on trends like tokenization, which has the power to revolutionize the financial landscape by changing how investments are managed, used, and monetized. 

Tokenization is a process in which the rights to an asset are converted into a digital token on a blockchain, and ownership rights are traded and transferred on a digital platform. Almost anything can be tokenized, which includes, but is not limited to:

• Gold, art
• Collectibles
• Real estate
• Luxury items
• Data
• Contracts to the US Treasuries
• Public and private equity
• Debt
• Investment funds
• Infrastructure

Real world asset tokenization is expected to be a multi-trillion market, which is currently sitting around USD 300 billion. 

The Efficiency of Tokenization 

The current financial system is fraught with time delays, complexity, and inefficiencies. Using blockchain technology, tokenizing brings increased efficiency, reduced cost, and enhanced transparency. Moreover, it increases the liquidity of traditionally illiquid, non-fractionable assets. 

“What we're going to see is markets that historically have been inefficient becoming far more efficient,”

– said Pat O'Meara, CEO and Chairman at Inveniam, when talking about tokenization while giving a keynote at the inaugural TokenizeThis conference by Security Token Market (STM).

By representing physical assets as digital tokens on a distributed digital ledger, it's possible to unlock the value of real-world assets and exchange them in real time. Unlike traditional markets with set trading hours, crypto space allows for 24/7 trading of these tokens. Enhanced liquidity is one of the most important benefits of tokenizing real-world assets, in addition to increased Investor confidence by the transparency built into blockchain technology, which lowers the possibility of ownership conflicts. 

Over the last several hundred years, banks have played as an intermediary of trust between individual parties, corporations, cities, and states. But tokenization removes these prevalent entry barriers in traditional financial markets and lowers the costs.

Even the US Federal Reserve is taking a keen interest in tokenization as earlier this month, Fed Governor Michelle Bowman noted that:

“because new digital assets are currently focused on tokenization of certain traditional or even new types of money, tokenization is a research theme for the Federal Reserve and for central banks globally.” 

According to her, this topic will also inform other issue areas, including “stablecoin regulation, novel banking activities supervision, and efforts to improve the current payment system.“

Access to Markets in New Innovative Ways

From an investor point of view, tokenization has great implications as the ability to transform real-world assets into tokens can pave the way for a whole new world of products and services, allowing every person and organization in the world to diversify their portfolio of investments on a global scale, regardless of income or size. 

“It allows people to access the capital markets in new innovative ways where there are no choke points that are controlled by the incumbents (such as banks) who are extracting rents,”

– said O'Meara of Inveniam, a platform with $80 billion in assets.

While investors get increased democratization and access to previously unavailable assets, entrepreneurs get to tap into a wider pool of investors and expand more quickly.

But for investors, it's not just access to previously unavailable markets but rather a way to have a better way to store value. O'Meara expanded on it at the TokenizeThis conference by pointing out how banks have played the role of an intermediary of trust between individual parties, corporations, cities, and states. In this role, the bank deploys its customer funds in the expansion of means of production, civil infrastructure, and technology innovation, and it has been “massively impactful in spurring creation and innovation.” For the customer, however, this means taking the enterprise risk of that bank. 

Now, we're seeing an evolution of banks being the primary mechanism by which excess capital is distributed for the innovation and creation of economic means being created by individual actors, corporations, entrepreneurs, technologists, and governments building infrastructure to “this global economy where the internet is connecting the supply chain,” said O'Meara.

Transforming the Delivery of Stored Value

Besides the economics of delivery, blockchain and the Internet of value are also transforming the delivery of stored value by removing these banks as the middlemen — intermediaries of trust.

However, this doesn't mean the role of a bank will be gone; rather, it would be changed “dramatically” where banks are not going to be that central intermediary, argued O'Meara.

“What we're going to do is we're going to see people being able to store their value away from perceived risk and participate in a global economy.”

According to O'Meara, in this next iteration, we don't need an intermediary oracle of a bank where the medium needs to be a currency; rather, we can begin to tokenize a real world asset. “This tokenized real world asset has daily, weekly, monthly, and quarter liquidity changing the store of value,” he said.

He argued that as a cash saver, which is a large part of the middle class globally, one is negatively affected by the central bank's monetary policy of printing money as these savings are deflating every month, every year. But, if one is an asset owner or an asset creator, one is protected from that inflation. 

Tokenizing real world assets allows people to invest their money into a real world asset that inflates along with the currency. What this means is while the fiat currencies like the dollar, euro, or the pound aren't going away, “they are going to exist in a world where Bitcoin is next to it,” said O'Meara.

DeFi's Involvement in Tokenization

Tokenized real-world assets are a promising financial industry innovation that can modernize and reshape the financial landscape. And as the crypto market matures, momentum is building for tokenizing the multi-trillion global financial services sector. However, tokenization adoption is still in its early stages, and it might take some time to become widely accepted. Nonetheless, technology can change how we deal with and invest in real-world assets, and it is already seeing its application in the decentralized finance (DeFi) sector.

Real-world assets play a crucial role in DeFi, with protocols increasingly tapping into traditional credit markets such as equity and debt financing. After all, the market potential is huge, with credit fueling trillions of dollars worth of business and most of the global economy. 

While DeFi primarily uses digital assets, real-world assets like stocks, commodities, or houses are crucial for connecting to the established financial system. By tokenizing these assets, DeFi platforms allow users to access, trade, and utilize them in a decentralized and borderless manner. Moreover, real-world assets lower risk, open up chances for diversification and bring more stability to DeFi. 

Bringing real-world assets on-chain and into the DeFi ecosystem provides not just market efficiencies and access to liquidity but also unique collateral opportunities that can't be found in traditional markets.

For the DeFi ecosystem, it means new opportunities for investment yield, which are considerably higher than existing DeFi projects, providing access to sustainable revenue opportunities. Moreover, this gives access to diverse off-chain markets and widens customer bases to traditional finance.

Looking Ahead

Already, a number of dApps have tokenized hundreds of millions of dollars worth of assets. However, according to O'Meara, eventually, we're going to start to see new types of DeFi protocols, and this will be the stage when DeFi will be integrated with traditional commercial banking and mortgage banking. 

At that point, people will be able to say what's the cheapest source of capital for me? Is it a traditional bank? Is it me going into the capital markets, going to the institutional, or can I directly tap a DeFi protocol? said O'Meara, adding this will fundamentally change the role and the way we communicate trust.

This future, however, won't be dominated by a single blockchain. With a proliferation of layer 1s, with each one coming with its own strengths, weaknesses, and ecosystems, DeFi protocols will be making use of several blockchains, as we are already seeing. 

“We're going to live in a multi-chain world,” O'Meara said. He further noted that such a future will “see banks providing credit as a primary function but not as a gating function rather as a mechanism of on-ramp and off-ramp to payments.” According to him, in the coming decades, the bank's role will be completely redefined, and only those who own relationships with their customers digitally will survive.  

“I think people are going to trust banks who are going to service assets and act as an oracle on pricing, those are going to be around long term,” said O'Meara.

He further stated that the custodial and the wallet function is going to be “paramount” in the future with the full-on tokenization of real world assets. This tokenization of the capital stack, which he called 1.0, is not here yet, but “we're getting there.“

Join the waitlist for TokenizeThis April 11-13, 2024, via summit.stm.co.