For a long time, experts have been talking about how tokenization — the act of creating a digital representation of an asset on a distributed ledger — of a financial or real asset can unlock trillions in illiquid assets, giving retail investors access to investments with previously high minimum capital requirements thanks to fractional ownership or settle trades on a distributed ledger instantly.
But if we investigate the current tokenization offerings, none is truly taking off and attracting the masses. If the theoretical advantages are true, millions of investors must be onboarding on exchanges that offer tokenized assets. However, this is not the case.
What is the problem of most tokenization offerings?
Let us take the example of tokenized equity to showcase the current issues and hurdles. The tokenization lifecycle of an equity consists of multiple steps. The first is the legal structuring followed by the minting (creation) of the tokens, in most cases with ERC-20 tokens on the Ethereum blockchain. Contrary to many beliefs, minting is one of the easiest parts of tokenization — the bigger challenges follow. As the purpose of the equity tokens is to be traded, we need to have a marketplace. With this comes the questions of token custody, liquidity, settlement and regulatory compliance.
If we look at the current service providers in this space, there is nearly no one who can offer all the steps of issuance, custody, marketplace, liquidity, settlement, etc. in one integrated offering. This has some major implications for why tokenization is not taking off — namely, that issuers and investors must deal with multiple service providers. Most probably these service providers are also located in different jurisdictions, which adds a whole new dimension to it, as equity tokens should ideally be able to be traded internationally just like traditional equity. And that is not possible as regulation differs from country to country.
Another major problem of tokenization marketplaces is liquidity. Currently, there is very low liquidity on tokenized marketplaces if we are to look at the trading volumes while the volumes of cryptocurrencies are currently reaching new all-time highs on a weekly basis. A reason for this is that the few exchanges that are on the market cannot attract enough investors. The easiest solution to solve this issue is for tokenized asset marketplaces to be connected to traditional exchanges and to leverage their customer base as they already have the desired liquidity.
This is only possible if the UI/UX is equal to traditional exchanges, and the investors do not see and interact directly with the blockchain. If investors need to set up their own wallet and deal with the blockchain directly, then we will never see a big inflow of mainstream investors into tokenized assets, as this makes the whole process more difficult and inconvenient, which is the exact opposite of the end goal.
While on DeFi platforms, the UI/UX is often user-unfriendly. And people use these platforms because they offer a revolutionary new concept of technology based on decentralization. But the tokenization of equity is not revolutionary per se; it rather makes something existing more efficient. And investors will only use tokenized marketplaces if the UI/UX is as user-friendly as on traditional exchanges.
Another big topic in tokenization is regulatory clearance. If we continue with our example of tokenized equity, there is the question of how to deal with a digital representation of a security. In most jurisdictions, a token is not a security by itself. Rather, the token just represents the right to own the equity, but the equity still also exists in its “traditional” form. In other jurisdictions, however, there is even less clearance.
While tokenization is without question one of the most promising use cases of blockchain technology, the current setup is in most cases worthless, as it renders things more complicated rather than effective. To change this, we need a clear regulatory environment, such as in Switzerland, for example, to integrate all elements of the tokenization lifecycle into one offering, and have a “traditional” UI/UX for the investors. If we can get these three elements right, there is nothing to stop tokenization to become a major game-changer and open many new asset classes to the market. I believe that tokenization marketplaces should partner up with traditional exchanges to offer liquidity, especially for tokenized equity.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Darius Moukhtarzadeh is in the sales and clients team of Sygnum Bank. Sygnum is a digital asset bank that received a Swiss banking license from the Swiss Financial Market Supervisory Authority in August 2019. Prior to Sygnum Bank, Moukhtarzadeh worked for Ernst & Young in blockchain consultancy and for several startups in the Swiss Crypto Valley.