The world is being tokenized.
“Tokenization, an innovation built on blockchain technology, is making its way from cryptocurrencies to real assets,” said John Sarson, CEO and co-founder of Sarson Funds, a provider of digital asset management and cryptocurrency education resources for financial advisors. “The impact could be revolutionary.”
“Tokenization is the way cryptocurrencies make it to Main Street and end up having the largest number of people experiencing an ‘a-ha!’ moment about the value propositions of cryptocurrencies.”
What exactly is “tokenization?”
Tokenization refers to replacing sensitive information with a computer-generated value, or “token.” When applied to securities, it creates a security token subject to the same or similar regulatory scrutiny as the securities themselves. It can also be applied to other various use cases, creating a less scrutinized “utility token.”
In securities, tokenization is simply the creation of digital shares of an asset. In modern cases, these digital shares are tokens on a blockchain which can take advantage of the blockchain’s network. “Technically, an asset with a single owner can be tokenized, as can assets with no revenue stream,” said Sarson, who believes that tokenization will eventually become the way every capital asset is divided up among investors.
The concept is gaining popularity among Wall Street incumbents. Earlier this month, State Street Corp. announced that it was moving hundreds of staff into State Street Digital, a new digital assets unit that will build infrastructure and products for trading cryptocurrencies as well as support for tokenized assets.
“Tokenizing something really only takes one person pushing a button,” said Sarson. “That a firm as deliberate State Street will have 450 people tokenizing real estate and then creating structures to trade tokenized securities afterwards suggests that the trend will be with us permanently.”
State Street’s decision comes after years of testing the digital asset waters, including a 2019 partnership with Gemini Trust to pilot a cryptocurrency custody program.
“The benefits are that tokenization becomes a very easy way to transfer and diversify ownership, injecting liquidity and transparency into relatively slow-moving and opaque parts of capital markets,: said Sarson. Tokenization may also help asset managers avoid “capital bloat.”
Tokens can also be attached to different right and privileges, making it easier to securitize an asset using different shared classes.
“The process for investing in real estate could be permanently changed,” said Sarson, “but there’s one big catch: regulations.”
“While this process is happening and being embraced around the world, every time we have a security in the U.S., we need to adhere to exempt securities offering processes, which is why these types of investments have traditionally gone to accredited investors,” said Sarson. “State Street is trying to make a white-label exchange so that everyone on the exchange is able to buy exempt securities offerings. Elsewhere in the world, people are less concerned about this process, and many tokenized projects now sell outside of the U.S. exclusively.”
Today, a tokenized piece of real estate is considered a security in the U.S. that cannot be sold to someone who is not an accredited investor.
That’s still an improvement over private placements, said Sarson, because at least tokenized assets offer more liquidity.
“Private placement funds are a great example, any type of private placement, like a yacht you want to sell 10% of, or an RV you want to sell 50% of, or a condominium you want to co-own with a friend,” said Sarson. “Each token could represent a day or time period that they are allowed to use the property, and they could sell each token, creating liquidity where there used to be little or no liquidity.”
Tokenization would also provide huge benefits for asset owners, said Sarson. Information and payments can flow up and down through the blockchain, allowing dividends, information and proxy questions to flow down to token owners seamlessly, and votes and payment to flow seamlessly upward.
So while private real estate partnerships may be restricted to a limited number of partners, sometimes just a handful, a tokenized asset could be offered to thousands or millions of investors.
“You can open up purchases to the whole world, and the whole world can become buyers of your tokenized asset,” said Sarson. “Tokenization has the potential to bring more buying demand into the equation. More buyer demand almost always leads to higher multiples because there are more dollars chasing the same capital asset.”
So the owners of a popular sports franchise may have a $20 billion business, said Sarson, and decide to tokenize their business at 10 billion tokens for $2 apiece, but demand in the market could raise the value of those tokens to $4 or $10 apiece. Suddenly the franchise is worth $40 billion or $100 billion based on the fervency of its fan base alone, value that couldn’t have been realized in a private ownership structure.
But tokenization’s power goes beyond altered market forces.
“Along with tokenization comes division and democratization of ownership, as token owners can vote their shares,” said Sarson. “There are many other ways that you can create incentives for people to want to own your asset. You could create days where only token owners can come to games, or allow them early entry, or a vote or say on issues like should we renovate the stadium, or should we try to get a player in free agency. Tokenization brings an ability for people to participate at a very granular level.”
Tokenization is likely to take hold in real estate first because it will help property owners unlock the value of their assets without selling the entire asset, said Sarson.
As tokenization spreads to other parts of financial markets, it also holds potential for offering a truly consolidated view of individual financial assets.
“NFTs that were all the rage two months ago were digital ownership of digital assets, whether it be media, music or art. Tokenized real assets exist in the same wallet, right alongside your digital assets like Ethereum, right alongside your NFTs. Now you can have a user-operated digital wallet that holds all of these digital assets together in the same place, allowing visibility across your portfolio.”