Exploring The Design Space of Tokenization

Not everything should be tokenized. But for a certain class of assets the potential here is huge in driving efficiency in a range of markets.

The emergence of blockchain technology has revolutionized the way we perceive and trade assets. It has enabled us to tokenize traditional assets and create digital assets not bound to geographical boundaries or regulatory frameworks. Tokenization offers many opportunities for investors, startups, and businesses looking to expand their offerings and access new markets.

Having seen countless examples of experimentation with tokenization, I have developed a framework for tokenizing various asset classes, including stocks, real estate, commodities, artwork, and more which I think guides the proper model for approaching this new opportunity space.

I believe three main qualities apply when judging whether an asset is appropriate for tokenization. They are:

  1. The ability to create a digital native asset independent of any offline or off-chain asset. For instance, if we tokenize the ownership of a baseball card, it could provide a more efficient method of tracking its authenticity and trade history. However, if the card gets destroyed in a fire, there is no straightforward way of associating this unfortunate event with the digital asset in a precise and verifiable manner. Instead, we should look for assets that can be effectively "retired" or "burned" offline and fully reproduced with superior qualities through tokenization. Tickets may be a good example here where the physical ticket or mobile ticket market could easily be seen migrating to NFTs with promoters or artists placing inalterable rights on these tokens (max price, min price, secondary royalty, whitelisted addresses, etc.), which are virtually impossible to enforce in the current model.

  2. The ability to construct a market that does not require a massive rip and replace incumbent participants. Transitioning the US Treasury or Equity markets to a tokenized utopia would require a significant change since the current financial system has existed for centuries. The challenge would be to convince established markets and stakeholders to embrace new technology without obvious benefits to them. On the other hand, in the renewable energy sector, we are dealing with a market that mostly serves early adopters and has an immature, inefficient, and low-tech existing market. This particular market has great potential for transitioning towards a tokenized future without requiring complete replacement of the currently established infrastructure.

  3. UX improvement through tokenization. In this context, we focus on assets whose value relies heavily on their origin, accompanying data, ownership, and rarity level. For instance, when it comes to a piece of art, it's crucial to ensure that the artist genuinely created it and that it's part of an exclusive 1/100 edition with specific scarcity features. These elements are essential in determining the asset's worth and are why it's an ideal candidate for tokenization.

Some of the most popular categories of tokenization today, I feel, miss the mark - seeming more like a hammer searching for a nail than a truly native application of tokenization that meaningfully improves upon a problem. Tokenized treasuries, for example, address a problem that today serves just a small audience of crypto-native investors seeking access to higher yields than in risky DeFi markets. But the treasury market is unlikely to migrate on-chain anytime soon, meaningfully. Further, you're dealing with an asset of well-established provenance and minimal value from what amounts to a virtual avatar of an off-chain asset rather than a true replacement with a better version.

So, following the framework laid out above, what are a few examples where this model can be or has been implemented with more likely near-term success? I have seen a few examples that show promise:

Real Estate

Real estate is a massive market, but it has been traditionally inaccessible to most investors due to high transaction costs, lack of liquidity, and regulatory restrictions. Real estate tokenization can change all this by creating digital shares or tokens representing real estate asset ownership. Tokenization enables fractional ownership, enabling investors to buy and sell a fraction of a property, reducing the investment amount required to a fraction of the property's total value. It also enables the creation of a secondary market for real estate, enhancing liquidity and creating new investment opportunities.

It is important to note that when we talk about the tokenization of real estate, we are not talking about the tokenization of properties themselves; rather, we are discussing the tokenization of either the title of ownership in a manner that maintains real-world legal rights or the creation of a digital-native organization which would own the offline title and has its shares as the tokenized asset. Companies such as Homebase are interesting examples, experimenting with this model in its early stages.

Creator tokenization

Art and collectibles are some of the most valuable individual assets, fetching nine-figure valuations for some of the most expensive items. Still, their illiquidity often limits their value, and the industry is fraught with fraud and counterfeiting. Tokenization can create new opportunities for investing in art and collectibles by creating digital tokens representing ownership or contribution to a particular piece of art or collectible. Tokenization also simplifies the process of fractional ownership for a massive art collection, enabling investors to purchase and trade digital tokens representing a share of the collection. It also can mitigate the risks we often see from the counterfeit markets.

However, while the tokenization of artwork has been the mainstream force driving the narrative on NFTs and tokenized assets to date, the more exciting model here may be the concept of fan tokens. With fan tokens, we introduce a new model of tracking and investing in a creator and capitalizing on their success while actively offering rights to the token holder to the future outputs of the content creator. One example might be an emerging musician or painter who engages with their early fan base to offer a limited number of fan tokens at a nominal price, giving those token holders the right of first access to in-person experiences (concerts, art shows, etc.) or creative work (limited edition physical artwork runs). As an artist grows in popularity, this scarce access becomes increasingly valuable - as does the creative work they're producing or experiences they're offering. Here, both the creator and their audience benefit from the growth and success of the artist in a way that has not previously been possible.

Intellectual Property Tokenization

Intellectual property is an asset class with tremendous potential, but it is often difficult to value and monetize. Tokenization can increase accessibility and liquidity to intellectual property by creating digital tokens representing ownership or participation in a particular intellectual property. This can also create revenue-sharing models between creators and investors, making monetizing their intellectual properties easier for content creators. Two areas are especially notable in the context of IP.

First, music royalties, where companies like Royal and Anotherblock have partnered with royalty rights holders to sell the future revenue stream from their royalty rights through a fractionalized asset in the form of NFTs, offer a unique way for artists and collaborators to monetize their commercial rights. Here, the NFT holders get a yield-bearing asset tied to the value of the underlying royalty stream. Experiments are being conducted in scientific research with Intellectual Property (IP) forms such as IP-NFTs. These tokens represent the IP generated from scientific research, creating a more transparent and accessible market for patents and trademarks that can be used for drug discovery or AI modeling.

Renewable Energy Assets

The tokenization of carbon credits creates digital tokens representing credits derived from carbon offsetting projects. This offers a new market for carbon credits, making it possible for low-income investors or new market entrants to invest in carbon credit projects that were previously inaccessible. It also makes it easy for larger stakeholders to manage portfolios of carbon credits while avoiding administrative burdens.

Through the composability of these digital assets and the pre-existing models created in Decentralized Finance (DeFi), we can see how this climate market could easily become a truly digital native, on-chain asset class for real-world assets.

Conclusion:

The tokenization of new asset classes opens up new investment opportunities and creates a democratization of investment opportunities for both LPs and founders alike. The potential benefits of tokenization of these asset classes include enhanced liquidity, increased accessibility, and democratization, which can lead to increased investment in the asset classes and better returns for investors. It is an exciting time for the tokenization space as we continually see improvements and developments in tokenizing new asset classes. Feel free to get in touch if you're working on any of the above models or exploring other assets that could be ripe for tokenization.

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