Asset Tokenization: Digitized Commodities as a New Investment Opportunity
9 March, 2021
Tokenization of real-world assets gives investors a chance to securely trade the whole or a fraction of the commodities they own. At the same time, asset-backed cryptocurrency mitigates volatility and offers a stable and trustworthy investment opportunity.
Cryptocurrency has disrupted the financial industry in a previously unimaginable way. Blockchain enables secure and transparent operations in the cryptocurrency world while benefiting other IT operations and serving as a common ground for building trust in open environments.
Blockchain technology principles allow for the effective digitalization of real-world assets as well. In a process called tokenization, commodities such as oil, gas, gold, silver, and other precious metals are digitized and assigned an amount of cryptocurrency that corresponds to the real-world monetary value of the commodity in question. Tokenization offers obvious benefits to investors as they can use digitized commodities as a proxy to trade and invest in real-world assets quickly and securely.
Read on to find out more about the benefits of asset tokenization and commodities tokenization in particular, examples of tokenized commodities, challenges associated with the process, commodity-backed cryptocurrency, and other related topics.
What is asset tokenization?
Although tokenization is a relatively new concept introduced after the success of blockchain-based cryptocurrency, the beginnings of tokenization stem from the financial industry and securitization. In securitization practice, various types of contractual debts such as mortgages, loans, credits, and other assets that generate receivables are offered to investors in the form of securities. The investors can then trade these securities as if they were real-world assets.
The modern counterpart of securities — tokens — stand as a digital representation of a real-world tradable asset. After an asset has been tokenized, the tokens are offered to investors in a process known as an initial coin offering (ICO). To distinguish commodity-backed tokens from other cryptocurrencies that do not necessarily need to have a real-world counterpart, ICO is sometimes referred to as STO, or security token offering.
Tokenization increases the liquidity of assets while lowering the cost of trade and guaranteeing faster settlement. Next to commodities such as oil, gas, and precious metals, private securities or assets such as real estate or art can be tokenized too. As of the end of 2020, the total tokenized asset market is worth more than 18.1 Billion USD.
Benefits of asset tokenization
Tokenization allows a broader investor audience to reach these assets, while the high divisibility of commodity-backed tokens enables investors to purchase smaller percentages of real assets. The so-called token economy creates a more efficient and fairer financial system that eliminates traditional obstacles to creating, buying, and selling assets and other securities.
The common benefits of asset tokenization are improved liquidity, enhanced accessibility, better transparency, and transaction efficiency.
Asset tokenization of common illiquid assets enables their trade on the market. Tokenization broadens the investor’s access to the market, hence increasing the liquidity of an underlying asset. In addition, investment operations on the blockchain decrease transaction settling friction as blockchains span national and geographical boundaries and operate efficiently. Asset tokenization increases liquidity by enabling the automated transfer of ownership within compliance requirements. Reduced transaction complexity and costs open up new possibilities for trading using fiat money or other assets on regulated exchanges.
The division of the asset into tokens and the ability to partially own an asset after it has been tokenized lowers the barriers to entry for new investors and for those with smaller investment capacity.
Conventional trading of real-world assets limits the level of fractionalization. Tokenization, on the other hand, enables the buying and selling of tokens that can represent just a fraction of the entire ownership. The benefit of enhanced accessibility allows a broader investor base to participate in the investment process.
Blockchains have a heterogeneous technology composition consisting of cryptography, mathematical models, economic models, and algorithms. Blockchains make use of peer-to-peer networks and distributed consensus concepts to guarantee the security and integrity of stored data. The underlying distributed ledger system makes blockchain technology safe and open to inspection. All of the participating parties on the blockchain can see and audit any transaction that takes place. The blockchains are also immutable. So valid transactions cannot be deleted or changed as any such attempt would leave an easily detectable trace. Once the transaction occurs, all of the data concerning tokenized assets are recorded in the blockchain and the owner of the assets can be easily verified.
On the blockchain, all transactions get settled automatically once certain events are triggered. The usual triggering events are receiving a payment or sending tokens. Transaction settling times are reduced as transaction verification takes only a fraction of the time it would take in the traditional investment closure process.
Smart contracts on the blockchain assist in automating the process and eliminate the need for human intervention. Smart contracts are similar to regular contracts, but they exist in the form of a computer program that controls the conditions for their automatic execution. Smart contracts are very reliable and flexible and cannot be removed unless all involving parties wish to cancel. Since all of the blockchain transactions are peer-to-peer and no intermediaries are needed, the overall efficiency increases due to higher speed and lower costs.
Challenges of asset tokenization
Due to the amount of change and disruption that asset tokenization is expected to cause in the structure of the market, financial organizations and regulatory bodies remain a bit skeptical. Despite many well-demonstrated advantages, market leaders approach blockchain-based infrastructure with extreme care.
A range of issues regarding data security, privacy, technological reliability, and legal and security uncertainties are currently holding asset tokenization back from reaching its full potential. Nevertheless, given the course of technological progress and the rate of adoption of tokenization, the current challenges are likely to be short-term.
Data security and privacy
Blockchains are inherently secure systems. However, privacy issues regarding tokenization may also arise due to a blockchain’s distributed structure, involving the sharing and storing of sensitive user data across multiple blockchain nodes. Blockchains are secure, but the security of individual nodes in the network cannot be always guaranteed.
The theoretical background of blockchain goes back to the previous century, but its practical implementation is relatively recent. The first practical demonstration of blockchain was carried out in 2008 as the infrastructure for Bitcoin. In the eyes of many investors and asset owners, blockchain is still a relatively new technology. Next to Bitcoin, several other blockchains have maintained a successful record. Nevertheless, smart contracts and other blockchain applications have not yet reached a desired level of reliability in some industries.
Legal and regulatory uncertainty
Security regulations do not generally take into account the underlying technology. This means that the technology must adapt to existing regulatory and legal boundaries. In the case of tokenized assets, some of them can fall under the full scope of relevant regulations, and these may vary from jurisdiction to jurisdiction. Regulatory uncertainties slow down the initiation and trading of tokenized assets.
With every new technology come also new risks and challenges. Asset tokenization will become an essential source of capital in the future. This is true not just for the financial sector but for the wider economy as well. With such a promising future, solutions to the current challenges will emerge quickly. Security and privacy concerns are being mitigated by specialized wallet hardware that uses biometric data and cosignatory approaches to further secure blockchain interaction and increase data privacy. Technological reliability is being enhanced through the emergence of new successful projects, and regulatory challenges are being mitigated through the integration of technology and policy making.
Examples of tokenized commodities
In general, three types of assets can be represented as tokens. These are intangible, fungible, and non-fungible assets.
Intangible assets exist due to operational law and do not exist in physical form. Examples include patents, copyrights, company shares, etc. Fungible assets can be interchanged with other assets that are equal in value. The most common fungible asset is a fiat currency, so in crypto terms this would correspond to fiat-currency-backed tokens. Non-fungible assets, on the other hand, are unique and not necessarily interchangeable, for example gold. Despite their non-fungible properties, these assets can also be tokenized where tokens represent their pricing. Let’s look at some details around the tokenization of oil, gas, gold, silver, and other precious metals.
Oil and gas
Blockchain applications are establishing themselves as a backbone technology for many operations across the oil and gas industry. On the more popular side, Bitcoin mining is now considered an alternative to the environmentally damaging and costly gas flaring from oil wells. In addition to these applications, we have recently started seeing the use of blockchains for the tokenization of oil and gas assets.
Traditionally the oil and gas sector has always had a close link with institutional investors. The main reasoning behind such a market outlook is due to the size and complexity of oil and gas projects. Oil and gas enterprise leaders mostly prefer to cooperate with professional investment organizations that can meet financial obligations quickly and effectively. Nevertheless, this outlook is changing. Recently, due to the environmental stigma that the oil and gas sector holds, some investment firms have decided to look elsewhere. As a result, smaller organizations and projects have started finding it more difficult to attract funding.
These market dynamics are now forcing enterprises to consider funding oil and gas projects through many small contributions rather than a few big ones. Such an approach involves greater operational efforts that until now have been avoided.
Blockchain-based tokenization platforms are now being used to avoid high management costs in dealing with many small investors, while opening the door for oil and gas companies to attract even wider and more diverse investment audiences. With tokenization, the liquidity and transactional efficiency of oil and gas assets are increased. This means that the scalability of tokenized assets in this industry will become higher as well. Due to regulatory obstacles, the mass tokenization of oil and gas assets is currently not possible, but efforts in this direction are ongoing.
Next to naturally forming diamonds, gold has been a safe medium of investment for many years now. Gold ore is mined in its raw form around the world. After mining, the gold is transported to a refinery where it is produced in different grades. The product is tested for purity and marked by nonpartisan assessors. After marking, gold is stored in bullion form in bullion banks. Bullion banks then store or trade the gold depending on market conditions. The banks offer services such as spot trading, forwards, options, vaulting, and so on. The usual customers of bullion banks are gold traders, goldsmiths, manufacturers, wholesalers, and central banks.
However, the gold trade and its supply chain are manual and outdated. Physical characteristics such as size present a considerable challenge, as gold bars are difficult and slow to transport across long distances, expensive to store, and not easily divisible. Blockchain has the potential to truly revolutionize the gold trading industry through the asset tokenization process.
Tokenized gold is easy to trade and convert. Programmable smart contracts bring a new dimension to gold trading. Moreover, gold tokenization encourages asset fractionality that enables participants to own and perform activities with just part of an asset. This leads to better liquidity and the involvement of more investors. In the total tokenized asset market, gold has a market size of nearly 160 Million USD.
Silver is very similar to gold. Due to the similarities in extraction procedures, the supply chain and trading process is also similar. Silver has a lower market value than gold as it is found in greater abundance.
Silver tokenization, therefore, provides similar benefits to gold tokenization. As commodity-backed tokens can be continuously and globally traded they are far more liquid than many other forms of precious metal ownership. Tokens are also easier to safely store and do not carry the risks of theft associated with physical metal custody. New examples of silver-backed cryptocurrency are appearing on the market regularly. Due to the abundance and high value of pure silver, silver tokens are gaining in popularity.
Other precious metals
Many commodities will benefit from tokenization. The assets with strong value propositions are the ones to benefit from this process the most. Precious metals palladium, platinum, and rhodium are currently being tokenized. Similar processes to those utilized in the tokenization of gold and silver are applied to these valuable commodities, bringing transparency and improved ease of investing. Their tokenization will provide investors with the opportunity to diversify their portfolios and trade with ease on global markets.
Commodity-backed cryptocurrency is often referred to as stablecoin. Stablecoins bridge the gap between the decentralized and secure nature of cryptocurrencies and the stability of valuable commodities and fiat currencies. A stablecoin is a cryptocurrency designed to minimize price volatility by following an asset or a currency with a more stable value.
A crypto stablecoin is different from other cryptocurrencies, which have no inbuilt mechanism to minimize exchange rate volatility. The marketplace, with volatile supply and demand, determines the price of cryptocurrencies such as Bitcoin. In contrast, the benefit of stablecoin is that it is anti-volatile and closely mimics the performance of the backing assets.
Commodity-backed stablecoins are backed by other kinds of interchangeable assets, such as precious metals. The most common commodities to be collateralized are gold and silver, but there are also stablecoins backed by oil, real estate, and baskets of various precious metals. Cryptocurrency backed by gold and silver, for example, is much less likely to be inflated than fiat-backed stablecoins.
There are many different stablecoins on the market. Most stablecoin companies build their tokens on Ethereum and peg them to either fiat currency or other valuable assets. Below, we’ll consider some examples.
Paxos Gold (PAXG)
Pax Gold (PAXG) is a cryptocurrency that is pegged to gold. Each PAXG token has its counter value as one fine troy ounce of a four hundred ounce London Good Delivery gold bar. The backing gold reserve is stored by the Paxos Trust company. The PAXG value in other fiat currencies is a reflection of the value of gold in those currencies.
CACHE Gold (CACHE)
A CACHE token is an Ethereum ERC-20 standard token customized to track physical assets such as gold. CACHE provides proof of reserve (PoR) assurance and transparency as compared to other asset-backed tokens. CACHE tokens are 100% backed by a physical asset that is registered, tracked by RFID, photographed, and assigned to CACHE directly by commercial vault personnel using the GramChain asset tracking system.
Tether Gold (XAUt)
Tether Gold (XAUt) is a cryptocurrency backed by gold. Similar to The PAXG, an XAUt coin has the value of one troy fine ounce of physical gold on a London Good Delivery bar. The underlying gold is uniquely allocated to the owners of the coin. The owners know the unique serial number, purity, and weight of the gold they own. XAUt coins can be traded as ERC-20 tokens on the Ethereum blockchain.
Petro (PTR), or petromoneda, is a cryptocurrency backed by Venezuelan oil and mineral reserves. Petros were pre-mined by the Venezuelan government, which encourages the use of Petro for payments, oil trading, taxes, fees, real estate, etc. Despite the government’s backing, there is a long way to go before Petro or any other oil-backed cryptocurrency becomes the first oil-backed national cryptocurrency.
LODE is a Liechtenstein asset management company that tokenizes silver bullion on the blockchain. LODE has two tokens. The silver-backed cryptocurrency, AGX coin, functions as digital silver bullion. It can be exchanged and each coin represents one gram of silver which is vaulted and reserved within the LODE ecosystem. The second token, LODE is designed for investors. Investors can make use of LODE as a dividend-paying certificate. In tokenized form, the owners of LODE will receive profits from the issuance and fees from AGX tokens. In this way, investors can earn a dividend on silver bullion which would otherwise be sitting idle in a vault.
The most important things to consider when tokenizing an asset
Asset tokenization is not an easy process as it requires expertise in business, economics, technology, and strategy. Here is a step-by-step guide to how to tokenize an asset.
Asset selection, business model, and token economics
The asset to be tokenized should be selected according to the market value it provides. Next to selecting an asset, a decision about how to tokenize an asset should also be made (profit sharing or equity). Besides, it is also important to properly analyze the competition at this stage.
Just like any other business, asset tokenization needs a sustainable business model. To be successful it is important to have a clear vision of how the tokenized assets will create and deliver value in a sustainable fashion.
The token economy is an essential consideration for tokenization. Token economics is used to determine the number of tokens that will be available in the market. The right balance between supply and demand must be achieved.
Tackling technical and regulatory challenges
Underlying blockchain technology bridges the gap between vision and reality. There are two options when it comes to tackling technical challenges: foster a technology team internally, or partner up with an experienced blockchain development company that already has experience developing similar products. Shifting the load to a successful outsourced company allows you to focus your attention on the business value of the tokenized assets.
Depending on the market, regulatory obligations sometimes evolve with the driving technology, but sometimes they evolve regardless of infrastructure technology. Regulatory challenges can be severe depending on the type of asset to be tokenized. The general strategy is to involve legal advisors at the early stages of product development.
Educating the audience and creating an MVP
Educating the audience through whitepapers and case studies is an essential consideration in the tokenization process. The infrastructure and supporting system for asset tokenization has advanced technology at the moment, but the people who will invest in your token may not be experts or even tech-savvy. The education material you will put out will serve to bridge the gap between the experts in the field and the potential investors.
Due to the limited number of asset tokenization projects, developing and launching a Minimum Viable Product (MVP) is absolutely necessary to test how well the developed platform fits the market. The MVP should not be too complicated, but should offer adequate features to make it useful for early adopters. An MVP is a great tool for checking your business model assumptions and coming up with a realistic list of features for your platform.
Investment, product, and network
After the successful MVP launch, it is time to attract investors. The MVP has demonstrated market readiness for the asset tokenization platform, and provided the necessary feedback and usage data. Investors should be getting on board easily if all the wheels are turning smoothly.
After the investors are on board, it is time to get down to business and build the final version of the asset tokenization platform. The final product should include the valuable feedback obtained during the MVP and suggestions from your investors.
Once you have a fully-fledged asset tokenization platform that has investors and users and is generating profits, it is time to start building the network and expanding the user base.
With the help of blockchain technology and in line with the cryptocurrency market, commodity assets can be tokenized. In the simplest terms, tokenization means the digitalization of real-world tradable assets. In the tokenization process, the asset is stored on a blockchain and can be easily traced, transferred, and traded. Normally lacking any intrinsic value, the token that represents the asset carries the value of that asset. Similar to stablecoin being backed by a fiat currency such as USD or EUR, the token is backed by commodity assets such as oil, gas, gold, silver, or other precious metals.
Building a successful and stable tokenization platform can be challenging for a company that does not have prior experience with real-world blockchain projects. PixelPlex, though, has designed a super advanced and convenient Security Token Offering Platform (STO) that is perfectly capable of bolstering tokenization processes. It can help you digitize any asset and provides overwhelming and strong support when running your STO campaign. Besides, the platform can be easily customized so as to correspond to your specific business needs and requirements.
Don’t hesitate to reach out to us — we’re always here to help.
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