Tokenization involves converting various assets, such as commodities, real estate, or financial assets, into blockchain-based tokens that can be traded on crypto exchanges. This process allows real-world assets to be transformed into crypto assets, integrating the worlds of decentralized finance (DeFi) and traditional finance (TradFi). The belief is that everything of value will eventually be tokenized, leading to significant implications for investors.
A recent Federal Reserve paper on tokenization demonstrates that the central bank is taking this concept seriously and recognizes its potential for investors. The paper explores the idea of transforming real-world assets into tokens and highlights the growing presence of tokenized gold. With approximately $2.15 billion worth of tokenized assets on permissionless blockchains as of May 2023, gold is the most prominent asset being tokenized. This trend allows gold to be locked in the digital realm while bridging the gap between the tangible and the intangible.
The Federal Reserve paper emphasizes the significant market for tokenized gold, which had a capitalization of around $1 billion as of May 2023. Pax Gold (PAXG) and Tether Gold (XAUt) dominate this market, controlling 99% of the tokenized gold market. These digital representations of gold are not just symbolic; they can be fully redeemed, enabling holders to claim the underlying physical gold, albeit subject to certain restrictions and fees. This provides digital investors with opportunities and considerations. Owning and trading tokenized gold offers a unique combination of liquidity and stability. However, engaging in this journey requires nerves of steel and careful consideration of redeemability features, accompanied by an understanding of the associated risks and benefits.
The tokenization of assets extends beyond gold. Real estate is also experiencing tokenization, allowing investors to gradually accumulate real estate wealth by owning digital tokens that represent legal rights to residential properties. Companies like Real Token Inc. (RealT) have pioneered this concept, tokenizing 970 property units with a total value exceeding $52 million as of September 2022. This innovative approach to real estate investment provides access to an asset class that is typically out of reach, bringing it within investors’ grasp. Nevertheless, tokenizing real estate faces challenges due to the varying nature of assets and complex legal and tax processes. Each step forward in real estate tokenization requires striking a balance between innovation and regulation.
The Federal Reserve paper also explores tokenization in other asset classes, such as stocks, bonds, and exchange-traded funds (ETFs). Tokenized versions of these assets represent ownership of the underlying asset, offering similar economic exposures but occasionally providing a different investor experience due to factors like trading hours and intrinsic properties. Programmability in decentralized finance (DeFi) applications broadens the reach of traditional financial instruments. Crypto investors can use tokenized financial assets as building blocks for lending, borrowing, and hedging on DeFi platforms, similar to how they currently use Ethereum-based crypto assets. Over time, the line between DeFi and traditional finance will blur.
Tokenization comes with various benefits for investors and markets, as acknowledged by the Federal Reserve paper. It expands access to markets that are otherwise difficult or expensive to enter, such as real estate. Investors can own fractions of specific assets, providing a contrasting ownership experience compared to broader portfolio ownership in real estate investment trusts (REITs). Crypto tokens’ inherent programmability enables additional features to be embedded in tokenized assets, potentially benefiting the markets of the referenced assets by implementing mechanisms to save liquidity and improve price discovery. These innovations lower entry barriers, appeal to a broader range of investors, and foster more competitive and liquid markets. Tokenization also enhances lending mechanisms by using tokens as collateral, facilitates quicker transaction settlements compared to traditional securities, and may improve liquidity and efficiency in the markets for the reference assets.
While tokenized markets are currently smaller in scale compared to traditional financial markets, there are potential implications for financial stability. Tokenization creates interconnections between digital and traditional financial systems, potentially transmitting shocks from crypto markets to asset markets, particularly in the case of illiquid assets like real estate. The 24/7 trading of crypto assets compared to the limited trading hours of many reference asset markets could lead to volatile outcomes during stress events. Fire sales of tokenized assets could affect the solvency of institutions holding substantial shares of these assets. Furthermore, tokenized assets with redemption options, such as collateralized stablecoins, may face runs on the issuer due to uncertainties surrounding collateralization levels, especially when transparency is lacking. As tokenization grows, traditional financial institutions become exposed to crypto asset markets by directly owning tokenized assets or using them as collateral, potentially impacting traditional financial markets.
In conclusion, tokenized assets are the future. From tokenized gold to real estate properties to financial assets, the Federal Reserve recognizes the transformative potential of tokenization. While the paper approaches this concept with caution, investors should embrace its possibilities and seek new opportunities and strategies offered by tokenized real-world assets. By being pioneers in this new frontier, investors can explore wealth-building opportunities, one token at a time.