Change is a constant factor in the financial markets. Over the course of centuries, the methods of buying, selling, transferring, and owning assets have seen minor improvements, but no groundbreaking innovations have emerged. While legacy systems have been functional, they are slow and inefficient when it comes to accommodating the scalability and flexibility required in a digital world. Presently, developers worldwide are working on building the necessary infrastructure to realize the tokenization of Real World Assets (RWAs).
Larry Fink, the CEO of BlackRock, highlights how the introduction of Exchange Traded Funds (ETFs) has revolutionized investment practices. He believes that the next evolutionary step for markets and securities lies in the tokenization of securities.
Let’s begin by explaining how tokenization works and what the impact may be. When we talk about assets, they are generally broken down into 2 categories: Tangible and Intangible. Tangible assets would be things like real estate, machinery, cash, vehicles, computers etc. Intangible assets could be logos, trademarks, goodwill, patents etc. Both segments can, and most likely will be tokenized in the near future. To explain how this all works let’s use an example of real estate.
At present, if you would like to buy a home, you must come up with the money to purchase the property, make an offer and spend weeks, if not months, going through the traditional transaction process. This process may prevent billions of people who don’t have the capital, from ever investing in real estate. The transactions are slow, cumbersome, and highly illiquid. You can’t just sell your property in seconds. Our current system also does not allow you to short or bet that a property value will decline.
Now, fast forward a couple of years…
Let’s say a group of investors purchase an apartment building for $10,000,000. After all the property taxes, maintenance and fees are paid, the building generates $60,000 a month profit. The investors then digitize the ownership of that property by creating a smart contract and placing the digital property on a blockchain like Ethereum. They then create tokens which can be sold and traded on peer-to-peer marketplaces. In this example, let’s say they create 10,000,000 tokens, so each token has a value of $1. When the tenants pay their rent, the smart contract automatically distributes a portion of the rent to the token holders. If someone bought 1000 tokens of this property, they would receive $6 in income each month. They would also gain (or lose) value on each token depending on the current trend of the real estate market. At any time, they could sell their tokens, therefore making real estate investments very liquid. This fractional ownership fosters financial inclusion as well. Allowing someone who could never own the whole building to be a partial investor in it. It would also open the possibility to go short on real estate, which could only be done on real estate ETFs and REITs. Most importantly, no lengthy closing processes, just instant transfer of ownership.
If you think this is a pie in the sky idea, just know that we are already witnessing tokenized real estate. The first tokenization of real estate took place in France in 2019 with the tokenization of a luxury property using the Ethereum blockchain. Dozens of new companies like Propy, Homebase and Parcl are looking to carve out a niche in digital, fractional, tokenized real estate market.
Because these tokens are recorded on an immutable blockchain, there is also a permanent, transparent record of where all tokens are.
This introduces another major innovation to our financial system: ownership. With current systems like the stock market or banks, you are lulled into a belief that you own those assets. You don’t. If you “Own” shares of Apple in your Ameritrade account, you don’t actually own them. They are held in the “Street name” of the broker you are using, and then sent to a transfer agent like the DTC (Depository Trust Company). Yes, you are SIPC insured on those deposits, by don’t “Own” them. There have also been some significant accounting errors with the DTC and transfer agents over the years. Lack of transparency and confusing business structures make this process less than ideal. As consumers, we should hold ownership of all our assets, not rely on other entities to keep track of them all. As for the money you have sitting at your bank, that money is not there. It has been lent out. You simply have an IOU for the money, and FDIC insurance.
The point is, we are quickly moving to a society where people want to have physical ownership of their assets. Whether it is the title to a car, deed to a house, gold, silver, baseball cards, combine harvester, grain silo, satellite, or your 1000th of a cruise ship.
The blockchain revolution is making this all possible. For investors, the question is, what protocol will these companies use to digitize assets on? Ethereum is the current king, but network congestion and limited transactions make it a poor choice for mass adoption at this point. Will it be Solana, Avalanche, or Cosmos? How about EOS, Cardano or Algorand? Right now, there are dozens of layer one smart contract platforms fighting to be the leader in the digital asset revolution.
As the global markets adopt this groundbreaking technology, it is important to step back and see where the investment opportunities will present themselves. For example, with real estate there will be winners and losers. Traditional realtors may be competing against decentralized real estate marketplaces where tokenized properties are traded like Pokémon cards! This tokenization of assets allows for direct ownership and trading of assets, cutting out brokers and other middlemen. We may see the 3% commission paid to realtors become a thing of the past! The blockchain protocols which host the tokens will be the real victors in all of this. But choose wisely as we don’t know who will win that race yet.
On the date of publication, Merlin Rothfeld had a position in: ^ADAUSD , ^SOLUSD , ^ETHUSD , ^ATOMUST , ^EOSUSD , ^ALGOUSD , ^AVAXUSD . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
