By: Michael Megarit

Most people think that Blockchain technology is limited to cryptocurrencies such as Bitcoin and Ethereum. In reality, most physical and financial assets are being digitized and traded electronically on peer-to-peer networks that largely bypass traditional intermediaries such as notaries and lawyers.

From 2016 to 2022, the total market capitalization of digital assets in the USA grew from $14 billion to $3 trillion, which represents a compound annual growth rate (CAGR) of 193%. While this largely concerns digital consumer assets, such as music, videos and pictures, the world of investing is also concerned by this paradigm shift.

In this article, we will explain how asset digitization is driving revolutionizing capital markets.

What is Asset Digitization?

In technical terms, asset digitization is the process by which physical and financial assets are “tokenized” on a permissioned or permissionless Blockchain and then bought, sold, and traded by retail investors and institutions.

Distributed ledger technology records information in a way that makes it difficult or impossible to modify or delete it.

In theory, any capital market instrument can be digitized, whether it is securities, derivatives, bonds, real estate, precious metals, private equity investments, or even art pieces. Once digitized, these assets retain the same defining properties as their traditional capital market counterparts, such as lock in periods, voting rights, trading restrictions, and trading conditions.

The radical change is that trade settlement is done by a “smart contract” that self-executes once the buyers and the sellers meet specific requirements.

Smart contracts allow buyers and sellers to connect without the interference of a third party.

This setup means that transactions and agreements can be carried out among disparate, anonymous parties without the need for a central authority, legal system, or external enforcement mechanism. Assets can be traded on peer-to-peer exchanges in the same way that stocks trade on online brokerage platforms.

The “Tokenization” of Assets

As mentioned, the digitization of assets involves “tokenization”, a process by which an issuer creates a digital token on a distributed ledger, such as a public or private Blockchain. The tokens represent the digital or physical asset, and they are issued on a Blockchain to ensure that information and transactions are stored permanently and cannot be modified or deleted by any participant.

Asset tokenization converts assets such as stocks, bonds and real estate into digital tokens that can be purchased to acquire a stake in that particular investment.

Since every transaction is tracked and recorded, ownership of the digital asset is immutable and cannot be contested or revoked.

Redefining Property Rights

A major advantage of tokenization is the fact that it can break up large, lumpy investments into investable shares. In fact, it facilitates the creation of a fractional ownership interest in assets that are otherwise difficult to divide.

For example, if you own a house with a market value of $1 million, you can divide this amount in one million ‘tokens’, each representing one ownership stake of 0.0001%. If you decide to sell 250,000 tokens, you are giving up 25% ownership of your property in exchange for $250,000, while retaining a majority stake. This is convenient and opens up the possibility of raising cash in novel ways.

Fractional ownership will revolutionize how investors build their portfolios.

Simultaneously, tokenization grants proportional ownership rights of the underlying asset, which confers the owner with specific duties and privileges. In our example, selling 25% of your property means that your new investors become eligible to receive a portion of the income generated by the asset, but are also required to pay a portion of your property taxes, maintenance charges, and other relevant fees.

Thus, tokenization has the potential to democratize the ownership of traditionally illiquid, expensive, and cumbersome assets while also ensuring increased transparency, security and quicker trade settlement. Indeed, while traditional real estate transactions can take anywhere from several weeks to several months, buying and selling tokens on a distributed ledged can be settled in minutes.

Now that we’ve explained the technical aspects of asset digitization, let’s explore some practical examples that illustrate how it works in the real world.

Example no1: Digitizing Financial Assets

The first example concerns asset digitization on traditional stock exchanges.

In 2021, Switzerland’s stock exchange (SIX) received regulatory approval to launch SDX Bourse, a stock exchange and depository for Blockchain-based securities that enables investors to buy tokenized stocks, bonds, ETFs, real estate and other assets on a single platform running on distributed ledger technology.

On SDX, every transaction will be recorded digitally across multiple sites, which will help market participants authenticate every transaction, guarantee ownership rights, detect fraudulent activity, prevent market manipulation and help enforce anti money laundering and terrorist financing legislation.

By offering a fully transparent ledger protected by a robust regulatory framework, this new digital asset marketplace paves the way for the global adoption of digital asset trading.

Example no2: Digitizing the Gold Market

A second example of asset digitization is offered by Tradewind Markets, a precious metals marketplace that provides institutions with a Blockchain-based platform to purchase gold and silver digitally and directly.

The platform is a private, permissioned, and cryptographically secure interface only accessible to dealers and institutions.

Tradewind market works with all of the precious metals supply chain.

It relies on a comprehensive ecosystem to tokenize gold and silver that is physically held in depositories. From the mining of the metal to the distribution by retailers, every transaction that occurs on the supply chain is recorded on the Blockchain.

When clients purchase the physical metals digitally, they can consult the Blockchain to trace its origins, quality, and current storage location. This marketplace combines the properties of an ETF or derivative with the assurance of having effective ownership of the underlying metals.

The advantages of this platform over traditional methods of buying and selling precious metals are numerous:

• The digital token is backed by physical metals which can be delivered upon request.
• There are no management and administrative fees, which reduces the cost of ownership.
• The underlying Blockchain upon which the system is based preserves vital information about the entire supply chain, which guarantees that the assets purchased are legitimate.
• The metals are stored in secure locations – such as the Royal Canadian Mint – which means that investors don’t have to worry about storing them themselves.

This type of platform increases the overall security of precious metals ownership, which has traditionally been blighted by major risks to investors, and also suffered from a lack of transparency as to the origin of the metals traded on secondary markets.

Example no3: Digitizing the Real Estate Market

Our third example comes from real estate, which is arguably the most important asset class in the world.

In 2020, BrickMark, the world’s leading Blockchain real estate investment firm, purchased 1,600m² of prime commercial real estate in the heart of Zurich’s central business district. While this sounds like a regular everyday transaction, the novel aspect of this deal is that a large part of the $160 million investment was paid using BrickMark’s Ethereum-based tokens.

From idea to reality: Brickmark purchased Swiss real estate valued at $130+ million in large part using its native token hosted on the Ethereum Blockchain.

Historically, real estate is regarded as an illiquid investment reserved for high net worth investors and institutions. Further, the high cost of acquisition makes it difficult for retail investors with limited means to build diversified property portfolios.

However, the digitization of real estate assets facilitates the fractionalization of physical property into tokens that can be owned by several hundred – even thousands – of different investors who can exchange them on the secondary markets. This will create a highly liquid market where shares of real estate will be traded much like stocks and bonds.

Each token represents a share of ownership of the building, and holders are entitled to receive a portion of the rent earned and, if the property appreciates, part of the capital gains.

These tokens can then be sold on the secondary marketplace, enabling investors to a small stake in the investments. Also, the fact that tokens are based on the Blockchain eliminates the need for buyers and sellers to hire notaries to keep transactions secure.

If generalized, this system will help retail investors and institutions invest in private real estate, a sector that is reserved for high net worth investors and institutions.

The Challenges to Global Adoption

Asset digitization is not a niche phenomenon. It is a growing trend that will permeate every aspect of the capital markets. However, like most innovations, its adoption will have to overcome several challenges.

First of all, every country has their own legislation and rules, which means that the creation of cross-border digital assets will challenge national frameworks.

Second, there is also varying appetite amongst governments to promote asset digitization for commercial purposes. While the Swiss are at the forefront of this trend, not every country is as forward-thinking or willing to disrupt existing industries.

Third, every country has different systems controlling land ownership, disparate approaches to investment regulation, varying tax and accounting regimes, and a myriad of structures underpinning investment vehicles. Overcoming these obstacles and unifying approaches will be a major challenge.

Lastly, while tokenization is itself a seemingly easy process, it requires independent regulatory oversight and robust infrastructure to ensure control over the fractionalized assets. At present, Blockchain is a novel technology that is yet to be fully understood by most politicians and business owners. Thus, it will take a lot of education and lobbying to ensure that adoption can spread beyond the spheres of early adopters.