Tokenization has been one of the blockchain industry’s dominant trending narratives, with many legacy financial institutions also predicting its rapid adoption in the years to come. While blockchain and cryptocurrencies have definitively gained more mainstream attention over the past several years, asset tokenization is a relatively unknown and newer sector within blockchain in outer circles.
As more technological development continues to ensue within blockchain ecosystems and more regulatory clarity is established due to increasing investor interest, more traditional institutions will most likely start to explore tokenization-related business strategies, products, and services for the short and long term.
Naturally, this opens a whole host of questions that need to be addressed and key factors that need to be considered for companies to implement a successful real-world asset (RWA) tokenization strategy.
In this blog, we’ll go over five essential considerations businesses must consider before starting to tokenize their assets.
Key Takeaways
- Tokenization is an emerging area within blockchain and finance, with increasing interest from traditional institutions.
- Companies need to consider several key factors before tokenizing assets: regulatory compliance, asset selection, technology and infrastructure, security and custody, and market demand.
- Regulatory compliance is crucial, as laws vary by jurisdiction and can significantly impact the feasibility of tokenization projects.
- Asset selection is important; not all assets are suitable for tokenization. Factors like valuation, market size, and liquidity should be considered.
- The choice of blockchain network is critical. The network should be secure, efficient, and capable of handling smart contracts and token transactions at scale.
- Security and custody of both the digital tokens and the underlying physical assets must be carefully managed.
- Market demand and liquidity are essential for a successful tokenization project. There must be a viable market for the tokenized assets.
Things to Consider When Tokenizing an Asset
1. Regulatory Compliance
The legal framework and regulatory environment for asset tokenization in jurisdictions where a company’s assets will be tokenized and transacted are critical considerations for any business looking to get started.
Regulations can vary widely according to location and can impact the feasibility of any tokenization product or service, although there is a shift towards a more favorable regulatory environment in an increasing number of countries.
In the US, its securities laws determine whether a tokenized asset is classified as a security and affects how and who is eligible to purchase it. If it’s categorized as a security, it must comply with relevant securities regulations, such as registration, disclosure, any investor accreditation requirements, etc.
Finally, tax implications, including capital gains, income tax, VAT, etc., also need to be considered for both issuers and investors. Each of these can change the profitability of tokenizing a real-world asset, potentially making specific tokenization projects unrealistic from a business perspective.
As regulations are constantly changing, under discussion, or being updated, it’s important to stay on top of these in the relevant jurisdictions and to consult with legal and compliance experts.
Related reading:
- Future predictions on the asset tokenization market
- A basic guide to asset tokenization
- Assets to consider for tokenization
2. Asset Selection
The next key consideration is the type of asset to be tokenized. Not all assets are ideal to be tokenized due to a variety of factors.
There are several asset types, including real estate, art, commodities, intellectual property, and financial instruments. The regulatory requirements, the size of the market, the liquidity, the ease of acquiring it, and whether the underlying real-world asset needs to be stored under special conditions (for example, wine) are important factors when choosing which asset to tokenize, among a host of other considerations. Projected revenue, costs, etc., must all be taken into account.
Another important metric is the valuation of the asset. Some real-world assets that are difficult to accurately and fairly value are less than ideal candidates for tokenization. Without a clear and predictable market price, the valuation can vary widely and create too many inconsistencies for businesses to invest in. Also, the pricing of tokenized assets at the start and end of any potential sale could be more difficult to reliably model and predict.
3. Technology and Infrastructure
If the relevant laws and regulations are clear and established, and an asset is an ideal candidate for tokenization, the next question becomes the selection of a decentralized blockchain network or platform to issue the assets on.
A tokenized asset is created and transacted on a particular blockchain network. First, the blockchain chosen should be able to host and process smart contracts and token transactions without much friction (exorbitant transaction fees, a history of network breaches, network congestion, etc.).
Also, a tokenization product or service issuing assets that are built on top of a blockchain network needs to be able to create custom assets that can be easily transacted on a large scale, thereby requiring a secure, efficient, and trustworthy decentralized blockchain.
In the case of transacting tokenized assets, the cost of transaction fees when using a particular blockchain network is an important factor. They should be low and predictable; if that is not the case, trading the assets becomes difficult, which can dissuade other businesses and users from getting involved.
4. Security and Custody
Decentralized blockchain networks and some smart contract programming languages are sometimes subject to hacks, exploits, and attacks. Bad actors analyze dApps and the underlying blockchain networks to find vulnerabilities, steal funds, or create ways to divert transactions.
Thus, the security and history of a blockchain network and programming languages must be analyzed before building a tokenization product or tokenizing an asset.
Next, custody solutions of the underlying asset should be considered and, if needed, designed and properly set up. Oftentimes, there is a third-party custodian who takes responsibility for securely storing the original asset that is being tokenized. In the case of diamonds, it would be a physical custodian. In the case of financial contracts, it would be some sort of digital solution. If opting for a custodian, the asset needs to be held by an entity that has the proper licenses and permits in the affected business.
Finally, proper private key management by the tokenized asset issuer and custodial service providers is essential. Who can sign a transaction? How many tokenized assets are in a wallet? How many of these tokens are in cold storage? How many signatures are needed? These are important questions that have to be answered before the service launches so there is greater transparency behind the storage of the physical assets and their digital token versions.
5. Market Demand
In the end, the company behind a tokenization product or service or tokenized asset should consider market demand. The current size of the asset market, future demand, and the cost of entering that market are very important.
Liquidity is also another important factor. Assets that tend to be expensive but difficult to sell (e.g., classic sports cars) usually have smaller secondary markets. This means trading for these assets happens more infrequently and can take longer for a sale to be concluded, making it less ideal from a market demand perspective.
What is the typical customer base for a company’s assets? Would they have an easier time learning how to use tokenized versions of an asset? What would be the learning curve? Is there a robust market for these assets on primary and secondary markets? What’s the future outlook for these assets? Would tokenized versions integrate with any other existing company product or service? Could these tokenized assets be leveraged for other financial services? These are some other questions to consider before tokenizing an asset.
NMKR: A Simple Way to Tokenize Assets
NMKR is no stranger to asset tokenization, having been one of the first pioneers to enable companies to tokenize real-world assets by leveraging the Cardano blockchain. It offers plug-and-play tools for any business or individual to quickly get started with tokenizing assets as NFTs without requiring technical coding skills.
Its platform has been used by Tiamonds to tokenize and sell physical diamonds and Book.io to tokenize e-books.
In the case of the tokenized diamonds, the physical diamonds were held in a secure vault, and each issued NFT digitally represented ownership of an individual stone. The owners could freely trade the tokens and use the NFT to redeem the physical diamond from the custodian at any point while having transparent access to relevant information through the NFT.
To learn more about NMKR and its tokenization services, visit here.
Read more: A case study on e-book tokenization using NMKR
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Disclaimer
You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by EMURGO to invest.
