Asset Tokenization: Underlying Logic and Path to Large-Scale Application

The most eye-catching topic in the blockchain field in 2023 is undoubtedly the tokenization of real-world assets. This concept has not only sparked heated discussions in the Web3 world but has also received significant attention from traditional financial institutions and government regulatory bodies in many countries, being regarded as a strategic development direction. For example, several authoritative financial institutions have successively released their own research reports on tokenization and are actively promoting related pilot projects.

At the same time, the Hong Kong Monetary Authority explicitly pointed out in its 2023 annual report that tokenization will play a key role in Hong Kong's financial future. In addition, the Monetary Authority of Singapore, together with the Financial Services Agency of Japan and several financial giants, launched the initiative called the "Guardian Project" to deeply explore the immense potential of asset tokenization.

Although the topic of asset tokenization is very popular, there is a divergence in understanding within the industry, and discussions about its feasibility and prospects are quite controversial.

On one hand, there are views that asset tokenization is nothing more than market speculation and cannot withstand in-depth discussion.

On the other hand, some people are full of confidence in asset tokenization and are optimistic about its future.

At the same time, articles analyzing different viewpoints on asset tokenization have emerged like mushrooms after rain.

This article aims to share perspectives on asset tokenization, providing a deeper discussion and analysis of its current status and future.

Core Viewpoint:

• The future key development direction of asset tokenization will be a new financial system using DeFi technology, driven by authoritative institutions such as traditional financial institutions, regulatory agencies, and central banks, which is based on a permissioned blockchain. To achieve this system, it requires a computational system ( blockchain technology ) + non-computational systems ( such as legal systems ) + on-chain identity systems and privacy protection technologies + on-chain legal tender ( CBDC, tokenized deposits, legal stablecoins ) + a complete infrastructure ( low-threshold wallets, oracles, cross-chain technologies, etc. ).

• Blockchain is the first effective technological means supporting the digitization of contracts, emerging after the development of computers and networks. Therefore, it can be said that blockchain is essentially a platform for digital contracts, where contracts represent the fundamental form of assets, and tokens are the digital carriers of assets formed after contracts. Thus, blockchain has become the ideal infrastructure for the digital expression/tokenization of assets, namely digital assets/tokenized assets.

• Blockchain, as a distributed system maintained by multiple parties, supports the creation, verification, storage, circulation, and execution of digital contracts as well as other related operations, solving the problem of trust transmission. Furthermore, as a "computational system", blockchain can meet humanity's demands for "repeatable processes and verifiable results"; thus, DeFi has become a "computational" innovation in the financial system, replacing the "computational" aspects of financial activities. Automatic execution not only achieves cost reduction and efficiency enhancement but also allows for programmability. However, the "non-computational" aspects, which are based on human cognition, cannot be replaced by blockchain. Therefore, the current DeFi system does not encompass credit, and unsecured lending based on credit has not yet been realized in the current DeFi framework. The reasons for this phenomenon include the current lack of an identity system in blockchain that expresses "relational identity" and the absence of a legal framework to protect the rights and interests of both parties.

• In terms of traditional financial systems, the significance of tokenizing real-world assets lies in creating digital representations of real-world assets ( such as stocks, financial derivatives, currencies, and equity, etc. ) on the blockchain, thereby extending the benefits of distributed ledger technology to a wide range of asset classes for exchange and settlement.

• Financial institutions further enhance efficiency by adopting DeFi technology, using smart contracts to replace the "calculative" aspects in traditional finance, executing various financial transactions automatically according to predetermined rules and conditions, thereby enhancing programmability. This not only reduces labor costs but also, in specific contexts, it can provide new possibilities for enterprises, especially offering innovative solutions to financing challenges for small and medium-sized enterprises, which opens a door full of potential for the financial system.

• As the attention and recognition of blockchain and tokenization technology in the traditional financial sector and by various governments continue to strengthen, and with the ongoing improvement of blockchain infrastructure technology, blockchain is moving towards integration with traditional world structures and addressing real pain points in practical application scenarios, providing feasible solutions for actual scenarios, rather than being confined to a "parallel world" disconnected from reality.

• In the future, under a landscape of multiple different jurisdictions and regulatory systems, cross-chain technology is particularly important for addressing issues of interoperability and liquidity fragmentation. Tokenized assets on-chain will exist on public blockchains as well as on permissioned chains operated by financial institutions, and cross-chain protocols like CCIP will enable the connection of tokenized assets on any blockchain to achieve interoperability and realize the interconnection of thousands of chains.

• Currently, many countries around the world are actively promoting legal and regulatory frameworks related to blockchain. At the same time, blockchain infrastructure, such as wallets, cross-chain protocols, oracles, various middleware, etc., is rapidly being improved. Central Bank Digital Currencies (CBDC) are also continually being implemented, and token standards that can represent more complex asset types are emerging, such as ERC-3525. Coupled with the development of privacy protection technologies, especially the ongoing advancement of zero-knowledge proof technology, and the increasing maturity of on-chain identity systems, we seem to be on the brink of large-scale application of blockchain technology.

1. Introduction to Asset Tokenization Background

Asset tokenization refers to the process of representing assets in the form of tokens on programmable blockchain platforms. Typically, tokenizable assets can be divided into tangible assets such as real estate, collectibles, etc., and intangible assets such as financial assets, carbon credits, etc. This technology, which transfers assets recorded in traditional ledger systems to a shared programmable ledger platform, represents a disruptive innovation for the traditional financial system and may even impact the future financial and monetary systems of humanity as a whole.

First, it is necessary to present an observed phenomenon: "There are mainly two distinctly different groups regarding the understanding of asset tokenization," referred to as Crypto asset tokenization and TradFi asset tokenization. The asset tokenization discussed in this article is from the perspective of TradFi.

( Asset Tokenization from a Crypto Perspective

First, let's talk about the tokenization of assets in Crypto: The tokenization of assets in Crypto is considered a one-sided demand from the Crypto world for the yield of real-world financial assets. The main background is under the continuous interest rate hikes and balance sheet reductions by the Federal Reserve, where high interest rates significantly impact the valuation of risk markets, and the reduction of the balance sheet has greatly withdrawn liquidity from the crypto market, leading to a continuous decline in yield in the DeFi market. At this time, the nearly 5% risk-free yield from U.S. Treasuries has become highly sought after in the crypto market, with the most notable activity being a certain project making large-scale purchases of U.S. Treasuries this year. As of September 20, 2023, this project has purchased over $2.9 billion in U.S. Treasuries and other real-world assets.

The significance of this project in purchasing US Treasury bonds lies in its ability to diversify the underlying assets through external credit capabilities, and the long-term additional returns brought by US Treasury bonds can help stabilize its own exchange rate, increase the elasticity of issuance, and incorporating US Treasury bonds into the balance sheet can reduce dependence on other assets and minimize single-point risks. Moreover, since the income from US Treasury bonds will all flow into its treasury, it has recently increased demand by sharing part of its US Treasury bond income and raising the interest rate to 8%.

This approach is obviously not replicable for all projects. With the surging prices of tokens and the rising market sentiment surrounding the concept of asset tokenization, various asset tokenization projects are emerging one after another, aside from some larger projects following a compliant route. In reality, various assets are being tokenized and sold on the blockchain in all sorts of ways, including some rather outrageous assets, leading to a mixed bag in the entire sector.

The logic of asset tokenization in crypto mainly revolves around how to transfer the rights to the income generated by assets such as U.S. Treasury bonds, fixed income, stocks, etc., with the income rights of ) to the blockchain, how to mortgage off-chain assets to obtain liquidity of on-chain assets, and how to move various real-world assets onto the blockchain for trading (, such as sand, minerals, real estate, gold, etc. ).

Therefore, we can find that the tokenization of assets in Crypto reflects the unilateral demand from the crypto world for real-world assets, and there are still many obstacles in terms of compliance. The approach taken by the aforementioned projects is essentially that their teams enter and exit funds through compliant channels and purchase U.S. Treasury bonds through legitimate means to obtain their returns, rather than selling these returns on-chain. It is noteworthy that the so-called asset tokenization of U.S. Treasuries on-chain does not refer to the U.S. Treasury bonds themselves but rather their rights to returns. Furthermore, this process also involves converting the fiat currency returns generated by U.S. Treasury bonds into on-chain assets, increasing the complexity of operations and friction costs.

The rapid rise of the concept of asset tokenization cannot solely be attributed to this project. In fact, a research report titled "Money, Tokens, and Games" published by a certain bank from the traditional financial sector has also generated a strong response within the industry. This report reveals the keen interest of many traditional financial institutions in asset tokenization, while also stimulating the enthusiasm of a large number of speculators in the market. They have been spreading rumors about major financial institutions about to enter this field, further raising market expectations and speculative atmosphere.

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) Asset Tokenization from a TradFi Perspective

From the perspective of Crypto, asset tokenization primarily expresses the one-sided demand of the crypto world for the asset returns of the traditional financial world. If we build on this logic and view it from the perspective of traditional finance, the scale of funds in the crypto market is basically negligible compared to the traditional financial market, which often amounts to trillions. Whether it is U.S. Treasury bonds or any other financial assets, there is no need for an additional sales channel on the blockchain.

Therefore, from the perspective of traditional finance ( TradFi ), asset tokenization is a two-way approach between traditional finance and decentralized finance ( DeFi ). For the traditional financial world, DeFi financial services, which are automatically executed based on smart contracts, represent an innovative financial technology tool. The asset tokenization in the traditional finance sector focuses more on how to integrate DeFi technology to achieve asset tokenization, empowering the traditional financial system, reducing costs, improving efficiency, and addressing the pain points existing in traditional finance. The focus is on the benefits that tokenization brings to the traditional financial system, rather than simply finding a new sales channel for assets.

It is necessary to distinguish the logic of asset tokenization. Because asset tokenization from different perspectives has vastly different underlying logic and implementation paths. First, when choosing the type of blockchain, the two have different implementation paths. The asset tokenization in traditional finance follows the path of a Permission Chain###, while the asset tokenization in the crypto world follows the path of a Public Chain(.

Due to the characteristics of public chains such as no access requirements, decentralization, and anonymity, the asset tokenization of crypto finance not only faces significant compliance hurdles for project parties, but also provides no legal rights protection for users when encountering adverse events like rug pulls. Furthermore, the rampant behavior of hackers places a high demand on users' security awareness. Therefore, public chains may not be suitable for the tokenization issuance and trading of a large number of real-world assets.

The tokenization of traditional financial assets is based on permissioned chains, which provide the basic prerequisites for legal compliance across different countries and regions. At the same time, conducting KYC on-chain to establish an on-chain identity system is a necessary condition for achieving asset tokenization. Under the premise of having legal system protection, institutions that own assets can issue/trade tokenized assets in a compliant and legal manner. Unlike the tokenization of assets in Crypto, the assets issued by institutions on permissioned chains can be native on-chain assets rather than mapping to assets that already exist off-chain. The transformative potential brought by the tokenization of these native on-chain financial assets will be enormous.

Summarize the core points of this article, the future of tokenization of real-world assets is important.