In the rapidly expanding and evolving digital economy, tokenisation is primed to transform how we interact with assets. By creating digital representations of real-world assets on a distributed ledger, tokenisation promises to enhance efficiency, transparency and liquidity across various markets and sectors. With recent estimates projecting that the tokenisation of real-world assets is set to reach US$18.9 trillion by 2033, one question looms large: what exactly is tokenisation and how is it shaping the future?
What are digital tokens and what does tokenisation really mean?
Tokens can be used to represent anything. Tokens are legal representations of a share of an asset, a set of permissions or a set of claims that are owned or controlled by the token bearer. Historically, tokens are physical items, for example a lottery ticket or a casino chip. The advancement of information technology and the internet has enabled digital tokens. Over time, tokens have become increasingly digitised, operating as packets of data that represent either a physical asset (eg, fractional ownership of real estate), permissions (eg, the right to a discount for goods or services on an online platform) or claims (eg, electronic representation of a debt).
Traditionally, digital tokens are issued and maintained ledgers or databases controlled by a central entity, for example bank deposits in a commercial bank. Whilst these systems may be more efficient in isolated controlled networks, token holders are obligated to trust that the centralised controlling entity and network will allow the token holder to claim the benefit or the property associated with the token when and where required. A lack of interoperability between different centralised ledgers or databases demands multi-layered infrastructure operated by a variety of intermediaries, complicating token activity, including transactions or claims.
Distributed ledger or blockchain technology enables digital tokenisation without these challenges, by disintermediating and decentralising token maintenance and activity, This enables users to claim their assets or benefits more effectively, removes trust barriers, and consolidates information technology infrastructure into a single network layer, which enhances efficiency and reduces costs.
Industry, governments, central banks and regulators are exploring and implementing the tokenisation of many categories of assets including:
- financial assets (eg, securities, financial products, funds and commodities);
- real estate;
- environment social governance related assets (eg, carbon and biodiversity credits);
- digital identity and data;
- money (eg, central bank digital currencies and tokenised deposits); and
- entertainment, collectibles and consumer goods (e.g. art, luxury goods, in-game assets and virtual goods).
The tokenisation of the above-mentioned ‘real-world assets’ (RWA) is now being piloted and developed by organisations across the globe.
What does the tokenisation process entail?
Tokenisation of RWA promises to modernise the process of funding, trading and managing assets. Tokenisation of RWA is the process of generating digital representations that record claims on traditional, real or financial assets in the form of cryptographic digital tokens on a programmable platform, typically a distributed ledger or blockchain. The tokenisation process occurs through ‘ramps’ or platforms, which apply the necessary computational transformations from traditional systems architecture and ledgers to the distributed ledger or blockchain. This typically occurs by locking assets in the platform of origin as collateral for the tokens issued on the distributed ledger or blockchain. This is achieved using smart contracts, which are computer programs that are stored on and interact with distributed ledgers that automatically execute upon satisfaction of pre-determined conditions.
Tokenisation involves three key elements:
- assets: the underlying, tangible or intangible resources which may or may not possess inherent economic value and are owned or controlled by individuals or organisations;
- ledgers: the record of information about ownership and transfer; and
- tokens: the digital assets created through distributed, programmable ledgers and smart contracts.
There are structural differences between traditional and distributed (or programmable) ledgers in recording and transacting assets.
Traditional ledgers use two segregated components:
- the database layer which stores records of assets; and
- the application layer which incorporates centralised logic and rules and manages the recording, updating and deletion of assets on the ledger.
Tokens and distributed ledgers combine a core and service layer (similar to the two traditional layers mentioned above). The core layer contains the identifying information to define the asset and its owner (eg, ERC-20 standard with data such as name, owner and number of tokens). The service layer specifies the rules and logic governing the use (eg, in smart contracts).
What are some of the characteristics and benefits of tokenisation?
The following table expands on the above characteristics of tokenised assets, detailing its key benefits, namely enhanced efficiency, transparency and versatility when compared to traditional assets.
The following table expands on the above characteristics of tokenised assets, detailing its key benefits, namely enhanced efficiency, transparency and versatility when compared to traditional assets.
What are the legal considerations for tokenising RWA?
Tokenisation, and distributed ledgers, are emerging technologies and accordingly, there is uncertainty about the application of laws and regulations to RWA in tokenised forms, for example whether stablecoins constitute ‘money’ or tokenised carbon credits are captured under carbon market regulations. In some cases, however, traditional regulatory scopes are wide enough to adequately cover the technological change and issuers of tokenised RWA will need to comply with extensive, well-established regimes. The following table explores some of the legal considerations for issuers and users of tokenised RWA.
What next?
As we continue to explore the potential of tokenisation, it is clear that distributed ledger technology and digital assets hold promise for transforming the way we interact with RWA in the digital economy. However, widespread adoption will require careful navigation through a web of legal considerations arising from the novel characteristics of the technology. In future briefings, we will explore in greater detail these specific legal and regulatory considerations, and how the frameworks may respond to tokenised versions of traditional, regulated assets.
Footnotes
- The Treasury in the Regulating Digital Asset Platforms proposal paper adopted an adaption of this principle extending digital asset holding arrangements which resemble traditional asset custody arrangements into the Australian Financial Services Licensing regime.
- Organisation for Economic Co-operation and Development, Regulatory Approaches to the Tokenisation of Assets (OECD Blockchain Policy Series, 2021).
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