Digitalization is taking its course. One part of this is the tokenization process, which is used to digitize various financial products. Shares that used to be issued in paper form are now digitally represented, with a broker or intermediary usually still performing this task. Many processes are simplified with the help of blockchain technology. But what can we expect from tokenization in the future? What is possible?
The term tokenization is currently mainly used in connection with regulated financial products, often in the context of real world assets (RWA). This makes it possible today to represent shares digitally, in the form of a blockchain token. Every investor can now store their shares on their own crypto wallet in the form of security tokens. In contrast to utility tokens, which are familiar from ICOs or NFTs, security tokens are not so easy to create and issue. They must comply with the rules of the responsible financial authority. In Germany, this is BaFin.
Tokenization projects are no more and no less secure than traditional financial instruments. Blockchain technology is a new type of representation. Among other things, it simplifies transferability, trading and also offers completely new possibilities thanks to Web3. The projects are subject to the same rules as traditional financial instruments.
How does tokenization work?
Companies that want to raise money to expand their business must first define how much money is to be raised and what type of tokenization is to be carried out. For example, should shares in the company be sold? Should rights to the company’s profits or special products be assigned to investors? Or is it a bond that is to be repaid with interest over a certain period of time? There are many possibilities. Companies often seek help from platforms such as Intokia, which can handle the necessary processes professionally. Once the legal work has been completed and everything is ready for the sale, tokens can be sold to investors via an online portal. Profit distributions, dividends or other payments can then be paid out either directly via the blockchain – e.g. in the form of stablecoins or classically by bank transfer.
Potential for real estate
Tokenization is a good option for real estate, as it can no longer be sold to just one owner, but to several at the same time. People who want to invest, for example the residents of a property, do not have to buy the entire property, but can purchase fractions that are represented by blockchain tokens. The rental income from the property, minus management costs, is distributed to all token holders on a pro rata basis – usually annually. In purely technical terms, however, quarterly, monthly or even daily would of course also be possible.
Potential for companies
The tokenization of companies is also an exciting area. Companies that want to expand and therefore need capital can use tokenization to receive funds from several investors at the same time. With traditional fundraising, investors have to go to a notary to transfer shares. With tokenization, however, money acceptance is automated and does not require a notary. The tokens are sent to the investors after the money has been transferred. This is either carried out by the company itself or automatically by a tokenization platform. Everything is therefore fully automated and works without the offline hurdles that exist in Germany. Here, for example, it is not so easy to transfer company shares online. Various types are possible, such as equity, shares, profit participation rights or bonds with variable or fixed interest rates.
Interplay between DeFi and tokenization
Decentralized finance offers some effective, decentralized offerings, such as decentralized trading. Security tokens can be fully unified with DeFi without any loss of functionality such as required KYC processes with compliance to all rules. The solution for this is a so-called KYC-NFT, which allows security tokens to be traded on decentralized exchanges. At the same time, the issuer is always informed about who is currently in possession of tokens. This is because there is a KYC obligation for the investor.
The security tokens are transferred to the investor’s wallet. Anyone who has been on the web3 or the decentralized internet for a while and uses dApps knows how easy it is to connect your own wallet to the application. The application then knows who you are and how many tokens you own. This enables online companies that offer their services exclusively online to interact with investors in a completely different way. Investors who have invested a certain amount in the project can be offered certain benefits. For example, a hotel could offer free access to the spa area to investors who have invested at least €50,000.
The disadvantages and challenges
Especially for larger or institutional investors, the question often arises as to how such tokens can not only be purchased, but also held in the medium to long term. This is because there are often no internal processes or infrastructure in place to hold crypto assets. This poses a challenge for project owners, as it may deter larger investors from investing in such projects. However, there is a simple solution: regulated crypto custodians. BaFin has already issued several licenses for this in the past. The crypto custodian fulfills one of the main tasks of a broker in the traditional financial world, so to speak. They do not require their own infrastructure.
Conclusion
Tokenization is still in its infancy, so much more is possible. The legal framework is in place. In Germany in particular, there have been many positive developments in this regard. New projects are launched every day. The market is huge because, in principle, anything of value can be tokenized. Be it shares in all kinds of companies, all kinds of products, art and anything else that can be described as an object of value, but also intangible things such as patents. It will probably take some time before the technology is accepted. But in the long term, tokenization will completely replace traditional share trading as we know it today.
