Asset Tokenization on Blockchain: Your Comprehensive Guide

Asset tokenization lets banks and fintechs boost liquidity while reducing costs and reaching a wider retail audience. 

Though fairly new, it’s off to a strong start. The bullish tokenization market topped $2.77 billion in 2022 and should reach $5.6 billion by 2026. Projects are launching left and right — Santander’s Agrotokens, Sygnum’s Art Security Tokens, and Nigeria’s national wallet are just a few examples. 

Touted as the key to democratizing finance and unlocking $16 trillion of illiquid assets, tokenization sure looks promising. Experts even predict that tokenized assets could make up 10% of the world’s GDP by 2027.

But beyond the hype, what real strategic value does it offer banks and fintech companies?

In this blog, we talk about what asset tokenization means and how it’s changing finance as we know it.

Table of contents

• What is asset tokenization?
• What are the types of tokenization?
• How do tokenized assets benefit banks and fintechs?
• What assets can be tokenized?
• Infographic: How are banks and fintechs exploring asset tokenization?
• What are the challenges in asset tokenization?
• How does asset tokenization affect the future of banks and fintechs?
• How can Cheesecake Labs help with asset tokenization?
• FAQ about asset tokenization

What is asset tokenization?

To tokenize means to create a digital representation of a tangible and tradable asset using blockchain technology. This digital representation — called a security token — can represent anything of value, from equity shares to art. 

What are the types of tokenization?

Tokenization can be broadly classified into two categories — blockchain and non-blockchain, each with its pros and cons depending on the intended use.

Blockchain tokenization is more suitable for assets that require high trust and auditability. On the other hand, non-blockchain tokenization is easier and more affordable for assets that do not need the same level of transparency and security.

There are four types of blockchain tokenization:

1. Fungible tokenization uses tokens that have the same value and can be exchanged with any other token of the same type. It’s the technology behind cryptocurrency applications that allows each currency unit (such as Bitcoin or Ethereum) to be interchangeable. It’s also useful for loyalty programs, making managing and distributing rewards to customers easier while offering flexibility and customization.
   
2. Non-fungible tokenization represents ownership of a unique asset (such as a piece of digital art or a specific real estate property). The value of these tokens is determined by the value of the underlying asset.
   
   Non-fungible tokens (NFTs) are created by recording information about the unique attributes of an asset onto a blockchain, allowing the secure ownership and transfer of that asset. This information can include details about the asset’s provenance, ownership history, and authenticity.
   
   NFTs have become increasingly popular in the art world, where they represent unique digital artworks that can be owned and sold like traditional physical art. They can also be used to represent other unique assets, like virtual real estate, gaming items, or even tweets.
   
3. Governance tokenization enables token holders to participate in the decision-making processes of decentralized networks. Governance tokens represent voting power, allowing holders to vote on proposals and elect representatives.
   
   This method is helpful in blockchain-based systems and decentralized autonomous organizations where token holders have a voice in how the entity or a project is managed.
   
4. Utility tokenization is particularly useful in decentralized networks or platforms that need a native currency or payment system to facilitate seamless transactions and exchanges without the limitations of traditional payment methods. Utility tokens represent access to a particular service or product, like computing power, storage, or bandwidth. Token holders can use their tokens to pay for services or products within the network and, in some cases, can even earn tokens by contributing to the network’s ecosystem.

Non-blockchain tokenization uses traditional databases instead of blockchain platforms. While non-blockchain tokens are faster and simpler to create than blockchain tokens, they are usually less secure and transparent. There are three ways to create them:

1. Vault tokenization replaces sensitive payment data (such as credit card numbers) with tokens without exposing the original data. The token values are then stored securely in a centralized vault. This approach is practical for scenarios requiring persistent token values, like processing payments across multiple transactions/systems. Storing token values in a central vault allows for easier management, tracking, and enhanced data protection.
   
2. Vaultless tokenization does not require a token vault for storage. Instead, tokenization happens on a per-transaction basis, with the token values generated and used only for the duration of that transaction. This offers increased security and reduced complexity in scenarios where many small transactions need to be processed quickly, such as online retail. In these cases, using a centralized token vault can create significant overhead, slow down transaction processing, and increase the risk of data breaches.
   
3. Natural language processing tokenization involves breaking down information into smaller, simpler components such as words, sub-words, or characters. This allows computers to understand and process information faster, which can be useful in areas like machine learning and artificial intelligence.

How do tokenized assets benefit banks and fintechs?

For financial institutions, tokenization makes it easier to safely buy, sell, transfer, and fractionalize asset ownership. Unlike private and isolated ledgers, a publicly accessible blockchain allows interoperability among market participants, so transactions are executed faster, and balances are automatically updated. And because security tokens can embed the holder’s rights and legal responsibilities, transactions have greater transparency.

Cost savings is another selling point, as tokenization can be 35% to 65% cheaper than traditional securitization. What’s more, it lets banks tap new markets. Highly divisible and highly liquid tokens allow smaller investment amounts and shorter investment periods. This empowers more customers to access opportunities that were once restricted to the wealthiest clients.

Moreover, digital tokens have the advantage of being programmable. They can be coded to automate dividend or interest payments, for example.

They can represent voting rights, and voting can be done via the blockchain infrastructure. Banks can even create funds that automatically invest in a range of tokens based on pre-established criteria. The possibilities are endless. 

What assets can be tokenized?

Almost any asset class can be digitized and traded on blockchain platforms — from traditional assets like bonds and equity to more exotic use cases like artwork and sports teams. For example:

• Equity shares can be tokenized to create single, shared, and unchangeable ownership records, replacing the inefficient paper-and-spreadsheet method. This allows transparent shareholder interactions on the secondary market. Several big names, including Twitter, Tesla, Apple, and Alibaba, have issued tokenized stocks in the last few years. 

• Tokenized bonds are a popular alternative to traditional bonds. These blockchain bonds are convenient because they have a more streamlined issuance process than traditional bonds. Tonekized bonds have various digital assets held in a decentralized database and aren’t owned or regulated by specific entities, giving bondholders more choices. 

• Investment funds can be tokenized, with each token representing an investor’s share of the fund. For example, Hamilton Lane made their direct equity fund, Equity Opportunities Fund V, available to individual investors on the Polygon blockchain platform in January 2023.

• Fan tokens are another common form of tokenized asset. These tokens, created by sports teams, musicians, or other groups, give membership benefits to fans. Fan token holders might get access to exclusive content, token-holder-only experiences, or prizes. 

• Commodities such as oil, gas, precious metals, and agricultural products can be tokenized and traded more easily to increase liquidity and lower entry barriers for both individual and institutional investors. Commodity tokens enable instant self-custody and are less reliant on speculation.
  

Illiquid assets (such as artwork and wine) can be tokenized to provide clear provenance records, allow lending against such assets, and facilitate price discovery.

Interestingly, fine wines became the first tokenized securities under Switzerland’s new blockchain law in 2021 when Fine Wine Capital AG tokenized them on Sygnum’s Desygnate platform.

Infographic: Understand how financial institutions are exploring asset tokenization

What are the challenges in asset tokenization?

1. Uncertainty in regulations and code of conduct
2. Smart contract security loopholes
3. Tax complexities

Asset tokenization is seeing increased trading volume, positive sentiment from stakeholders, and recognition from governments and monetary authorities. It’s poised to transform finance by equalizing market access and promoting fairness and security.

But regulations and legal frameworks have yet to catch up, creating challenges that limit the potential of a tokenized economy.

Uncertainty in regulations and code of conduct 

There are no universally recognized accounting regulations or ethical standards for developing and managing tokenized assets. The borderless nature of blockchain technology also poses a challenge.

Tokenization also potentially violates current regulations on cross-border data flow, intellectual property rights, and capital controls. All these factors create uncertainty and expose investors to potential malpractices.

Global policymakers have yet to establish legal frameworks that cover all aspects of digital asset management. But the situation is improving.

Organizations like the Financial Action Task Force, Financial Stability Board, International Organization of Securities Commissions, and Bank of International Settlements are collaborating to establish worldwide standards and guidelines for this purpose. 

Smart contract security loopholes 

The blockchain’s decentralized nature makes it secure against cyberattacks, but the same cannot be said for smart contracts, which have become prime targets for hackers.

Smart contracts possess three fundamental characteristics — transparency, immutability, and the ability to express value. These characteristics are crucial for their operation, but they also create security risks. 

In February 2022, the Wormhole cross-chain bridge attack drained $320 million off Solana and Ethereum. DODO DEX was also hacked in March of the same year, resulting in approximately $3.8 million in cryptocurrency losses.

Without proper auditing and security measures, smart contract investments can be stolen and irreversibly lost. Diligent auditing is critical in protecting against smart contract funds.

Tax complexities 

The muddiness of cryptocurrency tax regulations is a significant issue for stakeholders who buy, sell, and trade digital assets. Due to cryptocurrencies’ decentralized and global nature, tax laws vary widely across different jurisdictions, creating confusion on how to comply with tax obligations.

This ambiguity can lead to unintended tax liabilities and penalties. It also creates hesitation in the crypto market, deterring some investors from participating. 

Clearer guidelines for taxing digital assets are needed as cryptocurrencies become more mainstream. This will provide direction for stakeholders, ensure compliance, and generate revenue for governments.

How does asset tokenization affect the future of banks and fintechs?

Asset tokenization has the potential to revolutionize the financial system by creating a more efficient and democratic structure. Financial institutions need to adapt to a growing token economy where cryptographic technology replaces third-party intermediaries as keepers of trust. Those who proactively engage with this technology, plan for the future, and adapt to the new realities will thrive.

Cheesecake Labs provides blockchain consulting services for banks and fintechs that need help identifying their requirements, choosing the right technologies, and implementing an asset tokenization solution.

How can Cheesecake Labs help with asset tokenization?

Cheesecake Labs delivers consulting and development solutions in asset tokenization, stablecoins, tokenomics, CBDC, smart contracts, Web3, dApps, NFT, and decentralized finance.

Our blockchain services are designed for fast-growing startups, fintechs, and banks that want better business outcomes — from revenue growth and cost reduction to consumer impact.

As the top blockchain company(LATAM), we’ve worked with banks and fintechs in various regions. Our team worked with BITT to create an international DCMS, enabled TASCOMBANK to distribute the digital version of the Hryvnia on the Stellar public network, and helped Mercado Bitcoin with the Central Bank of Brazil’s LIFT project.

Cheesecake Labs also improved and optimized Solana’s largest NFT marketplace web portal and worked with the Stellar Development Foundation to develop Stellar Aid Assist. This platform uses digital technology for humanitarian aid. We likewise collaborated with eCurrency and ANZ Australia on a use case for CBDC.

While we build blockchain applications, wallets, and exchanges on different platforms, we have particular expertise in Stellar.

Stellar is a blockchain network specifically designed for asset issuers, enabling fine-grained control over asset ownership at the protocol level. It also allows the creation of fully permissioned assets using SEP-8, a protocol that lets issuers define custom policies down to the ledger transaction level through an off-chain authorization server.

As an official Stellar integration partner, we know the network and ecosystem like the backs of our hands. Contact us to discuss your project. We can’t wait to work with you!

FAQ about asset tokenization