- Asset tokenization has the potential to bring trillions of dollars of real-world value on to the blockchain
- Tokenized assets benefit from permissionless liquidity, open access, on-chain transparency, and reduced transactional friction compared to traditional assets
- In order to properly function, tokenized assets require high-quality, reliable pricing data from secure and reliable oracles like Chainlink
“Asset tokenization” is a term for the use of blockchain technology to represent ownership or rights to an asset as a tradable, on-chain token. Though it most commonly refers to the tokenization of financial or fungible assets, such as shares in a company or a quantity of gold, asset tokenization can hypothetically refer to the tokenization of any material or nonmaterial thing possessing monetary value: everything from a piece of art to a patent to an hour of a skilled worker’s time. As such, asset tokenization is among the most promising use cases for blockchain, with the upper bound of its growth potentially encompassing nearly all of human economic activity -- a dollar number estimated to be worth well over a hundred trillion annually.
Perhaps more impressive than the long-term promise of this use case are the strides towards adoption already being made today. In the past year alone, major enterprises such as Deloitte, BNY Mellon, and EY have studied asset tokenization and concluded that it possesses the capacity to disrupt multiple industries, specifically the 9 trillion-dollar annual global securities industry and the 9.6 trillion-dollar global real estate industry. Additionally, Microsoft, Vanguard, and Sotheby’s have announced or gone live with projects tokenizing industrial assets, securities, and real estate, respectively. By these metrics, asset tokenization is already among the most popular blockchain use cases currently achieving real-world enterprise adoption.
At the heart of both the current success of asset tokenization and its long-term potential is the remarkable number of advantages and additional utility that comes with tokenized assets relative to non-tokenized ones. Tokenization can allow for increased liquidity of traditionally illiquid assets; greater accessibility and ease-of-access for otherwise cloistered investment opportunities; greater transparency regarding ownership and ownership history; and a reduction in administrative costs associated with the trading of these assets, including management, issuance, and transactional intermediaries. Finally, tokenization allows for assets which previously could not access the DeFi ecosystem a path towards doing so, unlocking a whole new realm of potential through asset-backed composability.
As anyone familiar with the oracle problem knows, any instance where a blockchain needs to interact with the external world can present security risks and other complications, and asset tokenization -- a process that by nature relies on information about the world that is generally off-chain -- is no exception. Secure oracles will be key for asset tokenization to reach its full potential, as markets will need reliable information about the underlying assets in several key processes such as minting, trading, managing, and more.
This blog will explore the myriad benefits of tokenized assets, as well as analyze the need for Chainlink's secure and reliable oracles to power their growth and adoption.
Benefits of Tokenized Assets
In addition to offering a decentralized and trustless alternative to a real-world product, investment vehicle, or service, tokenized assets also actively improve the assets in a variety of other ways. Specifically, tokenized assets present a clear path towards making numerous assets more valuable, accessible, and useful relative to their legacy counterparts, as well as creating a vehicle by which off-chain data can augment their utilization within the Defi ecosystem.
Fine art is often used as an example of a potentially high-value, but extremely illiquid asset. Due to their scarcity, pieces of fine art enjoy the so-called “liquidity premium” -- the theory that low-liquidity assets yield higher returns over time. However, collectors who wish to sell their art are often put at a disadvantage because there may or may not be a robust market of buyers to accommodate a fair value sale. Because of this, the art world encompasses an entire sub-industry of middlemen whose primary function is to accommodate collector-to-collector or artist-to-collector exchange: galleries, dealers, auction houses, etc. This leads to significantly higher transaction costs relative to other assets -- a pattern similar to other illiquid assets, such as real estate.
Tokenization allows assets to enjoy the benefits of low liquidity without the transactional drawbacks. With tokenization, an asset can be represented as millions or even billions of tokens, creating fractional ownership, which can be subsequently listed on a variety of widely-available and accessible exchanges. This eliminates the need for costly transactional intermediaries and expands the potential buyer pool while simultaneously preserving the liquidity premium because the tokens are still tied to a unique asset.
Many of the highest-upside assets are out of reach to common investors due to financial or regulatory constraints. For instance, consider financing a big-budget movie: the upfront costs, as well as the risk of a production crew going over-budget, comfortably price out all but the wealthiest investors. However, a successful film can earn a return on the investment multiple times over in a relatively short time frame. Other low-access, high-return examples include collecting sports cars, investing in distressed foreign assets, or the purchase and renting of multifamily real estate.
In this case, the benefits of tokenization essentially become similar to crowdfunding, but within a model where the group of investors funding or purchasing an asset also reap the financial rewards of their participation. This allows smaller investors a path towards investing in riskier, but higher-upside assets with relatively low capital. Examples include the tokenization of the production of the film Papicha, where proceeds were tokenized as described above, as well as CurioInvest, who are working to tokenize rare supercars.
Many high-value assets suffer from a lack of reliable and easily-available information regarding returns, ownership history, sale history, and other key metrics investors need to be able to make informed economic decisions. This lack of information is especially acute when evaluating foreign assets, or instances where an investor cannot personally inspect an asset prior to purchase. A key benefit of tokenization is that it allows for the open tracking and auditing of all these records due to the fundamentally public nature of many blockchains.
With tokenization, investors can see a record of ownership as well as returns in interest or dividends, depending on the smart contract logic of the asset. Additionally, certain assets such as collectibles or race horses may become more expensive due to celebrity ownership or a rare bloodline. Provenance tracking on the blockchain allows for immutable records, significantly decreasing investment security risks by minimizing record-keeping trust. These features have the potential to significantly reduce the risk of fraud across multiple industries where forgeries and knock-offs are common, such as high-priced luxuries like wine and caviar, as well as fashion and art.
One of the most promising benefits of asset tokenization is also among the least well-explored: connecting the value of real-world assets to the composability of the DeFi ecosystem.
One example is DeFi Money Market, a project that allows for the tokenization of over eight million USD in car loans. Users deposit ETH, DAI, USDT or USDC, receiving mTokens in return -- tokens that earn interest on the real-world loans. This enhances the liquidity of the wider Defi space while simultaneously giving retail investors access to an investment class that would otherwise be difficult to access.
Moving forward, asset tokenization will allow for a plethora of opportunities for smart contracts developers seeking to tap into real-world value. Whole new types of synthetic assets, indexes, and token baskets can easily be built by combining tokens tied to various assets, and the ability to turn real-world revenue streams into collateral offers another jolt of innovation for an already rapidly-expanding DeFi field.
The Need for Oracles in Asset Tokenization
While asset tokenization has the potential to enhance the utility of a wide variety of real-world assets and simultaneously buttress growth and innovation within the DeFi space, it is also a use case whose functionality is highly reliant on secure oracles. In order for something of monetary value to be accurately represented and traded on the blockchain, there must be good information on the asset. This need is especially acute at four stages in a tokenized asset’s life cycle: when the tokens are created, when they are used as collateral, when users check their valuations, and when they are sold on secondary markets.
Chainlink, the most widely used oracle in the blockchain space, is playing a key role in providing tokenized assets with reliable data feeds in any oracle design framework that suits a developer’s security requirements.
Different assets will necessitate different oracle network structures and needs. Depending on the use case, Chainlink oracles can provide direct valuations to assets or serve as benchmarks for making decisions on them. Since Chainlink interoperates with any API and off-chain system, Chainlink oracles are able to source this data from multiple avenues, such as professional data providers (e.g. Kelly Blue Book for cars), independent/expert appraisers, exchanges/OTC markets, or any customized aggregation of data sources to create a single trusted valuation. The oracle can be run by a decentralized network of independent Chainlink nodes that call off-chain APIs to retrieve data or the data providers/appraisers can run Chainlink oracles themselves to relay data directly to smart contracts.
In order to further reserve the integrity of the network and maintain a high degree of data quality, unique crypto-economic incentives can be bootstrapped on to the oracle network. Chainlink tools like staking-backed service agreements and immutable reputation systems are able to track the historical quality of the valuations provided by appraisers, nodes, data providers, and more. This framework will incentivize accurate valuations as dishonest valuations will be financially penalized and their reputation score lowered, hindering their ability to earn future revenue as a data provider. It will also allow even niche and esoteric assets which rely on expert appraiser information to enter into the tokenized market while maintaining stronger crypto-economic guarantees that the valuation data is sound.
Oracle Use Cases for Tokenized Assets
Once the ideal oracle network structure for an asset has been established, there are a variety of ways that valuation oracle can be used.
In this instance, an oracle network would track the price of various tokenized assets in a portfolio at the UI and/or protocol level. This would allow for more informed calculations concerning the current balance of the portfolio, the cost of trading an asset, as well as the value that the asset should ideally fetch at an open market. Portfolio management can also take on the form of automated trading strategies via smart contracts that sell tokenized assets when they reach a certain price as fed to them by the oracle.
Bullionix currently uses Chainlink’s XAU/USD gold price feed on their GoldLink website, giving collectors of their gold-backed NFTs better information on the value of their tokens, as well as enabling more efficiency in the secondary markets where those tokens trade.
Use cases such as DeFi Money Market, which collateralize real-world assets in order to issue blockchain-based loans, leverage Chainlink’s Price Reference Data to price their underlying assets in order to ensure that loan ratios remain above liquidation levels. Upon liquidation, users would also have on-chain verification of the price at which their collateral was seized, allowing for greater transparency and security across the platform. This model can be extended to the minting of stablecoins or any other collateralized financial instrument.
Token and Interest Distribution Methods
Once a price oracle has established the value of an asset, a user interested in tokenizing it can use Chainlink oracles to verify a prospective purchaser’s accreditation in instances where legal compliance is necessary. Additionally, tools like Chainlink VRF can be used to ensure a provably fair distribution of asset-backed tokens when there is an overflow of demand, similar to how GET Protocol picks ticket holders from a waitlist of buyers.
If the issued tokens feature an interest-bearing component based on price appreciation of the asset, Chainlink oracles can also be used to calculate payments for token holders on a scheduled basis.
Pricing Asset Baskets
Asset backed tokens can be collected into pools or baskets of different assets and compositions, creating tradable derivatives on the blockchain with links to real-world value. For instance, tokenized baskets might be represented as multiple stablecoins, and would therefore need periodic price data in order to rebalance should market changes occur. Automated portfolios might also want to hold a weighted basket of assets, and would need price data on the underlying assets to know how much to buy or sell on a regular basis to maintain it's target ratios.
Though still in its earliest stages, asset tokenization is one of the most exciting and highest ceiling use cases for blockchain technology. However, without robust and secure oracles like Chainlink, tokenization will be limited in the value it can produce on-chain and be subject to centralization risks, which cuts into the very value proposition is was desgined to create . Only by deploying Chainlink decentralized oracles to access real-world information will this promising technology reach its full potential of bringing added value to any asset around the world.
If you want to learn more about the blockchain space, check out the Chainlink Blog for more content, including articles about Data Quality for DeFi, Dynamic NFTs, the Oracle Problem, Economic Rewards in Gaming, DeFi Composability, and much more.
If you’re a developer and want to connect your smart contract based application to off-chain data and infrastructure outside the blockchain, please reach out to us here or visit the developer documentation.
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