The financial industry has been transformed by technology in recent years. The rise of digital services, mobile devices, and artificial intelligence (AI) has made it easier for consumers to manage their money, invest and transfer funds/assets. However, traditional financial markets are dominated by a small number of intermediaries that control access to a range of assets such as stocks, bonds, gold and real estate. These intermediaries demand high fees, mostly because of the fragmented structure of the market; which often mean investors need a third party conduit to buy or sell an asset. This article explores what tokenisation is and how it is revolutionising financial markets by reducing intermediation costs and unlocking liquidity in non-traditional asset classes.
What is Tokenisation?
Tokenisation refers to the process of converting the rights of an asset into a digital token. An asset owner can then sell these tokens to investors who can buy them using a digital wallet. Asset owners are also known as issuers, whereas investors are called token holders. Tokens can also be referred to as digital securities or digital assets. Here, we use the term ‘tokenisation’ when referring to the conversion of rights to an asset into a digital token. The term ‘digital securities’ refers to the tokens themselves, and ‘digital wallet’ refers to the method used to store and transfer these tokens.
Compared to physical assets tokens are easier to trade and can be accessed without specialised intermediaries. This allows for investors to buy and sell tokens 24/7, everyday of the year. Tokenisation also facilitates the democratisation of investments as it allows individuals to invest in assets that were previously out of reach due to their high minimum capital requirements. In addition, tokenisation of assets also leads to a reduction in the risk of fraud and corruption due to the use of digital technology in processing transactions.
How Does Tokenisation Work?
There are several ways to tokenise an asset, with each having its own benefits. The following is a list of the most common ways to tokenise an asset:
- Issuing digital shares in an existing company: An issuer starts by digitising the ownership rights of shares in a company. This can be done, for example, by registering ownership on a blockchain-based platform. These are referred to as digitally native tokens.
- Creating a new security: An issuer can also create a new security by issuing new tokens using a security token protocol. This means that the new security will be governed by an underlying set of rules programmed into a smart contract.
- Adding token functionality to an existing asset: Another way to tokenise an asset is to add token functionality to an existing asset, for example, equities in a real estate investment fund (REIT) or bonds in a profit-share financing agreement.
- Converting an existing asset into a security: Some platforms allow the conversion of an existing asset into a security. This is often referred to as security token conversion.
Benefits of Tokenisation
- Reduced intermediation costs:Intermediaries are responsible for enabling buyers and sellers to transact with each other. They match buyers and sellers, promote trade and provide liquidity to markets. Therefore, intermediaries play an important role in promoting the efficiency of financial markets by reducing the time and cost associated with the trading process. However, the cost of intermediation, which includes intermediary fees, marketing costs and operational expenses, can be very high.For example, investment fund managers typically charge investors an annual management fee of 2-3% of the assets under management, plus 20% of any profits.Tokenisation has the potential to reduce the intermediation costs associated with trading non-traditional assets through greater automation and lower transaction costs. This is because in a closed-loop system, where the token can be exchanged directly, requires less intermediation.
- Unlocking liquidity: The trading volume of most non-traditional assets is very low, making it difficult to find buyers or sellers when the need arises, leading to an inefficient price discovery. Tokenisation can unlock liquidity by allowing investors to buy and sell tokens at any time via automation and this function is made even more efficient by introducing lower unit sizes. This allows for more investors to invest and trade a previously illiquid asset class.
- Access to capital: Tokenisation could also make it easier for individuals and small businesses to access capital by allowing anyone to invest in assets such as real estate, art and company shares. This could be particularly helpful for small businesses in developing economies.
Tokenisation has started to significantly transform financial markets by increasing liquidity, reducing intermediation costs and democratising investments. The convergence of the power of blockchain via its immutability, and transparency coupled with the usage of smart contracts as well as the concept of tokenisation is truly transformational. Indeed, coupled with the promise of enhanced financial inclusion via the lowering of cost and access to financial markets will drive the development of digitalisation of the industry even further.
Join us on this journey and come with Fusang as we chart the course to the future. To explore tokenisation even further, contact us at firstname.lastname@example.org