Financiers, investors, and industries overall are constantly looking for new ways to facilitate transactions between parties. With the advent of blockchain technology, the prospect of greatly decentralizing the flow of information, transactions, and the flow of goods is promising to change the way people do business forever.
Yet at the same time, the eagerness of increased profits and efficiency is tempered by a cautious appraisal of the cryptocurrency market. No longer obscure enough to avoid public attention but not mainstream enough to be considered a normal part of the business world, blockchain technology in the coming years will cross this threshold and help improve the way commerce is conducted both on an institutional and retail level.
What Is Fractionalization
One big way ICO’s promise to accomplish this is through the idea of fractionalization. Fractional ownership is a system where several unrelated parties can share and mitigate the ownership and risks of a high-value tangible asset. Often times this is strictly for monetary reasons, but in many cases, there is an amount of personal access involved in the asset. The idea of fractional ownership has been around for a while, mainly in the ownership of business jets, yachts, or even holiday properties – being able to share the costs of these expensive assets that couldn’t be used full-time by any one owner.
In the business world, fractional ownership as concept has been around for a while. Ever since shares of companies were sold on stock exchanges, this idea that ownership of a large entity can be split and sold openly has opened the door for smaller, retailer investors to chip into a world that otherwise would be dominated by the wealthy.
Mutual funds, hedge funds, and Real Estate Investment Trusts (REITs) all operate on a similar principle, allowing individual investors to acquire ownership of a larger portfolio of commodities, financial instruments, or real estate properties. The later of which, although accounting for 60% of all mainstream assets globally, remains a relatively illiquid asset category. REITs have managed to instill some level of liquidity into this asset class, but there are obvious limitations.
Blockchain technology promises to take this process one step further, using cryptocurrencies to “tokenize” all types of asset classes. Tokenization is the process where the rights to an asset are transferred into a digital token on a blockchain, an idea that permits the advantage of cryptocurrencies while keeping the characteristics of the asset.
Tokenizing real-world assets would allow them to be traded with more ease and flexibility then otherwise would be possible through the transfer of paper. Cutting out the complex legal agreements and paperwork, as has partially been done by commodity exchanges, would help make this process even easier – as well as cut down on erroneous transactional and legal fees.
Smart Contracts and the Role They Play
First proposed by legal scholar and cryptographer Nick Szabo in 1994, the idea of smart contracts was birthed by the idea that decentralized ledgers could be used for self-executing contracts that can be converted to computer code, stored, replicated, and supervised by the network of computers running on the blockchain.
Over twenty years later, smart contracts are now a reality, helping exchange money, property, shares, or anything else of value in a conflict-free, transparent way while cutting out the involvement of middlemen altogether.
Suppose that you were renting a home from someone and you were to pay your rent in cryptocurrency. You would get a receipt held in our virtual smart contract where I give you the digital entry key at a specific date. If the key doesn’t arrive, the blockchain releases a refund. If the key arrives before the rental date, the contract releases both the fee and key to both parties when the date arrives. This “if-then” premise of the contract, which is supervised by hundreds of computers that participate on the blockchain network, ensures that no-one can tamper or hack into the code.
In the same manner, retail or institutional investors can acquire factional ownership of various real-life assets that have had their rights of ownership converted into tokens.
As for the technology, there are a variety of protocols that support the fractionalization of real assets and the use of smart contracts to facilitate this process. Most ICO’s working in this area would regard Ethereum as the leader in this field. Known for its smart contracts as well as it’s own public, open-source distributed computing protocol, Ethereum has created a decentralized virtual machine named the Ethereum Virtual Machine (EVM) which, in addition to being a shared software that is used by all, is tamperproof. It also boasts being the largest decentralized smart contract platform on the planet, making it a go-to for future ICO’s striving to tokenize assets.
Other blockchain protocols are working to enter the world of smart contracts as well. Stratis recently announced at their Blockchain Expo in London that they will be introducing a new smart-contract feature. Nxt is another protocol offering sets of template smart contracts that can be easily modified by users, with the team promising that their templates are easily adjustable and codable for their user’s needs.
The Current ICO Tokenization Landscape
At this moment in time, many cryptocurrency projects are jumping straight into this issue, creating tokens that promise to let users fractionally own a wide variety of otherwise illiquid asset groups. The real estate market is a particularly enticing group for these enterprising projects. REIDAO, a Singapore-based ICO wants to bring real estate investing to small-scale, retail investors, using the smart contract capabilities of Ethereum to create crypto assets backed by real estate. “We want to [offer] democratized property opportunities, to be accessible by everyone, wherever they are,” explains Darvin Kurniawan, CEO of REIDAO to Bitcoin Magazine.
Another project called Blocksquare is also jumping in on the real estate market with their own PropToken’s. In addition to becoming partial owners, users of PropToken’s are entitled to receive a portion of any rental income generating by the properties in the form of BST tokens, which can be traded at exchanges.
ICO’s are even eager to jump into the world of non-tangible assets. One crypto project called Proof managed to raise over a million dollars in pre-ICO funding in only two short days. Its ambition is to be a marketplace that can tokenize and trade fractionalized assets, both physical and non-physical in class. Property, debt, equities, copyrights, and even intellectual property are all free game as Proof strives to disrupt the traditional marketplace for these assets.
Still, it’s not surprising why real-world assets remain a lucrative target group for these cryptocurrency projects. The housing market in the United States alone is estimated at $32 trillion. On a global scale, there is over $217 trillion in real-world assets, much of it being signified by paperwork and remaining highly illiquid. Even if only a small percentage of these marketplaces can be tokenized by enterprising ICO’s, the result would still mean hundreds of billions if not trillions of dollars on liquid assets now entering the economy.
Professional economists constantly laud the importance of liquidity in our modern, interconnected economies. While there is some value in the high-frequency trading that institutional traders provide, there is considerably more value to be added through converting traditionally illiquid asset classes into a more easily accessible version. While mutual funds and REIT’s have taken a right direction, blockchain tokenization is the next logical step to making ownership of expensive assets available to all.
Also published on Medium.