Tokenization in Blockchain

In this Blockchain tutorial, we are going to learn about Tokenization in blockchain. And we will understand the whole tokenization process. Also, we will cover the following topics.

  • What is a Token in Blockchain
  • Tokenization in blockchain
  • Advantages of tokenization
  • Disadvantages of tokenization
  • Difference between coin and token in blockchain
  • Types of tokens
  • Process of Tokenization

What is a Token in Blockchain

Before understanding the whole concept related to tokenization in the blockchain. We need to understand what are tokens and why they are used.

Tokens are used in a variety of industries, including economics and computing. And a token is mainly used to represent an object. Traditionally, tokens are often used in everyday life to signify some sort of value. For example, using a gift card to redeem some goods.

Similar to general use, tokens in a blockchain environment are also used to represent some kind of value. However, there are some key differences between them.

A token in blockchain resides digitally on a blockchain and is cryptographically operated. This implies a token is created, secured, and transferred via cryptographic protocols.

Since, now we got an idea about tokens, in the next section, we will try to understand tokenization.

Also, read: Blockchain Architecture

Tokenization in blockchain

The rise of blockchain has revolutionized the way people invest in assets. And tokenization plays a significant role in that.

Tokenization in Blockchain
Tokenization in Blockchain

Tokenization is one of the most well-known blockchain applications, and it is impacting numerous industries, particularly the financial sector.

In the blockchain environment, tokenization is the process of digitally representing an asset on a blockchain.

Moreover, it can be used to symbolize anything of worth, including commodities, real estate, art ownership, currency, etc.

For example, a property worth $1000 can be converted into 1000 tokens, with each token representing around 0.001% of the property’s value.

Furthermore, tokens facilitate the exchange of ownership of indivisible assets through a blockchain network. Payments and settlement of transactions among participants are two of the most prevalent blockchain token applications.

Now, as we have covered some basics related to tokenization in the blockchain. In the next few sections, we will look at some of the merits and demerits of tokenization.

Read: Types Of Blockchain

Advantages of tokenization

While considering tokenization, it offers benefits like transparency, security, low cost, and many more. Let’s look at some of the core benefits in detail.

Advantages of tokenization
  • Transparency: Utilizing tokens in blockchain technology makes them more transparent as compared to traditional use. And this implies that any operation can be easily monitored and seen by everyone.
  • Security: As discussed earlier, tokens in a blockchain environment are created and secured cryptographically. Still, it is important to note that proper implementation must follow best practices and adhere to recognized security industry standards.
  • Flexibility: In the starting, we have illustrated how tokens are used in a variety of areas. This widespread usage of token-based systems makes tokenization easy and flexible to use across borders.
  • Better liquidity: With a blockchain, the token will be easily available to a larger audience. As a result, assets can be made available to a much greater audience once tokenized, increasing market liquidity. And with tokens, even illiquid goods like paintings can be tokenized and traded.
  • Faster transaction processing: The use of blockchain technology eliminates the need for traditional middlemen, resulting in faster transaction times and other processes.
  • Low cost: Tokenization is less expensive to execute than traditional financial services. And it has also reduced costs to the end-user due to digitization. Moreover, tokenization leads to a more transparent, efficient, and fair financial system.
  • Decentralization: If tokens are utilized on a public blockchain, it will help to make use of blockchain technology’s decentralization. However, because of the monitoring and inspection demanded by investors, exchanges, and other interested parties, a level of fairly acceptable centralization is introduced in some cases.

Read: Consensus in Blockchain

Disadvantages of tokenization

Despite all of these benefits, there are still challenges in the tokenization ecosystem that must be solved. These will be discussed next.

Security issues: Blockchain technology is considered to be one of the most secured systems. And this is mainly because of the decentralized nature and use of cryptography. Making it is difficult to initiate cyberattacks and commit fraud on a blockchain.

Unfortunately, this isn’t fully accurate, because of the way tokenization platforms and DApps are deployed on the blockchain. There are some security flaws that hackers can take advantage of.

Token legality: Tokens and cryptocurrency are unlawful to hold and trade in some places, therefore this is a worry.

Technological limitation: We all are already familiar with conventional financial systems as it has been a standard. But with tokenization, things have changed and will continue to change rapidly. However, for some people, technological illiteracy can be a problem and a hurdle.

Regulatory concerns: It is critical that the tokens be regulated so that investors may invest with the same level of confidence as they would with traditional financial institutions.

But, one main problem with tokenization and any blockchain technology is that it is mostly decentralized. And it is impossible to hold someone accountable if something goes wrong.

Read: Decentralization in Blockchain

Difference between coin and token in blockchain

Till now, we got a clear idea about tokenization and why tokens are used in blockchain technology. With the rapid advancement of blockchain technology, the development of numerous types of tokens and connected ecosystems has increased.

But, before understanding various types of tokens, first, we need to understand the basic difference between a coin and a token in terms of blockchain. And we will illustrate the difference in this section in more detail.

Difference between coin and token in blockchain

A coin in a simple term can be referred to as a cryptocurrency with its own independent blockchain. Bitcoin, Ether, Dogecoin, Litecoin, and Monero are some of the most well-known coins.

Coins are typically developed with their own infrastructure, with control over how they are created, how they are protected, how transactions are processed or recorded. In simple terms, a coin is a digital asset that is native to its blockchain. For example, Ethers has Ethereum blockchain, Bitcoin has its own blockchain.

A token, on the other hand, is a digital representation of an asset that operates on some other blockchain. Tokens are a special type of smart contract that allows users to create, issue, and manage tokens that are derivatives of the main blockchain on platforms like Ethereum.

For example, BAT, BNT, Tether, and numerous stablecoins like USDC are some of the most widely recognized tokens on Ethereum.

Read: Cryptography in Blockchain

Types of tokens

Now that we know the difference between a coin and a token, let’s look at different types of tokens and they are used.

Fungible Tokens

The fungible tokens are based upon the idea of fungibility in economics. Fungibility is referred to the interchangeability of one asset with another of the same type.

And in the same manner, the fungible tokens operate. These are a few properties associated with this type of token.

  • A fungible Token of the same type is nearly indistinguishable from one another.
  • A fungible token is entirely interchangeable with another token of the same value if they are both of the same value.
  • Fungible tokens can be broken down into smaller parts.

Let’s understand these properties with the help of an example. Consider a $50 note, now this note can be exchanged with another $50 note. And it can also be exchanged with five $10 notes.

This interchangeability is possible till the value (in this case it’s $50) and type (in this case its dollar) are the same.

Non-fungible Tokens

The non-fungible tokens are quite different in comparison with fungible tokens because non-fungible tokens are not interchangeable. Moreover, this type of token has the following set of properties.

  • Non-fungible tokens are distinct from other tokens of the same type or category.
  • These tokens cannot be exchanged with tokens of the same type since they are unique and distinct.
  • These tokens cannot be broken down into smaller parts, they are only available as a complete unit.

Let’s understand these properties with the help of an example. A bachelor’s degree, for example, is a distinct asset from other degrees of the same type. It is connected with a single individual and hence cannot be interchanged, nor can it be divided into fractions.

Stable Tokens

Stable tokens, also known as stable coins, are a type of token whose value is tied to the value of another asset, such as fiat currencies or some precious item. These tokens have a consistent price when compared to the price of another asset.

Cryptocurrencies are naturally volatile, and their value varies dramatically. And due to their instability, they are inappropriate for everyday use.

Whereas stable tokens provide a mechanism to connect fiat currencies like the US dollar with cryptocurrencies. These tokens are price-stable digital assets that behave similarly to fiat currency while retaining the mobility and utility of cryptocurrencies.

Now, there are mainly 4 different types of stable tokens available.

  • Fiat collateralized: A regular fiat currency, such as US dollars, backs these stable tokens.
  • Commodity collateralization: Fungible commodities (assets) like oil or gold are used to support these stable tokens.
  • Crypto collateralized: In this type, a stable coin is one that is backed by another cryptocurrency.
  • Algorithmically stable: This kind of stable token does not have a reserve to back it up, instead it relies on algorithms to maintain track of market supply and demand.

Security Tokens

The security tokens can be referred to as conventional assets that are transformed into digital token. So, conventional security is stored in a bank account and traded on secondary markets, while security tokens are stored on a blockchain

Security tokens are covered by all standard securities rules and regulations. But because of their decentralized nature, it eliminates the need for a middleman, they are considered as a more efficient, scalable, and transparent choice.

Read: Digital Signature in Blockchain

Process of Tokenization

So, when we talk about tokenization, any type of asset can be tokenized and offered on a blockchain. For example, bonds, equities, real estate, loans, and even intellectual property.

Moreover, things that are traditionally illiquid can be tokenized and transformed into tradeable assets.

Smart contracts, also known as token contracts, play an important role in the implementation of tokens. Token contracts are programs that enable the verification of business regulations as well as the transfer of value from one user’s wallet to another.

Now, let’s understand the whole tokenization process using an example. And for this example demonstration, consider we want to tokenize a real estate for example a property.

Process of Tokenization

By using tokenization, we can transform $100,000 property into 100,000 tokens. And each token would be worth 0.0001 percent of the property’s value. When a user buys a token, they gain 0.0001 percent ownership of that asset.

While purchasing 50,000 tokens, on the other hand, allows an individual to have nearly 50% ownership.

Users could not delete ownership of tokens after purchasing them since blockchain is an immutable ledger. As a result, it’s easy to see how blockchain can assist in bringing the benefits of asset tokenization closer to people.

Ethereum and EOS are two popular systems for tokenization.

Also, take a look at some more Blockchain tutorials.

So, in this Blockchain tutorial, we have learned about Tokenization in blockchain. Also, we have covered the following topics.

  • What is a Token in Blockchain
  • Tokenization in blockchain
  • Advantages of tokenization
  • Disadvantages of tokenization
  • Difference between coin and token in blockchain
  • Types of tokens
  • Process of Tokenization