TOKENIZING REAL-WORLD ASSETS - towards a regulated and stable token-driven economy
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Informational Paper from The Tokenizer prepared for Maker: TOKENIZING REAL-WORLD ASSETS - towards a regulated and stable token-driven economy June 2019
TABLE OF CONTENTS
1. Introduction 3
2. Executive Summary 4
3. Virtual tokens – the basis of a token-driven economy 5
3.1 Defining a token 5
3.2 Different kinds of crypto tokens 5
3.2.1 Utility tokens 6
3.2.2. Security tokens 6
4. Tokenization of assets 8
4.1 Defining tokenization 9
4.1.2 Fungible tokens 9
4.1.3 Non-fungible tokens (NFT) 9
4.1.3.1 ERC-1155 Crypto Item Standard 10
4.2 How and why tokenize real-world assets? 10
4.3 Challenges of tokenizing real-world assets 14
5. Stablecoins – a brief introduction 16
5.1 Fighting volatility 16
6. Maker and the Dai Credit System 17
6.1 The mechanics of the Dai Credit System 17
6.1.1 The CDP interaction process 17
6.2 Entering the Second-Generation Tokenization Phase 19
6.2.1 The Dai Credit System’s importance for tokenized assets 19
6.2.2 Asset tokenization’s importance for the Dai credit system 20
6.3 The challenge of scalability and the link to tokenization of everything 21
6.3.1 Critical elements for the scale of the Dai Credit System 21
7. Tangible use cases for the Dai Credit System 22
7.1 DigiX 22
7.2 Tradeshift - tokenizing invoices 22
7.3 Adding tokenized assets as collateral for Dai 24
8. The future of a token-driven economy 26
8.1 Realising the potential of the token-driven economy 26
8.1.1 Scalability 27
8.1.2 Regulation 28
8.2 Maker’s role in unlocking the economic potential 28
9. Conclusion 29
Appendix 1: Glossary of Maker Terms 30
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets
- towards a regulated and stable token-driven economy1. Introduction
Despite heavy turbulence in the market for cryptocurrencies since the beginning
of 2018, a massive downfall in the ICO (Initial Coin Offerings) market and a
general widespread skepticism of anything related to crypto, something new and
very promising is finally about to emerge and unfold in the crypto space like a
rising phoenix from its ashes.
The keywords are tokenization of real- During the previous year, we have seen a
world assets, maturity of stablecoins and completely new industry of tokenization
the merging incorporation of regulations. starting to grow rapidly. We think that
We are witnessing two fast-growing 2019 is the year of tokenization – or
trends merge and complement each rather, the first year of a new era of
other: tokenization. We urge all stakeholders,
including businesses, public authorities,
The first one is tokenization, where all and regulatory authorities, to pay close
illiquid assets in the world, from private attention.
equity to real estate and fine art, become
liquid and all liquid assets can be traded As a strong supporter of the
more efficiently.1 tokenization revolution, The Maker
Foundation has asked The Tokenizer to
The second is the rise of a new token- prepare this information background
driven economy. The new economy is paper on tokenization.
enabled by the removal of the volatility
in the crypto space with the help of Large scale tokenization of real-world
stablecoins like Dai from MakerDAO, and assets helps The Maker Foundation
by further liquidating billions of USD realize the goal of making our stablecoin
worth of tokenized assets through the Dai available to everyone. And at the
Dai Credit System. same time holders of tokenized assets
can increase the liquidity of their assets
By unlocking the economic potential of even further by using it as collateral
blockchain, these two complementary in the Dai Credit System – introducing
and correlated trends constitute one the a new phase of a second-generation
most important developments since the tokenization.
invention of the blockchain technology
itself. While this might sound like science
fiction, it is already happening.
1. Today to total amount
of assets in the world
has an enormous
value of USD 280
trillion.
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CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 3
- towards a regulated and stable token-driven economy2. Executive Summary
Imagine taking a shipping container, a very tangible 40-foot metal box, and
moving it into a purely virtual space. Imagine putting 10,000, 100,000, or
even 10,000,000 of these metal boxes on a blockchain and creating a digital
representation in the form of a virtual token or coin that you can start trading for
other assets or commodities. The process is just like trading bicycles, sneakers,
real-estate or bonds for dollars in the traditional economy.
This scenario would have been science through loans, and the same is possible
fiction a few years ago, but today it is in the token-driven economy. Though, in
a technological possibility, and soon a completely decentralized manner, this
it will likely be the basic principle of a will occur at a higher speed and a lower
new, revolutionary global token-driven cost.
economy - backed by tangible assets
or commodities from the real world as This complex concept needs to be
collateral, whether shipping containers, explained in detail. To do so, let’s start by
real estate, gold, oil, grain, or in principle, defining some basic terms and putting
anything of value. them into context – thematically and
historically.
The idea of fueling a new token-driven
economy by tokenizing real-world assets The initial chapters of this white paper
and making them easy to trade – liquid are about defining the term ‘token’ and
– on a blockchain-based exchange is the looking at different types of tokens
Yin of the topic of this white paper. The related to the crypto space. From there
Yang is the development of stablecoins we will explain the term ‘tokenization’,
to eliminate the extreme volatility of the process of tokenizing something,
cryptocurrencies and create stability, the new trend of tokenizing real-world
which is a prerequisite for a token-driven assets, the relation between tokenization
economy. and stablecoins and how this will create
a foundation for a token-driven economy
We will also discuss the ability to take going forward.
the tokenized assets and use them for
the creation of more stablecoins to
further fuel the new economy. Within the
traditional economy based on fractional
reserve banking money is created
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CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 4
- towards a regulated and stable token-driven economy3. Virtual tokens – the basis of a
token-driven economy
3.1 Defining a token intangible assets such as intellectual
The etymological origin of the word property or securities like shares,
‘token’ goes back to Old English bonds or derivatives, as well as very
tac(e)n and Germanic *taikna- and tangible assets like gold, oil, real estate,
means ‘a sign’ or ‘a symbol’. Tokens as collectables (fine art, antique cars) or, in
different kinds of “payment signs” or principle, any real-world asset.
representation date back to the Roman
Empire under the name of ‘tesseraes’. The prerequisite for such a tokenization
From the 1590s tokens are recorded process is a system that allows issuance
in the meaning of a “coin-like piece of of these blockchain tokens based on
stamped metal”2 as a representation of a real-world assets, and enables secure
certain value, either a monetary value or tracking of the underlying assets at any
a service of a certain kind. These kinds of time to avoid fraud – such as double-
tokens have been used in many different spending – or damage to the assets.
contexts from hospitals to casinos and
brothels (see below). A system with these abilities would act
as the ultimate springboard for a new
3
token-driven economy.
2. https://www.etymon-
line.com/word/token
3.2 Different kinds of crypto tokens 3. https://www.
During the last couple years, the market pinterest.dk/eilalie-
has been flooded with almost 2,000 new kovuo/brothel-to-
ken/?lp=true ;
crypto tokens or cryptocurrencies that https://usadisplay.
More recently, the terms token and are all tradeable on one or more of the net/?attachment_
tokenization are found in the digital world’s many new crypto exchanges. id=13551#prettyPhoto
payment industry. Within the EMV /0/ ; https://en.numi-
sta.com/catalogue/
paradigm4 of payment cards, tokens This huge growth in the numbers of pieces23200.html
are used for security reasons as a tokens has been driven largely by the 4. EMV stands for Euro-
replacement of sensitive data like the blockchain based crowdfunding method pay, MasterCard and
identifier number known as Primary called Initial Coin Offering (ICO). The Visa, and the EMV
paradigm is a set of
Account Number (PAN), which is printed ICO concept was created by software standards related to
on every issued plastic payment card. developer J.R. Willet in 2012 in his these payment card
whitepaper The Second Bitcoin White schemes.
In the crypto economy, the terms Paper. Willet was the first to put the
‘token’ and ‘crypto token’ are often ICO into play when he issued Mastercoin
used synonymously with terms like (now Omni) and launched the first token
‘cryptocurrency’ and ‘crypto coin,’ sale following his own model.
but ‘token’ also has a slightly different
meaning. A token is a representation for Interest in the new financing option
‘something’ on the blockchain that does (as an alternative to VC funding)
not necessarily have to be a currency – subsequently grew among startups.
like bitcoin – but could also be a wide In 2016, the popularity of the ICO
range of other types of assets. These phenomenon increased, and in 2017
tokens could be representations of it accelerated significantly all over the
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Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 5
- towards a regulated and stable token-driven economyworld, raising more money – USD 5.6 3.2.1 Utility tokens
billion – during than traditional VC On blockchains and blockchain-based
funding. At the same time, the crypto platforms, native tokens often have
market rose significantly in the fourth certain functions that either enable
quarter of 2017 and the ICO success the transaction validators to be
continued throughout the first quarter compensated for their work and/or allow
of 2018, according to Coindesk , and the users to utilise the services offered
more capital was raised globally via ICOs by the platform.
(USD 6.3 billion) in Q1 of 2018 than in the
whole of 2017 . The classic examples are Bitcoin and
Ethereum. In both the Bitcoin and
In March/April 2018 the massive growth the Ethereum proof-of-work systems,
of the ICO market ended abruptly. This miners are compensated for their work
was primarily a direct consequence of a when they solve involved mathematical
general downturn in the cryptocurrency puzzles and close a new block before
market, and an increasingly critical focus anyone else. And in both systems, the
from regulatory authorities worldwide of native tokens – bitcoin and ether –
the ICO concept, raising questions of the are used for transaction fees. On the
legal status of crypto tokens issued as Ethereum platform, the transaction fee is
part of ICOs. called ‘gas’, and is paid in ether.
The main issue in question from the 3.2.2. Security tokens
SEC and others was whether some, While a lot of the tokens issued as part
many or perhaps all the tokens issued of the many ICOs during the past two
as part of ICOs conducted globally have years have claimed to be only utility
in fact been securities – legally in the tokens, the starting point for issuing
same category as shares, bonds and security tokens is completely different.
derivatives – and not just commodities
or so-called utility tokens. Security tokens are securities, and they
are governed by the regulatory rules
One huge challenge that these tokens of the jurisdictions in which they are
had in common was extreme volatility, issued and operate. This raises both new
which has crippled their ability to handle challenges and new opportunities.
some of the basic functions that they
were originally created for – such as The challenges concern compliance with 5. https://www.coin-
peer-to-peer payments. the relevant regulatory requirements. desk.com/6-3-bil-
lion-2018-ico-fun-
The opportunity is that by issuing a ding-already-outpa-
This overwhelming problem of volatility security token that complies with legal ced-2017/
fostered a new kind of token called requirements, it is possible to make 6. It is important to
a stabletoken, or stablecoin, with the the token as attractive as traditional underline that the
Telegram ICO takes
purpose of securing some stability in securities such as company shares. On up a disproportiona-
the crypto space. Later in this white top of that, because a security token is tely large part of the
paper we will make a deep dive into issued on a blockchain and uses smart funding and without
stablecoins and see how the best among contracts, it offers a whole new layer of Telegram the ICO
downturn that we
the growing number of stablecoins encoded special features and benefits see now would have
unlocks the token-driven blockchain for the token owner. In other words, one been visible already
based economy and makes it possible to of the main differentiators between a in Q1 2018.
start tokenizing some of the enormous traditional share and a security token is
values of real-world assets. that a token enables you to add a layer
of built-in code, making the security
token a programmable share.
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CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 6
- towards a regulated and stable token-driven economyWhile a traditional share offers Stephen McKeon, a Finance Professor at the University of Oregon,
ownership and voting rights at talks about programmability:
the annual general meeting, the A key feature of security tokens is that they are
programmable share can include a
number of additional features. The
programmable. Many elements of the contracting
most important feature is that while environment can be hardwired into the architecture
a traditional share only gives the of the security. When securities are tokenized,
shareholder a cut of the bottom line compliance can be automated, which means that
figures – the profit – the security token regulated trade will no longer be restricted to
can be programmed to pay out a cut of
the top line – the revenue – too, once
walled gardens. Security tokens will be able to
a quarter like a dividend. Receiving trade anywhere, including decentralized exchanges.
an additional cut of the revenue is a Further, baking compliance into the token could help
significant benefit because the revenue market participants navigate the extremely complex
is ‘untouched’ by the company and its task of selling securities across borders.8
internal costs in a very different way
than the bottom line figures.
It is critical to distinguish between
A programmable share combining a cut private securities and public securities.
from both top and bottom line would If a token is considered and handled
be the ideal product for a shareholder. solely as a private security, in many
Other benefits can be built into the jurisdictions there will be the possibility
programmable share. These benefits of using certain regulatory exemptions.
could include VIP access to certain In these cases, the comprehensive IPO
features depending on what kind of (Initial Public Offering) requirements
company we are talking about or will only come into force if a token
discounts on fees when using certain violates the restrictions related to the
services offered by the company. exemptions in question, and begins to
act as a public security.
The increased focus on security tokens
and their potential in the crypto space Perhaps the most important argument
are partially fuelled by the constant for choosing an STO over an IPO is,
scrutiny of the ICO concept by legal as described above, that the security
authorities around the world. This has token has the potential to act as a
unsurprisingly led to the development of programmable share and offers a set
a variation of the ICO, called an STO or of functionalities and attributes that a
Security Token Offering. traditional share does not have. The STO 7. Apparently the STO
allows for the creation of an investment term was coined by
the company
In contrast to a utility token, as typically product that is better than traditional Polymath.
issued via an ICO, in an STO the owner stocks and bonds. It has the potential 8. https://hackernoon.
of the security token may – depending to reward investors both from the top com/the-securi-
on jurisdiction – legally obtain the exact line via a revenue-sharing model and ty-token-thesis-
4c5904761063
same rights as the owner of a traditional from the bottom line through a dividend.
security, for instance, a company share. Those companies that can honour an
Since the security token is a piece of investor’s request for a focus on and
software code using smart contracts a profit from both top and bottom at
on a blockchain, it has the ability to the same time have the potential of
incorporate completely new features becoming the new stars in the eyes of
and rights that make the security tokens the investors.
far more sophisticated than traditional
securities, enabling the issuer to
customise the security token to specific
target groups. RETURN TO TABLE OF
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Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 7
- towards a regulated and stable token-driven economy4. Tokenization of assets 9. https://www.
credit-suisse.com/
corporate/en/re-
search/research-in-
Tokenization is likely to become one of stitute/global-we-
By tokenizing private alth-report.html
the most important and influential trends
in the crypto space in the coming years. securities, we can potentially 10. Notice: American
’Trillion’ = Euro-
move them from the Low pean ‘Billion’ =
Since these are the very early days of Liquidity/High Cost-Effectiveness 1,000,000,000,000
the tokenization revolution, we lack quadrant to the Higher Liquidity/
the precise economic potential of the Higher Cost-Effectiveness
expected global tokenization, but it is
quadrant, as illustrated in the
expected to be in the trillions of dollars.
At Maker, there is no doubt the potential chart above. Tokenized private
is huge, and they certainly intend securities (i.e. crypto-securities)
to actively support the tokenization can be more easily traded on
movement as much as possible through the secondary markets without
the Dai Credit System. the administrative burdens of
traditional private securities. In
According to Credit Suisse’s Annual
Global Wealth Report9, the total value of other words, tokenized private
all assets in the world in 2017 added up securities can potentially have
to no less than USD 280 trillion10– or 280 more liquidity while maintaining
times the value of the world’s currently their cost-effectiveness.
most valuable company, Apple. Credit
Suisse even expects the number to
Given that the asset categories
increase further in the coming years and within the private securities
reach USD 341 trillion by the year 2022. market are massive (in the
trillions), and that the illiquidity
The tokenization company Harbor discount can be as high as 20-
describes in its white paper The 30%, the tokenization of private
Regulated Token™ (R-Token™) Standard
the benefits of tokenizing private
securities has the potential to
securities and underscores that the unlock billions of dollars in value.”11
economic potential is massive:
Liquidity versus cost-effectiveness of securities and tokens
Public Securities Tokens
High
More liquidity
Liquidity
Low
Private
Securities
Cost Effectiveness RETURN TO TABLE OF
Low Low
CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 8
- towards a regulated and stable token-driven economy4.1 Defining tokenization fungible tokens, whether unbacked
The basic idea of tokenization is the intangible tokens like bitcoin or fungible
use of smart contracts on a blockchain tokens representing fungible real-world
to create a virtual representation of a assets like gold, oil or electricity. For
certain asset in the form of a token. instance, the fungible gold-backed DGX
Depending on the type of asset to be token issued by DigiX with the value of
tokenized, different tokens and token one gram of gold is an ERC-20 token.
standards have been developed for
the tokenization process, and different 4.1.3 Non-fungible tokens (NFT)
challenges and opportunities come with For tokenization of non-fungible assets,
the tokenization of the asset in question. a corresponding standard – ERC-721 –
for the building of non-fungible tokens
Tokenizing tangible real-world has been developed for the Ethereum
commodities differs from tokenization blockchain.
of intangible assets like a software
licence. Tokenizing fungible assets like Each token built on ERC-721 standard
identical types of shares differs from the represents a unique piece of an
tokenization of non-fungible assets like a asset. This can be tangible real-world
unique work of fine art. assets like real estate, works of art,
diamonds, antique cars or other
Regardless of the type of asset to be unique collectables. But it can also be
tokenized, the basic purposes and intangible non-fungible assets. These
benefits are the same: by tokenizing include legal contracts, copyrights,
assets and thus equipping them with proof of identification, different kinds of
a virtual representation in the form of licenses like software licenses or unique
a token on a blockchain, it is possible virtual collectables like the popular
to cut away costly and inefficient phenomenon Cryptokitties, which in
middlemen. This makes it faster and fact was the first example of a non-
easier to trade and exchange the assets fungible asset tokenized via the ERC-721
far easier and faster, and in a much more standard.
decentralised manner than ever before. On Github, typical use cases for NFTs
Let us take a brief look at different built on ERC-721 are described like this:
asset types and corresponding token
standards, and afterwards, we will look NFTs can represent ownership
closer at the benefits of tokenization. over digital or physical assets.
4.1.2 Fungible tokens
We considered a diverse universe
The type of asset to be tokenized, and of assets, and we know you will
whether the tokens should be fungible dream up many more:
or non-fungible, determine the specific Physical property — houses,
11. https://harbor.com/
process for tokenization. unique artwork rtokenwhitepaper.
Virtual collectables — unique pdf. Stephen Kade,
A group or class of fungible tokens Co-founder of
are all identical and the value of all the
pictures of kittens, collectable TrustToken, makes
tokens in the same class is always the cards the same comparison
in this article: https://
same. This means that one token can be ’Negative value’ assets — blog.trusttoken.com/
replaced with another token of the same loans, burdens and other introducing-the-
class and it will make no difference. trusttoken-platform-
responsibilities tokenization-
you-can-trust-
The ERC-20 Ethereum standard was 67f1998b77ec
designed for issuing of all kinds of
RETURN TO TABLE OF
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Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 9
- towards a regulated and stable token-driven economyIn general, all houses are distinct Fungible Non-Fungible
and no two kittens are alike. NFTs Intangible Cryptocurrencies Cryptokitties - virtual
are distinguishable and you must Finacial securities (shares, collectables
bonds, derivatives) Digital IDs
track the ownership of each one Copyrights
separately.”12 Licenses
...
4.1.3.1 ERC-1155 Crypto Item Standard Tangible Oil Artworks
The latest development within token Gold Collectables
Electricity Real Estate
standards pushed forward by the Carbon Credits Diamonds
gaming industry is a standard called ... ...
ERC-1155 that makes it possible to
ERC-20 ERC-721
combine fungible and non-fungible
tokens in the same smart contract. The ERC-1155
developer Witek Radomski explains its
purpose on Github:
all developing blockchain and smart
This standard outlines a contract based tokenization platforms.
smart contract interface where These companies are creating solutions
for tokenization of all kinds of real-
one can represent any number world assets from intellectual rights over
of Fungible and Non-Fungible commodities and collectables to real
assets in a single contract. estate with the purpose of increasing
Existing standards such as ERC- liquidity, cutting costs, enabling
20 require the deployment of fractional ownership of assets and
opening up the USD 280 trillion market
separate contracts per token. The of real-world assets for investment. This
ERC-721 standard’s Token ID is a makes it possible for anyone, anywhere
single non-fungible index and the in the world to invest and create a future
group of these non-fungibles is global investment market far more
deployed as a single contract with democratized than the market of today.
settings for the entire collection. These tokenization services specialists
Instead, the ERC-1155 Crypto Item obviously have a technical focus, but
Standard allows for each Item ID they also have a regulatory focus. The
to represent a new configurable services provided by these platforms
token type, which may have its are worth nothing if they do not ensure
that the customers using the platforms
own total supply value and other comply with relevant legal requirements
such attributes.”13 12. https://github.com/
when tokenizing assets through their ethereum/EIPs/
platforms and services. blob/master/EIPS/
4.2 How and why tokenize real-world eip-721.md
assets? Factora provides smart contract-based 13. https://github.com/
ethereum/EIPs/issu-
A new group of companies that infrastructure to create automation for es/1155. Read more
specialises in delivering services within issuers and transparency for investors— about ERC-1155 here:
the field of asset tokenization has “enabling standardization, transparency, https://blog.enjin-
already emerged. and liquidity across capital markets.” coin.io/erc-1155-the-
crypto-item-stan-
*Harbor describes themselves as the “all- dard-ac9cf1c5a226
This group includes companies like in-one platform for digital securities”.14 14. https://harbor.com/
Factora, Harbor, Swarm, Polymath
and TrustToken. These companies are
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Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 10
- towards a regulated and stable token-driven economyPolymath states that their “Polymath traditional securities trading world, we
ST-20 standard embeds regulatory should expect rapid settlement, which
requirements into the tokens themselves, means that settlement will be cut down
restricting trading to verified participants significantly. Currently, securities traded
only.”15 TrustToken explains how their on traditional exchanges settle between
SmartTrust is “a new type of trust one and three days after the transaction
developed in collaboration with the top date (T+1 to T+3) depending on the type
trust law attorneys in the world”.16 And of security, while bitcoin transactions
finally, Swarm’s Market Access Protocol settle in approximately ten minutes.
(MAP) ”takes care of compliance so McKeon is confident that we will reach a
that token issuers can focus on their point of rapid settlement, but he warns
core function of managing the assets about the complexity involved:
and conveying their investment’s value
proposition.” 17 Trades for bitcoin or ether
settle in minutes, not days,
Relevant areas of regulatory compliance
for the tokenization of real-world
but there are a lot more
assets certainly encompass securities parties involved in securities
laws in the jurisdictions in which transactions—more than most
the tokenization is taking place, the investors appreciate. There are
jurisdictions in which the tokens are complexities such as short selling
expected to be traded, and most likely and margin buying. Blockchain
also KYC/AML policies, tax laws and
marketing practices acts.
has the potential to increase
settlement speed for securities,
Provided that the legal requirements but it’s more complicated than a
are met, tokenization of real-world comparison to cryptocurrencies.
assets unlocks valuable benefits that 15. https://blog.
The degree to which these polymath.network/
cannot be redeemed in a conventional processes can be automated unveiling-polymath-
environment. McKeon lists eight features core-toro-
of tokenized assets that he believes
through interoperable smart 62ec6562359d
“form the foundation of the thesis that contracts will determine the gains 16. https://www.
trusttoken.com/
security tokens will see widespread in settlement speed.”19 17. https://medium.
adoption across numerous asset classes com/swarmfund/
in the coming years.”18 The eight Interoperability and automation are map-for-security-
features are: certainly recurring keywords when token-issuers-
3d4af2d4ae24
24/7 markets describing features and benefits 18. https://hackernoon.
Rapid settlement related to tokenization of assets. com/the-security-
Asset interoperability McKeon says about the feature of asset token-thesis-
Automated compliance interoperability: 4c5904761063
19. https://hackernoon.
Reduction in direct costs com/the-security-
Increased liquidity The thesis underpinning token-thesis-
Fractional ownership the idea that everything will 4c5904761063
Expansion of the design space for
security contracts.
be tokenized is grounded in * http://www.factora.io
the aspiration that everything
Since neither the internet nor blockchain will be interoperable. If the
have any limitations regarding time or ecosystem for global assets
time zones it is very likely that the future becomes interoperable, it means
markets of security tokens will be around we can hold ownership claims
the clock 24/7 markets. And since
trading of tokens will be on-chain events
to a commercial building, early-
cutting away the middlemen from the stage equity, corporate bonds, a RETURN TO TABLE OF
CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 11
- towards a regulated and stable token-driven economyT-bill, a single-family residence, And EY reached the same conclusion
in their report Chain Reaction in 2016,
and a decentralized network on
saying that “within a typical finance
the same platform. Further, we team at banks and insurers, between
could self-custody these types 50 and 100 working days are lost each
of ownership claims in a single month reconciling differences. Adopting
hardware wallet, if so desired.”20 a shared ledger approach will help, by
enabling all parties concerned to identify
Furthermore, smart contracts will have the same transactions at the source, with
the ability to include compliance as well. data being published simultaneously
Harbor’s CEO Josh Stein has described — significantly reducing the number of
a future trading scenario in a blockchain reconciliations required.”24
and smart contract based environment
with automated compliance built into Increasing liquidity is a major driving
the security tokens like this: force behind the growing trend of
tokenization of real-world assets. Of
By automating compliance, the total wealth of USD 280 trillion
issuers can allow their investors to in the world in 2017, financial assets
account for 54%, debt accounts for 20. https://hackernoon.
trade to the limit of their liquidity 13% and real (non-financial) assets the com/the-security-
across multiple exchanges. Now remaining 33%25. These numbers vary a
token-thesis-
4c5904761063
imagine a world where buyers and great deal from country to country, and 21. https://techcrunch.
sellers around the world can trade most of the world’s wealth is already in com/2018/08/28/
relatively liquid assets, but a significant security-tokens-will-
24/7/365 with near instantaneous be-coming-soon-to-
settlement and no counterparty part is placed in other, non-financial an-exchange-near-
and less liquid asset types. For a large you/?guccounter=1
risk — that is something only percentage of these, it must be assumed 22. The above-
possible through blockchain.”21 that tokenization could be considered an mentioned article
(note 25) discusses
option. the exchange
An interesting related question is how question.
the development of exchanges will play Already liquid asset classes like 23. http://www.
out as tokenization gains momentum. traditional financial securities, such as portfolio.hu/en/
companies/front-
Are the likes of Harbor going to develop shares, can benefit from tokenization. line-eyewitness-
the next generation exchanges for the In May 2018 VC firm Morgan Creek of-2008-crisis-
trading of regulated security tokens? Will announced their plan for a full a-supporter-of-
it be the cryptocurrency exchanges? The tokenization of all the shares of the blockchain--inter-
view.36624.html
players from the old world like Nasdaq? IT company Anexio. Partner Anthony 24. https://www.
Or perhaps a combination of all the Pompliano stated: “Once all assets are ey.com/Publication/
above? Time will show and most likely tokenized, then we believe the entire vwLUAssets/
very soon.22 financial system will be more efficient EY-chain-
reaction/$FILE/
and compliant. Morgan Creek is focused EY-chain-reaction-
When it comes to reduction on direct on tokenization because that’s where how-blockchain-
costs, McKeon points at reconciliation we believe there is less hype and more technology-could-
as one of the areas in which trading of a sustainable value being created.” revolutionize-the-
finance-function.pdf
tokenized asset could lead to substantial While tokenization of already relatively 25. https://www.
cost savings over traditional securities. liquid assets makes sense, the biggest credit-suisse.com/
Many others, including CEO of Digital opportunity is the tokenization of corporate/en/
Asset, Blythe Masters, have pointed more illiquid asset classes like equity research/research-
institute/global-
out the savings potential in eliminating from non-exchange, privately traded wealth-report.html,
“the need for reconciliation”23 by companies, real estate, and art, antiques p. 47.
using blockchain or distributed ledger
technology (DLT).
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CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 12
- towards a regulated and stable token-driven economyand collectables. Because the liquidation Tokenizing a work of art introduces a digital
of such assets is more difficult and costly signature that cannot be altered. The digital token
(the right buyer must be found, and if representing the Mona Lisa is one of a kind. It is
the seller needs to sell immediately he is not a copy. But the token can be broken down into
likely to lose money) the valuation often
includes a so-called illiquidity discount
sub-tokens, each also digitally signed. In this way,
which takes these disadvantages into “shares” of a unique piece of art can be sold to
account. the general public. […] Each holder of a Mona Lisa
token doesn’t have a copy of the Mona Lisa – they
Making these asset types more liquid actually own a part of the artwork itself, which they
through tokenization should remove the can keep as a store of value or sell to another willing
illiquidity discount, which could add up
to considerable amounts. In the R-Token
buyer.”
white paper published by Harbor the It is believed the first company in the 26. https://harbor.com/
rtokenwhitepaper.
conclusion is that “given that the asset world to realise this idea is Masterworks29 pdf
categories within the private securities founded by serial entrepreneur and art 27. It is not that
market are massive (in the trillions), collector Scott Lynn in 2017. The first it would be
and that the illiquidity discount can be piece of artwork to be tokenized and impossible to
do without
as high as 20-30%, the tokenization of sold off in fractions by the company was tokenization and
private securities has the potential to Andy Warhol’s 1 Colored Marilyn reversal blockchain, but
unlock billions of dollars in value.”26 series, which Masterworks bought at a it would be very
Phillips auction in New York in November burdensome and
there is absolutely
Another key feature and major 2017. Lynn explains the blockchain-based no tradition for
advantage of tokenization is a new platform for trading of art: such things in the
opening for fractional ownership. traditional world of
Fungible assets are well suited for art or investments
The platform lets anyone – even though we
fractional ownership – you can buy invest in major works of art for as have seen a few
just 1 gram of gold or 10, 100 or 1,000 experiments like
grams – no matter if the asset is traded
little as $20 per share. […] There this one: https://
in a real-life scenario or in a virtual are two ways an investor can get a www.reuters.com/
article/us-britain-
space represented by tokens. But for return. Firstly, an investor can sell art/london-art-
non-fungible assets, the matter is quite their shares to another investor exchange-lets-
different. A non-fungible asset like an oil on an approved trading platform. collectors-buy-
painting is a unique piece of art and until shares-of-a-
Secondly, a collector can make banksy-idUSBREA3
now fractional ownership of artworks
has not been an option.27
an offer to purchase a painting A0TT20140411
28. https://blockonomi.
from investors, and they can vote com/tokenization-
However, this might be about to change on whether or not to sell. […] blockchain/
29. https://www.
with the ability of tokenizing non- Blockchain allows us to approve masterworks.io/
fungible assets by using a standard such multiple exchanges to trade each 30. https://venturebeat.
as ERC-721 or ERC-1155. Oliver Dale from painting’s tokens to provide more com/2018/07/26/
Blockonomi puts it this way: masterworks-
liquidity to investors.”30 offers-fractional-
ownership-of-fine-
art-through-the-
blockchain/
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CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 13
- towards a regulated and stable token-driven economylimitation regarding the virtual
representation of tokenized assets:
“Tokenization is a method that converts
rights to an asset into a digital token.”32
Tokenization converts a right to the
asset in question, but not the asset itself.
This evident limitation for tokenization
of tangible, real-world assets leads to
plenty of concerns.
A major challenge is how to establish a
genuine and trustworthy link between
the digital tokens and the actual physical
asset:
How can I be sure that the assets, 31. 1 Colored Marilyn
which are supposed to back my reversal series, 1979
by Andy Warhol, oil
tokens, exist in real life?
and silkscreen inks
31 How can I be sure that the assets are on canvas 18 1/4 x
not being resold, replaced, stolen or 13 3/4 in. (46.4 x
destroyed? 34.9 cm). Estimate
$1,500,000 -
Art is just one example of a market in How can I legally claim ownership of
2,000,000. Sold for
which we will see fractional ownership (part of) the asset backing my token? $1,815,000. HTTPS://
based on tokenization of non-fungible WWW.PHILLIPS.
assets. But much larger and far more In the case of DigiX33, which is a COM/DETAIL/
ANDY-WARHOL/
valuable is, of course, a market like company offering gold on the Ethereum
NY010717/18
real estate. If token-based fractional blockchain, 1 DGX token = 1 gram of 32. https://medium.
ownership might look like a curiosity “bullion from LBMA-approved refiners com/coinmonks/
when it comes to fine art, it seems a lot that we store with our custodial vault”34, asset-tokenization-
on-blockchain-
more obvious and likely in the case of and DigiX promises that anyone holding
explained-in-
real estate. at least 100 DGX will be able at any time plain-english-
to redeem their tokens for genuine gold. f4e4b5e26a6d
Imagination is the only limit when 33. https://digix.global/
34. https://digix.zen-
it comes to tokenizing real estate. DigiX has even developed a protocol
desk.com/hc/en-us/
Anything from skyscrapers to football called the Proof of Provenance (PoP) articles/
stadiums, private estates to public to keep track of “the movement of 360001814051-
buildings and landmarks could be physical assets (gold in the case of DGX) How-does-the-pri-
ce-of-1-DGX-1-gram-
tokenized in the future, and offered in through the change of hands, from the
of-gold-
small fractions to anybody in the world. bullion supplier to the custodial vault 35. https://digix.zen-
Smaller investors would be able to in a transparent and cryptographically desk.com/hc/en-us/
build up their own portfolio containing secure manner. PoP proves the existence aticles/3600017859
52-What-is-the-Pro-
fractions of whatever interests them of the physical asset, the authenticity
of-of-Provenance-
within the global real estate market – of its ownership and the security of its PoP-protocol-
ranging from world-famous buildings to storage in the custodial vault.”35
local shopping centers.
DigiX explains that the protocol uses
4.3 Challenges of tokenizing real-world “private keys and documentations
assets uploaded onto IPFS, a distributed file
Some definitions of tokenization sharing database, and the blockchain”
underline an obvious but important to prove that the link between the DGXs RETURN TO TABLE OF
CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 14
- towards a regulated and stable token-driven economyin circulation and the gold bullions dollars. And as we will see below, the
stored in a physical vault somewhere potential does not stop with the sheer
in Singapore36 is always genuine and tokenization of assets – sometimes
unbroken. called first generation tokenization.
Although tokenization is still in its very
This example shows that it is possible early days, it is time to look even further
to establish and secure a trustworthy and explore the potential of a second-
link from the digital tokens to the actual generation tokenization, where global
physical asset, but its setup could be stablecoin systems are integrated into
relatively complicated. the ecosystem.
In the case of gold, a critical issue is The Dai Credit System has the ability to
the physical security for the real-world further increase the liquidity of a large
asset. The advantage, on the other hand, variety of tokenized asset types by
is that an asset like gold is not being enabling the token owners to take out
moved around, but stays in the custodial loans against the tokenized assets. By
vault. The opposite is the case, if we take doing so, new non-volatile money – Dai
shipping containers as an example. The – is created in a process that resembles
value of each container is relatively low – the way 95% of all money is created
around USD 2,000 - and containers are today in the traditional banking system
far from as exposed to theft as gold. But – by fractional reserve banking – except
the problem here is that containers are for the fact that Dai is backed by more
being moved around all the time, which than a full reserve of assets.
makes it far more challenging at any
time to keep track of their whereabouts. In the following chapters, we will explain
the mechanics as well as the potential of
In many cases of tokenization of real- this second-generation tokenization in
world assets – like in the DigiX case more detail, but first, we will give a short
– a certain degree of centralization introduction to stablecoins followed by a
when it comes to securing of the link presentation of Maker and the Dai Credit
between the actual asset and the virtual System.
representation will have to be accepted.
The owners of DGX tokens have to trust
DigiX and their business partners, and
that the bouillons are kept safely in the
vault in Singapore. – and to some extent,
this, of course, collides with the basic
idea of blockchain and decentralization.
This points to a need to think about the
legal situation of the link between the
virtual representation – the token – and
the assets that the token represents.
This is a work-in-progress because the
area is new and legislation is still being
developed around the world.
The potential value of tokenization 36. https://www.thesa-
of real-world assets is not currently fehouse.sg/
quantifiable, but there is little doubt
that it should be counted in billions of
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CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 15
- towards a regulated and stable token-driven economy5. Stablecoins – a brief introduction
37. As pointed out in
So far, we have described utility tokens In the next sections, we will take a closer among others this
and security tokens. Stablecoins are the look at an important relation between article: https://
third category of tokens, which will play tokenization of real-world assets and medium.com/@
a key role in the development of a token- stablecoins. We will also explain how the Digix/partnership-
announcement-
driven economy. downward spiral of the crypto market makerdao-and-
can be broken by a successful uptake digix-dgx-gold-
Stablecoins certainly have a utility: to of tokenization and stablecoins – or to tokens-to-play-a-
keep a stable price. If a stablecoin – like be more precise: multi collateral-backed crucial-role-in-the-
dai-8ed4c05b622c
Maker’s Dai – is pegged to the USD, stablecoins like Dai.
it must keep its value at one dollar or
very close to one dollar, despite what Dai currently offers the most
happens in the market. comprehensive and genuine answers on
how to fight volatility and at the same
5.1 Fighting volatility time helps realize the potential of a
Until now virtually all cryptocurrencies future token-driven economy.
on the market, regardless of history,
market maturity or volume, have turned
out to be volatile to such an extreme
degree that they are useless in a wide
range of contexts – that is in cases
of payments, loans, remittance, value
storage, and more.
Stablecoins offer a solution to the
critical issue of high volatility, which
can paralyze the entire crypto market,
as many cryptocurrencies37 “tend to
be correlated, i.e. they fall and rise
together”. Since today’s market is often
irrational, it is nearly impossible to
predict performance. This uncertainty
scares away potential investors.
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CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 16
- towards a regulated and stable token-driven economy6. Maker and the Dai Credit System
Maker was founded in 2014 and its this, daily volatility has meant that, in 38. Would have been
offering, the Dai Credit System, was the practice, bitcoin no longer serves the approx. three times
as much in late
first stablecoin project on the smart purpose intended by Satoshi Nakamoto, 2017!
contract based Ethereum blockchain. when he wrote in his famous white paper 39. https://bitcoin.org/
that: bitcoin.pdf
In addition, Maker issues MKR, the
governance token for the Dai Credit What is needed is an
System. MKR holders have voting rights electronic payment system based
on key strategic decisions regarding
the development of Maker and its
on cryptographic proof instead
technological platform. MKR owners of trust, allowing any two willing
concurrently act as safeguards, securing parties to transact directly with
the stability of the Dai Credit System in each other without the need for a
case of unexpected turbulence in the trusted third party.”39
system.
This was written in 2008, but
As the Dai Credit System grows and paradoxically bitcoin has been
evolves, Maker has established more completely useless as a payment means
than two hundred partnerships globally. for years now, ever since it became
popular as an asset class and started to
Later we will review just three of these attract investors.
partnerships and see how they utilise
Dai, but first a closer look under the The Dai stablecoin aims to remove the
hood of the Dai Credit System. volatility seen in the crypto market,
making it possible to start using
6.1 The mechanics of the Dai Credit cryptocurrencies for real-life practical
System purposes, and serve as a foundation for
To make any kind of trading – from a token-driven economy.
simple buying and selling to professional
trading – on a blockchain applicable A core element of the Dai Credit System
and attractive, it is crucial to eliminate is the Collateralized Debt Position or
the high volatility synonymous with all CDP, which is a fully autonomous/
cryptocurrencies today. automated smart contract enabling
anyone to deposit certain types of assets
Cryptocurrencies that might lose 10 as collateral on the Maker platform
or 20% of their value within hours and take out loans in Dai against the
are unattractive for blockchain based collateral.
trading – like instant settlement, low
fees, decentralisation, and high security 6.1.1 The CDP interaction process
– unless stability is introduced in the Step 1: Creating the CDP and
system. depositing collateral
To create a CDP, the user sends a
The classic example is the story of transaction that transfers the amount
the developer who bought two pizzas and type of collateral that will be used
in 2010 for 10,000 bitcoins, blissfully to generate Dai to a smart contract in
unaware that 10,000 bitcoins today the decentralized MakerDAO system.
would correspond to USD 65 million.38 At this point, the CDP is considered
But, apart from extreme examples like collateralized.
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Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 17
- towards a regulated and stable token-driven economyStep 2: Generating Dai from the 1 ETH=100USD
collateralized CDP 1 ETH 66 DAI 66 DAI 1 ETH
The CDP user then sends a transaction Open CDP Generate Dai Pays back Dai Withdraw ETH
to retrieve the amount of Dai they YOU CDP YOU CDP YOU
want from the CDP, and in return the
CDP accrues an equivalent amount of Your wallet Your wallet Your wallet Your wallet Your wallet
debt, locking them out of access to the 1 ETH CDP CDP CDP 1 ETH
collateral until the outstanding debt is Contains
Owed
1 ETH
0 DAI
Contains 1 ETH
Owed 66 DAI
Contains
Owed
1 ETH
0 DAI
paid. 66 DAI
Step 3: Paying down the debt and NOTE:
You can’t close this
CDP until the 66
Stability Fee DAI you generated
is paid back (to-
gether with a small
When the user wants to retrieve their stability fee)
collateral, they must pay down the debt
in the CDP, plus the Stability Fee that Fig. 1: This figure shows the normal interaction process as described in the
continuously accrues on the debt over four steps above when opening a CDP, generating Dai, paying back Dai,
withdrawing collateral (ETH) and closing the CDP.
time. Once the user sends the requisite
Dai to the CDP to
pay down the debt 1 ETH=100 USD 1 ETH=70 USD Much like a ”margin
call” the system
and Stability Fee, 1 ETH 66 DAI
has automatically
liquidated your
the CDP becomes CDP to the highest
bidder. While person
debt free. Open CDP Generate Dai
X gets to keep the
Person X CDP Person X CDP DAI that Person X Person X
has borrowed, the 1
ETH Person X puts
Step 4: into the CDP con-
tract has been sold
Withdrawing Person X wallet Your wallet Person X wallet Person X wallet
to someone else
Person X wallet
and used to pay off
collateral and 1 ETH CDP CDP CDP
Person X’s debt.
66 DAI
closing the CDP Contains 1 ETH Contains 1 ETH Undercollateralized
With the debt and Owed 0 DAI Owed 66 DAI LIQUIDATION
Stability Fee paid 66 DAI
down, the CDP
user can freely 66 DAI 1 ETH
retrieve all or some
of their collateral Pay DAI for ETH Receive ETH
back to their Person Y Person Y
wallet by sending
a transaction to
Maker.40 Person Y wallet
before auction
Person Y wallet
after auction
66 DAI 1 ETH
Fig. 2: This describes the event of automatic liquidation of a CDP in case of undercollateralisation.
To ensure there is always enough collateral in the system to cover the value of all outstanding debt
(according to the Target Price), a CDP can be liquidated if it is calculated to be too risky. The Maker
Platform determines when to liquidate a CDP by comparing the Liquidation Ratio with the current
40. https://makerdao. collateral-to-debt ratio of the CDP. Each CDP type has its own unique Liquidation Ratio that is controlled
com/whitepaper/ by MKR voters and established based on the risk profile of the particular collateral asset of that CDP type.
Dai-Whitepa- Liquidation occurs when a CDP hits its Liquidation Ratio. The Maker Platform sells off enough collateral
per-Dec17-en.pdf to cover the outstanding debt. Any surplus collateral will be returned to the CDP, so the CDP owner can
p. 4 withdraw it.
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Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 18
- towards a regulated and stable token-driven economy6.2 Entering the Second-Generation Authorized participants
Tokenization Phase generate DAi
As described earlier in this white Secondary Market
paper, the process of tokenizing an CDPs Dai
asset unlocks numerous advantages
like increased liquidity, fractional
Off-chain collateral is
ownership, rapid settlement, and more. ”tokenized” through
an intermediary Security
This can be considered ‘first-generation institution, where
Token
only authorized
tokenization’, and as mentioned above, participants can Exchange
custody and transfer
several companies around the world are them - a ”walled Authorized participants Authorized participant
garden”. with public adress
currently developing or offering this kind
of asset tokenization. Dai now exists
outside the walled
garden, in the public
Combining first-generation tokenization addresses of
the authorized
and global multi collateral-backed Security Security backed tokens
participants
stablecoin systems will allow us to enter
a second-generation tokenization phase
in which the potential of the tokenized
assets will be further developed and Fig 3: This shows how
Maker can facilitate
utilised – and at the same time we will In an interview with the CEO of Nomics, decentralized lending
be able to create the necessary setup Clay Collins, in July 2018, Josh Stein, on regulated products.
for issuance of sufficient amounts of CEO of Harbor notes:
non-volatile cryptocurrencies to fuel the
future token economy. I think it [tokenized securities
and real estate] has the potential
6.2.1 The Dai Credit System’s
importance for tokenized assets
to become the foundation or the
In the Dai Credit System, tokenized basis for Stablecoins. So today,
assets can be used as collateral in a CDP. for example, I’m a big fan of the
This enables the owner of the tokenized MakerDAO project and some of
asset to take out loans in Dai against the the other Stablecoin projects that
collateralized asset and use Dai within are out there. There is so much
the token economy – just like a crypto
counterpart to fiat currency – or to
friction involved because the
exchange Dai for USD, or to leverage the cryptocurrencies are so volatile,
owners’ position and buy more assets to and there’s so much commerce
put into the CDP. that wants to be done in what
is essentially fiat, and folks are
Currently, ether is the only collateral looking for crypto fiat, and that’s
available in the Dai Credit System,
but in a short while we expect to
what the Stablecoin projects
see more asset classes accepted as are about. The issue is, let’s take
collateral. Because assets like real the MakerDAO for example, you
estate or gold are far less volatile than pledge collateral, and in order to
cryptocurrencies, the Dai Credit System get Dai, you have to significantly
is expected to be much more stable and over-collateralize that contract
efficient for users as they will be able to
take out more Dai against less volatile
if you’re using cryptocurrencies
assets without jeopardising the security precisely because they are so
of the system. volatile. There is a confidence
issue in the value there. And you
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are vulnerable to a classic run CONTENTS
Informational Paper from the Tokenizer prepared for Maker:
Tokenizing real-world assets 19
- towards a regulated and stable token-driven economyYou can also read
