Blockchain’s utility goes far beyond cryptocurrencies and their speculative framework. We’ve seen applications in media, retail and even cannabis. Of all its potential applications, one of the most important is blockchain’s capability of facilitating a paradigm shift in the way we acquire and invest in physical assets.
The concept of asset tokenization — creating digital assets backed by physical assets — was a natural evolution of blockchain technology. Not only does this decentralization cut down on intermediaries (and thus the cost of doing business), it also creates a more stable environment for investment on the blockchain because of the inextricable link with a physical asset.
But physical asset tokenization is better in theory than it is in application. Despite such great intentions, every attempt in asset tokenization thus far has largely failed to gather the needed support for widespread adoption. Digix, for example, launched in 2014 with the intention of tokenizing gold on the ethereum blockchain. Despite their successful fundraise in ETH for their investor token, the Digix gold-backed token has yet to garner much interest as a stable token or for making payments. SLVR offered a silver-backed coin backed by silver in a mine in Mexico. It has since fallen off the map. Most other gold- and silver-backed tokens (such as AU, HGT and XAUR to name a few) have market caps under $10 million.
There are several reasons for these failures. First, traditional tokenized digital assets only serve as placeholders for a physical asset, trading at or below the spot price. This construction inhibits adoption of these digital assets as investment vehicles because other formats of investment, such as ETFs, are much more established and dependable as a means of capturing exposure to the spot price.
Consider a token which tracks the value of one gram of palladium in a vault. Redemption of the palladium backing such a token requires the token to “burn,” equating the token value with the physical asset value. With a mirrored price, there is limited incentive to adopt a varied investment route. Why would you invest in a palladium-backed token when you could simply acquire the palladium itself, or an ETF which tracks palladium? The convenience that the token offers via blockchain is not enough to motivate investment.
Second, many of these asset-backed tokens offer problematic legal paradigms. There has been a definitive lack of asset tokens which utilize entirely on-shore legal structures. Some are supposedly backed in vaults in Singapore, Cayman Islands, Russia and others by mines in Mexico and South America. Some use company-appointed auditors, while others neglect audits altogether. Still more have violated securities laws with respect to their Initial Coin Offerings, using funds raised to support the development of the token technology. The circumstances of the development of the token and the use cases—many are likely securities—complicate their utilization or consumption by a broad audience.
Third, the long arms of regulatory bodies have made it more difficult to launch an asset-backed token in the modern environment. Regulatory pillars include the securities acts, the enforcement resources of the CFTC, as well as state laws. These pillars are all the more relevant and serious given the general backdrop of token fraud, wherein there are over 1,500 so-called “dead coins” by some counts. As a result, some of the more properly capitalized entrants in the asset-tokenization space are tokenization service ventures, including various cryptocurrency exchanges and trading venues. This has left a research and development gap with respect to innovating asset token structure.
To attract investors into a physical asset-backed token, an appropriate construction must capture both the utility in the network on which the token resides and the spot price of the asset which is digitized. The absence of either of these stores of value would result in failed adoption or susceptibility to market manipulation. There also must be a structure in place in order to discourage wild swings in the relative values of the two token parts.
This two-part token format sets the stage for adoption of a physical asset-backed token as a bona fide investment vehicle. It also unleashes economic incentives for a physical asset’s natural supply chain to utilize the token as a way of conducting business.
While asset tokenization in its purest form is now a buzzword in the crypto space, its future holds more premise than promise. The success of any digital asset is based on adoption; without adoption, failure is certain. Traditional asset tokenization has failed to capture adoption and thus the asset-placeholder paradigm is simply a failed business model.
Seth Patinkin is the co-founder and CEO of Ampersand Markets, and did his PhD work in mathematics under the late John Forbes Nash at Princeton University.
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