Tokens Explained: a Gentle Introduction
A token is a unit of value that represents an asset or utility in digital form. “Asset Tokenization” describes the process of translating a real world or financial asset into digital tokens.
Terms like “Token Economy” and “Asset Tokenization” have made it into the news headlines. Not only on niche blogs revolving around digital technologies, but also in mainstream media outlets.
Technologically unsophisticated investors or newcomers to the sector might be overwhelmed by blockchain-specific terminology. No problem. Technological finesses are largely irrelevant to investors. A basic understanding of the main concepts is sufficient — most Biotech stock owners don’t know what “Pharmacokinetics” means either.
However, the term “token” appears often enough that investors may want to get acquainted with this novel concept brought about by the digital economy. So, what does it mean, when the Financial Times writes about “Tokenomics”?
A token is a unit of value representing an asset or utility
The term token refers to a unit of value, issued by a private entity, and stored on a blockchain, which is a form of a database. Tokens are digital assets and can have a wide range of functionalities. In a broad sense, there are two main types of tokens:
Security tokens: Security tokens represent a real-world or financial security in a digitalized form. They perform the exact same function and include the same rights as the security they represent. They are so to speak a digital copy of the asset. A security token could, for example, represent a company’s share, including profit-share and voting rights. It could also represent a share in a real estate asset or a share in an investment fund. As security tokens represent securities, they are regulated according to strict securities laws and regulations.
Utility tokens: A utility token represents the right to a specific, pre-determined functionality within a closed blockchain-based ecosystem. A utility token is like a ticket to a concert. The owner may use it at a specific time and place to access a specific concert, but he cannot use it to pay a restaurant bill. The use case is limited to a particular project. The Filecoin token, for example, enables users to buy storage space within the Filecoin network. As utility tokens do not represent an investment vehicle, they are not regulated by securities laws — at least in most jurisdictions.
Tokens and digital currencies are two entirely different concepts
Some may use the terms “tokens” and “digital currencies” — or “cryptocurrencies” — interchangeably. Others refer to digital currencies, such as Bitcoin, as “payment tokens.” Both wordings are misleading.
Tokens and coins are two different kinds of units created using cryptography. On the contrary to tokens, coins circulate as a currency and are a medium of exchange, unit of account or a store of value. Thus, one could buy a token with a coin, but not the other way around.
Furthermore, coins are not issued by a private entity, and they are running on their own blockchain. Bitcoin, for example, runs on the Bitcoin network. Tokens, on the other hand, are built on an already existing blockchain platform, such as Ethereum.
“Asset Tokenization” describes the process of replicating an asset in digital form
The term “Asset Tokenization” describes the process of replicating a real-world or financial asset in the form of a digital token. It’s possible to translate every asset, such as bonds, stocks, arts, or real estate into a digital format.
For example, a real estate developer might want to sell a property in digital form. A tokenization service provider will replicate the asset digitally by storing all of the property’s data, such as property value, building specifications, or location on a blockchain. The total asset value is then split into a specific number of tokens with each token representing a fraction of the original asset value.
The “smart contract” of the token, an encrypted and automatically enforced set of rules, will specify the rights of the token holder, for example, ownership rights or a share of rental payments.
Likewise, INVAO Group’s IVO token is a security token — regulated by Liechtenstein financial law — which digitally represents a share of its underlying portfolio. Thus, there is no difference between IVO and traditional bond investments, just that investors receive a bond share in digital form, instead of a classical securities certificate.
The main advantage of asset tokenization is that it significantly increases the liquidity of the digitally replicated assets. Investors from all over the globe can invest in the asset, with virtually no minimum investments and low transaction costs. Investors can buy tokens directly from the issuer or via regulated secondary exchanges, without having to use a broker or bank.
Lastly, terms like “Tokenomics” or “Token Economy” are describing the economic considerations behind a token-based ecosystem. On the investor’s side, however, the investment consideration is the same as in traditional capital markets; just that everything happens in digital form, at lower costs, increased speed, and with greater transparency.