The Role of Asset Tokenization in DeFi

Curious to learn how DeFi can tokenize assets? In this piece, we guide you through the technology’s operation, its benefits, and the various types of tokens that exist.

When most people think of blockchain technology, they typically consider popular cryptocurrencies such as Bitcoin, XRP, Dogecoin, Ethereum, and others. While cryptocurrencies are the technology’s most popular implementation, it is the underlying blockchain technology that has been so far-reaching that countless industries have adopted and implemented it since its mainstream introduction in 2008.

For example, you can now find various forms of this technology implemented in decentralized finance, global supply chains, healthcare businesses, real estate, and even the art industry. Decentralized finance, or DeFi, is one key area where the blockchain has had a profoundly impactful effect, making it possible, even easy, to convert real-world assets into tradable, usable, divisible, and decentralized digital tokens.

In this article, we’ll focus on a key concept driving growth in DeFi: asset tokenization. We’ll discuss what it is, its benefits, and common token types in DeFi.

Introduction to Asset Tokenization in DeFi

In decentralized finance, asset tokenization is the process of converting assets such as real estate, bonds, stocks, art, and other commodities into digital, blockchain-based tokens.

The revolutionary aspect of asset tokenization in DeFi is that it can work with a wide range of valuable assets, including art, precious metals, intellectual property, and traditional financial instruments. You can even obtain a loan on a crowdfunding platform, one of those being the 8lends platform by the Swiss company Maclear.

How To Tokenize Assets in DeFi

Step 1: Choose an Asset

The asset could be art, traditional financial instruments such as stocks, bonds, or fiat currencies. This step also involves assessing and establishing the asset’s value, as well as building the required legal framework.

Step 2: Value Verification and Custodial Arrangements

If the goal is to tokenize a real-world asset, it is vital to establish its value to ensure the created tokens accurately reflect it.

Consider an example of a $5 million apartment complex. Before tokenizing it, you must verify this value. That’s the only way to know how many tokens to create and fractionalize to match the value tied to each token.

In most instances, the verification and custodial arrangement processes require a decentralized solution provider or custodian to verify the asset and its value.

Step 3: Token Creation Using Smart Contracts

Once a decentralized solution provider or custodian establishes the asset’s value, developers use that value to create blockchain-based fractional tokens that represent its full value.

They accomplish this using smart contracts that fractionalize the asset and execute themselves using preprogrammed contract logic.

• Smart contracts are self-executing, scripted programs that automate blockchain actions when specific conditions are met.
• Fractionalization involves breaking an asset into various digital tokens that match its value. The most common token types are stablecoins, NFTs, utility tokens, and many others.

Another aspect of this step is choosing a blockchain platform. The most popular options are Ethereum, OpenChain, Ripple, and Monero, but there are other types of public, private, and permissioned blockchains.

Step 4: Initial token offering and distribution

Also called an Initial Coin Offering (ICO), an Initial Token Offering (ITO) is the process of making tokenized and fractionalized assets available to private or public investors.

Investors who purchase these tokens can then store them in their cryptocurrency wallets as proof of ownership of the tokenized and fractionalized asset.

Step 5: Trading and use in DeFi systems

After investors buy tokens of a digitized and distributed asset, they can hold them in their wallets, trade them on various exchanges, or use them within other decentralized finance systems that support their use.

Benefits of Asset Tokenization in Decentralized Finance

Tokenization in DeFi has several noteworthy benefits. These include the following.

Lower transaction costs

One of the primary advantages of using blockchain technology in decentralized finance is that it lowers the traditional costs associated with asset selling and buying.

As you know, traditional financial systems usually have intermediaries like brokers, banks, insurance companies, and other parties that charge fees for financial services. DeFi’s use of blockchain features like tokenization eliminates this.

In decentralized finance, transactions between buyers and sellers are direct. This eliminates traditional intermediaries and reduces transaction costs. Because the traditional finance system also usually has a backlog that can delay transactions, tokenization saves money and time by speeding up the purchasing and selling process.

Fractionality

As mentioned earlier, fractionalization in DeFi involves breaking an asset into smaller digital tokens that investors can buy and trade. It’s one of the primary advantages of asset tokenization.

Picture this: instead of staking $5 million to buy a high-rise apartment, you can find a tokenized real estate project like a skyscraper and buy a stake in it for a fraction of the cost.

The fractionalization of blockchain technology makes it possible for ordinary people who don’t have millions of capital to own fractions of high-value assets, such as fine art and real estate.

Ease of Access

In traditional financial systems, purchasing or selling an asset like a piece of fine art, real estate, minerals, intellectual properties, etc., is an involved process that takes time and a lot of patience. Tokenization in DeFi circumvents that.

Because they’re digital, selling and buying fractions of a tokenized asset is so easy that, thanks to DeFi platforms and apps, you can buy and sell tokens in minutes—and often in real-time—from anywhere.

Due to this being so effortless, you can swiftly change the market positions. For example, if a particular digital asset is on a bearish trend that will impact your balanced portfolio, you can easily sell it and vice versa.

Decentralized robust security

One of the primary advantages of the blockchain architecture that powers DeFi is its inbuilt security features.

Here’s how the process works:

When a transaction or event occurs on a blockchain, a verification mechanism verifies it, and the underlying system adds full tamper-proof blocks to the database.

This system is very secure, especially in DeFi systems like public and public-private blockchains that rely on transaction verification methods like cryptography or decentralized verification and traceability.

Types of Tokens in Decentralized Finance

Let’s now focus on the following token types in DeFi.

1. Utility tokens

Utility tokens give holders access to specific services or products within a decentralized blockchain-based finance system.

Because their primary purpose is to provide access to certain actions, services, or products within a DeFi system, utility tokens are commonly used during the Initial Coin Offering (ICO) phase of tokenizing an asset.

One example is when new decentralized finance systems reward users with utility coins for taking particular actions, like using a DeFi system, or discounts for early adoption.

Notably, utility tokens do not necessarily represent an ownership stake in a tokenized asset. Ethereum gas is an excellent example of a utility token.

2. Stablecoin tokens

Stablecoins are the most common token type in DeFi because of popular cryptocurrencies like Bitcoin.

A stablecoin is a token that tries to peg its value to a stable asset like a fiat currency, precious metals like gold, or other stable assets. Stablecoins are a popular way to mitigate the high volatility inherent to blockchain-based DeFi systems, such as cryptocurrencies.

Common stablecoin tokens include U.S treasury-backed, commodity-pegged, crypto-backed, fiat-pegged, and non-collateralized stablecoins.

3. Security tokens

Security tokens are another common and popular way of tokenizing assets in DeFi. These digital tokens represent fractional ownership or rights to real-world assets, such as real estate or a company.

However, despite sharing similarities, such as being blockchain-based, cryptocurrencies and security tokens differ. While cryptocurrencies are currency, security tokens are proof of fractional or outright ownership.

4. NFTs

NFTs, or non-fungible tokens, are digital assets on blockchain-based platforms, including art, digital content, collectibles, and other value-tied items.

NFTs gained mainstream popularity between 2017 and 2021 when creators like Beeple tokenized their digital work, and NFTs started appearing on mainstream blockchains like Ethereum.

Conclusion

We’ve defined asset tokenization in DeFi, covered how it works and its benefits, and highlighted four types of tokens you’re likely to see when tokenizing an asset.

As more institutions adopt and integrate blockchain technologies into their systems and operations, asset tokenization will instrumentally help us develop robust, better, and more secure DeFi systems for different aspects of modern life.

Maclear has developed a project called 8lends, which makes loans more accessible to ordinary businesses, while also presenting an attractive profit opportunity.

Explore it to discover the benefits it offers you today.