Tokenization could be a boon to crypto — or trigger disaster

It’s been a common thread of the crypto industry over the years: A new application built on blockchain comes to life, promising to be the tipping point for broad adoption, only to be thwarted by bad actors. 

FTX was positioning itself as a pro-regulation exchange promising a bright future for all, until it collapsed after mismanaging investor funds and fraudulent behavior. Similarly, crypto lender Celsius was brimming with potential until it went insolvent, leaving US$1.3 billion in missing funds. Bad business practices have continuously eroded progress in crypto.

We are now on the brink of another opportunity for mainstream adoption — tokenization of real-world assets (RWAs).  Tokenization involves representing real-world assets, such as real estate, art or commodities as digital tokens on a blockchain. Tokenized RWAs have the potential to create a new financial market, giving the existing traditional financial markets a long-due overhaul, one that combines the choice and flexibility found in DeFi with the safety and regulatory nature of TradFi. This means that we could finally realize the promise of DeFi and bring the benefits of blockchain to the masses and present a potential “Kodak moment” to those market participants that don’t come along.

But, like with most tech innovations, we have to consume it responsibly. The success of tokenization hinges on the responsible actions of the market participant. The crypto industry is running out of chances to regain trust and prove its reliability to the wider public. If done correctly, tokenized RWAs could bring mass adoption for crypto, but if not, it could be one of the final nails in the coffin for the industry and manifest the technology with unrealized promise. 

Year of tokenization

While decentralized finance was expected to democratize access to high-yield investing through its lack of geographical barriers, zero initial capital requirements, and 24/7 market access, the unregulated, volatile nature of the space, has meant that this has yet to be realized.

Tokenization could be the missing puzzle piece. The landscape of traditional finance has far more assets, liquidity and regulation. By taking the underlying premise of DeFi, namely transparency, 24/7 trading, automation, composability and self-custody, and incorporating the stability of TradFi assets and channels, tokenization can dramatically change the way we trade, build and compose financial markets. 

This promise hasn’t gone unnoticed by the industry. Blockworks named tokenization as “crypto’s theme of the year” for 2023, and tokenized gold surpassed US$1 billion in combined market cap in April. 

It’s not just the crypto space either. Mainstream organizations such as Goldman Sachs, Blackrock and Siemens are all beginning to look at representing assets on the blockchain. In fact, Larry Fink, CEO of BlackRock, recently said that tokenization will be “the next generation for markets.”  There’s a real hope that tokenization will mean blockchain technology finally moves into an era of meaningful real-world applications.

Consumer protection and transparency

If we’ve learned anything over the last 10 years in financial and crypto markets alike, it’s that bad business practices will catch up with organizations eventually. Tokenized RWA providers must learn from the mistakes of their predecessors if tokenization is to catalyze mainstream adoption and prevent another FTX or Celsius-level crisis.

Unfortunately, we’re already seeing instances of insufficient disclosures, inadequate consumer protection, and glossing over regulatory details creep into tokenization. There are some operating in the space that do not disclose the underlying assets that are being held, giving investors no indication of whether their balance sheets are clean or hardly identifying the specific actors in the value chain. Organizations base their tokens on “contract for difference” instead of the real asset, which does not entitle the buyer to any claim for the underlying collateral and thus no insolvency protection should the issuer go bankrupt. The normal consumer is not able to see that difference and how it can be majorly detrimental. 

Tokenized RWA providers clearly have a role to play here when it comes to consumer protection, but this also needs to go hand in hand with a solid regulatory framework. Where other areas of crypto regulation may be complicated, RWAs are comparatively quite simple. As the tokens represent real stocks, bonds and securities, they are without dispute simply regulated as such. This prevents the space from heading into murky waters where these assets become freely transferable, risking them being in the hands of those who shouldn’t have access to them, such as users from sanctioned countries.

The last frontier of mainstream adoption

The time to act is now. A recent market survey on tokenization by EY found hugely optimistic metrics for adoption: 57% of institutional investors are said to be interested in investing in tokenized assets, with 40% interested in starting this year or next. Those numbers are staggering.

And it’s not just the institutions. Based on our media analytics, we have seen widespread interest in tokenization, with media mentions of the topic increasing by 204% over the last year.

Tokenization holds immense potential for the widespread adoption of crypto. However, if we don’t learn from the past, we’re doomed to repeat previous mistakes. In order for the industry to move forward, tokenization providers need to take meaningful steps in ensuring transparency, security, and accountability. 

If we get this right, we can revolutionize traditional finance and bring the benefits of decentralized infrastructure to a wider audience. The industry’s reputation and future hang in the balance, the time to act is now.