This is chapter nine of The Token Handbook. It represents my own opinion and not that of any company I’m associated with.
First they ignore you. Then they ridicule you. And then they attack you and want to burn you. And then they build monuments to you. — Nicholas Klein
My name is David Siegel. I’m one of the original founders of 20|30, one of the companies whose hardworking team recently received a license from the FCA in London to issue equity tokens for companies. In this short essay, I describe the coming adoption arc of asset-tokens. I’ll use equity as the example, but the thesis holds for real estate, bonds, and other real-world assets that we will tokenize.
I believe it will take place in five stages:
1 Who cares?
2 The Turning Point
To go through these phases, we first need to understand …
What is a token?
A token is a native unit of value in a system or a claim to some value in another system. A token always has a specific purpose. A good example of a token is a poker chip from a casino. It functions as money only in a very limited domain.
Here are some physical tokens:
And here are some digital tokens:
What is Tokenization?
Tokenization is giving a real-life scarce asset a digital identity. With a token, a legal agreement says the token represents something like a gram of gold or 1/1,000th of a house, an insurance contract, a car, a work of art, a share of stock, etc. But there’s no middleman. If you have the private key, you effectively own the the real-world asset. In the case of stock, the token is the share — it completely replaces the paper share.
What is Ownership?
Different countries have different rules for different asset classes. Broadly speaking, there are two general types of ownership:
Legal ownership is the first line of ownership. In some countries, like the United States, you’re actually not allowed to own your own shares of stock — a custodian or broker/dealer has to hold it on your behalf. (This is to prevent “bearer shares,” which were dangerous because people used to try to steal them, sometimes at gunpoint.) Legal owners are always the “first level” of owners. In the following diagram, which doesn’t represent the United States, individuals are allowed to legally own the asset, and brokers and custodians own many of them on behalf of their clients.
Beneficial ownership goes to the end customer who buys or sells an asset. This comes from the intermediary model in many countries. When an asset receives a dividend or is sold, the beneficial owner — who paid for the asset in the first place — receives the money (or loss). In this diagram, the final layer of owners are the beneficial owners. There may be several layers of intermediaries.
It’s actually a lot more complicated than that, but this is good enough for our purposes. If you’re curious about equity ownership issues in the United States, listen to Caitlin Long describe her ground-breaking work in Wyoming.
Who Keeps Track?
After raising money from investors, entrepreneurs go off to start their company. Someone updates a spreadsheet that documents who owns which percentage of the company. That spreadsheet doesn’t get updated very often. So what! What matters is the entrepreneurs raised money, said thank you to the investors, and now they’re able to focus on their company.
It turns out that investors care. Just in case something good happens, they want a clear record of what they own. They want to make sure their ownership is not diluted or changed by whoever is managing the cap table.
Over the past ten years or so, companies have created cap-table software to help keep straight who owns which shares. This is more important as private companies grow past various milestones and people want to trade their stock. I am told that before Facebook went public, they paid accounting firms more than $100 million just to figure out who owned which shares! While that’s extreme, it is very common that the cap table is not up to date and someone has to figure out who owns what.
With a blockchain-based token, we say “the trade is the settlement.” As people trade tokens, the blockchain automagically updates. While a blockchain isn’t a cap table, it could function as one. We will soon have blockchains designed for the purpose of managing cap tables and other assets. Because it’s private information, the identity of the owners is not available on the blockchain. By law, the company must privately keep track of who owns how many shares.
The same will be true of real-estate, bonds, etc. There could be special-purpose blockchains, or we may use public chains like Ethereum to keep track of who owns what. Or both. The magic of a blockchain is that it keeps track of who owns what automagically as people trade, with no custodians or broker-dealers necessary (except as required by law).
What Happened to Cameras will Happen to Tokens
I compare tokens today to the first digital cameras.
The first digital cameras were clunky, heavy, slow, grainy, and made almost unusable images. But they had one advantage over film cameras: you could see the shot before you took it. Early adopters tried it, suffered, invented, and over time were rewarded with better and better cameras. At some point, it tipped, and after that it was a bit unusual to “still be shooting film.” Then the film companies went out of business, and now today it’s almost impossible to get your hands on a roll.
We’ll see the same thing happen with tokens. The one thing tokens do differently is remove the middlemen and settle transactions automagically. That matters little now but transforms the industry later.
With that groundwork, we’re ready to look at the phases of tokenization.
Phase 1: Who Cares?
This is the phase we’re in now. At the moment, tokens are shiny new pebbles that some avant-garde investors think are cool. If they lose their private keys, however, they are going to call the company and expect to get their shares back. If they are hacked, they will ask the company to “blacklist” those shares and give them new ones. So companies are going to have to deal with asset loss and recovery, and of course disagreements and disputes over ownership (example: in a divorce).
Tokens have one cool feature we haven’t seen before — the sale is the settlement. Today’s investors can look at the blockchain and see a real-time, accurate cap table of the company’s stock (without names). While that’s not particularly exciting today, it does hold a lot of promise for tomorrow.
Tokenization today is rapidly becoming a commodity service. It stands to reason that the tokenization platforms won’t stand alone. They will be part of the fundraising platforms sprouting up now. Wherever the money is, that’s where the tokens will start to appear.
Note: investors are going to be buying asset tokens with dollars, euros, pounds, etc. They are not going to be spending ether or bitcoin. To an investor, ether and bitcoin are also investments. You don’t buy an investment with another investment. You buy with your base currency.
Phase 2: The Tipping Point
Over time, while no one is really watching, it simply becomes easier and cheaper to issue stock as tokens. Eventually, the tools get better, the wallets improve, the dashboards, data feeds, reporting, analytics, and other services start to come together to give investors a real-time cockpit for trading tokens. Then we start to encode the rules, so people can see who is eligible to trade with, both domestically and cross-border. Imagine AngelList but with the ability to just buy or sell as much as you want any time (subject to restrictions).
This takes years. But then …
Token trading comes into the foreground as more advanced investors see the advantage of trading stock tokens. They start to switch from AngelList plus lawyers plus paper certificates to issuance platforms with automated legal services and tokens. Vendors start to add more features to their platforms. Everyone knows that the main goal of the platform is to bring buyers and sellers together — the technology doesn’t mean as much — but once we get a critical mass of buyers, sellers, and features, we will have a “killer app” that rapidly starts to suck investors off the old platforms.
This applies to all tokenized assets — as these ecosystems grow, they become more and more useful. Platforms add value by bringing buyers to sellers and adding more sophisticated features that both want.
Phase 3: Liquidity
Not only does this affect private-equity stock, but stock exchanges start to switch to tokens, eliminating the middlemen required to hold them (brokers, custodians, etc.). Groups start to lobby lawmakers to change the legal requirements around ownership. Tokenization quickly becomes the norm.
Some time in the next 5–10 years (but it could be sooner), we will see a phase transition in capital markets, leading to vastly more liquidity. A combination of algo-trading, low-cost transactions, disintermediation, and tokens will lead that transition. The only friction point will be regulation. Here’s what happens next:
Tokenization becomes the norm. Now it’s all about the platforms. Some will be centralized, others will be decentralized. Because most of these tokens are regulated in some way, there are plenty of rules and restrictions. But as more buyers meet more sellers on these platforms, the landscape changes. Now the old world fades. The tokenized world isn’t new any more, it’s not special, it’s not different. People don’t talk about tokens — they talk about stock.
World domination. Just as the New York Stock Exchange and others went from throwing paper in pits to trading on screens in offices, the public exchanges will start to change. There will be a leap of acceleration as tokenization takes over. The big exchanges buy up the smaller tokenized exchanges. The upstart private-equity exchanges become the worldwide public markets. The world has a new level of liquidity that it didn’t have before.
Decentralized exchanges finally become significant. Today, decentralized exchanges are difficult to use. While they are safer than centralized exchanges, their performance is very poor compared to centralized exchanges. Furthermore, if you need very low settlement fees to net every trade to the blockchain, otherwise centralized exchanges will continue to outperform. But at some point, decentralized exchanges running on fast blockchains could take a huge bite out of the centralized exchanges for many asset classes.
Liquidity increases dramatically. Now, most trades are automated, even small ones. We will see a jump in liquidity as buyers and sellers’ bots respond to cues in the market and trade easily, with low fees. In most asset classes, we should see 2–10 times as much as liquidity as we have today, possibly much more.
Phase 4: Innovation
With blockchain, smart contracts, and tokens, we can make all kinds of products that are difficult or impossible to make today. We can create loans, mortgages, derivatives, futures, options, and investment contracts of all kinds. Imagine combining a basket of assets with a real-time valuation and using that to collateralize the purchase of your home, with no banks, no mortgage companies, no middlemen. We could use tokens to represent micro-insurance contracts and then automatically adjust our insurance portfolio on the fly, as we need more or less insurance. As Lex Sokolin says: over time, the cost of creating a new financial product will go to zero, so it’s just buyers and sellers and market forces working together (and regulators adding friction).
We could have tokens for airline seats and trade them the way we trade stocks today. We could have tokens for music that pay the creator for each second the music is played. We could have reward systems that use tokens to encourage people to create new works of art and distribute the royalties automatically. There’s a world of programmable tokens coming, and it has nothing to do with middlemen.
I have written extensively about how we can take baskets of very high-risk/high-return investments — like startups or oil wells or movies — and tokenize the entire portfolio, providing a risk-adjusted return that has the potential to beat the market. Imagine not investing in a startup but instead buying a token that represents ownership of hundreds of startups. That kind of token should be available to the public, not just wealthy investors.
Over the next twenty years, we will tokenize most of the world’s assets. Fractionalized ownership will give art investors a chance to diversify and will increase liquidity in art dramatically.
We will tokenize real-estate, and that will change the landscape. Not only will we then have programmable land, but we can also create a store of value based on fractionalized ownership of a large portfolio of real-estate. There will be leveraged and unleveraged versions of this. In my view, these future real-estate-backed coins could replace gold as a store of value.
When we have liquidity at scale, we can start to really innovate. Tokens that represent ownership contracts will be a huge part of that future.
Phase 5: Inclusion
Tokens open a world of financial inclusion to people who can’t afford or wouldn’t qualify for a brokerage account. As the middle class rises around the world, people everywhere will have access to a worldwide financial stack that is cheap, safe, and fast. Average people won’t have to become investment wizards themselves. Instead, they will use software wizards and agents to help them create and maintain a smart portfolio that works best for them. New forms of money and new apps will give billions of people access to markets they never had before.
All assets will be tokenized. While tokenization today looks like a toy, within a decade it will be mainstream. Then, you’ll need a reason not to tokenize. This will bring much more liquidity than we have today.