Byte Me: tokenising the world

Hyper- bitcoinisation is the process of bitcoin taking over and becoming the primary global store of value and medium of exchange. There are some who still believe that we are on our way there.

But there is another possibility for how people think blockchain might disrupt the world: hyper-tokenisation.

The process of tokenisation is simple: a set of cryptocurrency tokens representing the value of an item (either a security or a real world asset) are created, registered on a blockchain and sold to investors. While they do not exactly reflect ownership of the asset, they could represent a claim on a share of the asset’s future cashflow .

For example, if you rented out a flat on Airbnb for a year, making £5,000 profit (this thought experiment takes place outside London, of course), you can tokenise it.

You would sell, say, 1,000 tokens for £10 each. Each token represents a claim on 0.2% of the flat’s earnings. You, as the tokeniser, receive two years' income up front, and tokenholders receive a cashflow that should turn profitable after a couple of years.

Sounds a little like securitisation, doesn’t it? That’s because it is — but now it’s on a blockchain!

There is, of course, nothing especially revolutionary about packaging up and selling future revenue, but on a blockchain, there are a few differences.

Firstly, it can be decentralised. You no longer need an investment bank to structure, market, sell and administrate your product, nor a clearinghouse to settle trades in the tokens.

The blockchain’s immutable ledger can cut through that web of complexity at a stroke.

Secondly, the cheapness of the process means that you could tokenise efficiently to raise rather small amounts of money, which lowers the barrier for entry and expands the market.

These two factors taken together could make tokenisation a peer-to-peer retail market for securitisation.

Thirdly, smart contracts offer a way to guarantee both sides of the bargain, though work on this technology is in development. These contracts, built into different blockchains, allows for contracts that automatically self-execute when certain conditions are met.

This means that rather than promising to pay someone with a paper contract that you have signed, and can be held to in court, you leave it to the code to make sure both sides of a trade meet their end of the bargain.

A lot of this is still in early development, and the legal territory for this type of contract is unchartered. Even in grown-up financial markets, trade bodies like International Swaps and Derivatives Association are working out ways to include smart contracts into their derivatives contract definitions.

But people are trying. Harbor, a blockchain compliance company, has raised $28m of funding in order to bring a real world asset tokenisation protocol to market.

There are plans to tokenise all kinds of things. The world of conventional securities is just the start. If you drive for Uber, why not tokenise your income and pay off your car loan early by selling tokens with a claim on a portion of your earnings?

Or how about an art gallery? Valerio Roncone, head of product management and development at SIX Securities Services, highlighted that instead of relying on charity or government donations, art galleries could tokenise the art, so that “people like you and me could participate and own part of the art”.

As with real estate, part of the potential benefit is that you don’t have to be able to afford the whole asset to participate.

Equally, franchises of all types can tap crowdfunded capital from investors using Franchise Token, an offshoot of tokenisation ecosystem Bankex. The developers of Franchise Token claim that by using smart contracts, companies of all sorts can distribute profits to their tokenholders .

And you don’t just have to think small. Chopping up the real estate market into easily tradeable, instantly settled tokens would free up a lot of liquidity.

Enthusiasts grow misty eyed about the democratisation of capital markets. No longer will exotic securitisations be the preserve of the institutional elite of finance. It can now serve as a competitor to payday lenders like Wonga (RIP) and pawnshops.

The more hardcore capitalists prefer to talk simply, but just as excitedly, about unlocking capital trapped in illiquid assets.

But is it for real? Well, there are a number of obstacles. Blockchain is both more and less secure than people think.

Despite the preponderance of stories about hacks, it is pretty hard to hack a blockchain itself. Exchanges and cryptocurrency storage facilities are hacked all the time, but altering the record of who owns what is, if not impossible, certainly very difficult.

However, it’s not all-powerful. Its scope is strictly limited to what happens on the chain. You might own a token entitling you to 5% of the rent my property earns, but it’s not so easy for a smart contract to ensure you get what you’re owed.

Unless a tenant pays rent in cryptocurrency, the underlying activity is unlikely to be taking place on the blockchain. There are systems called Oracles that observe off-chain activities that could theoretically observe the rent payment and trigger a smart contract to fetch you your returns, but unless one has cash on the blockchain — which, at this stage, probably means cryptocurrency — a smart contract is going to struggle to make someone pay up (at least until we can settle fiat transactions on blockchain). While getting paid in cryptocurrency works technically, it certainly won’t be what everyone wants.

In any case, current smart contacts are too rigid for use in a courtroom, according to a research note by law firm Ashurst, as they are as yet unable to handle some of the more woolly aspects of law such as making “reasonable efforts”. Until they’re fit for purpose, it’ll be tough for this market to take off.

These are technical hurdles and could be overcome with the right combination of technology and regulation.

But there are other hurdles. The reputation of securitisation has never recovered from that inglorious era a decade ago when the mainstream press learned about CLOs and decided to blame them for all the world's financial ills. It has yet to shake off its stigma as one of the darkest arts in a financier’s spell book. Opening up what is essentially a peer-to-peer version could prove a tough sell.

And let’s not forget the example of peer-to-peer lending. The involvement of institutions there suggests that the playing field might not remain level for long. How long would such a product have to be in existence before the first scandal broke of a pensioner tokenising their income for a fraction of its worth?