Industry
Tokenization glows up
Jul 31, 2023
Lumped into the nebulous and often disreputable bucket of ‘crypto’, tokenization has historically struggled to strike out on its own. There have been moments in its short history when the technology captured the public interest, but close association with fraudsters and gimmicks has often seen its fledgling reputation take a hit.
Welcome to the wild, wild west
The initial coin offering (ICO) boom of 2017 was one of the first hits. An ICO is a means by which to raise capital. Rather than selling equity as they would with a traditional raise, startups instead sell digital tokens that enable holders to interact with the company. Filecoin holders, for example, can save their files with its network of storage providers.
Since tokens are finite, investors bank on the value of the token going up as more people seek to use it and demand outstrips supply. CoinDesk estimates that ICOs raised over $12 billion throughout 2017 and into the first quarter of 2018.
The core weakness with ICOs is that anyone can create them. As 2017’s boom picked up pace, scammers jumped in to exploit a nascent market full of eager investors. Pump and dump tactics were wheeled out left, right and centre – tarnishing all things ‘crypto’ in the process.
Genuine ICOs are also hampered by a number of issues. Not least how easy the process is compared to a VC raise or initial public offering. ICOs require very little documentation, which means they are far more accessible for young businesses with experimental models or inexperienced leadership teams. Just as in traditional markets, many startups that raise through ICO fail.
Apes get bored, too
Alongside the ICO boom, 2017 also brought us the first non-fungible tokens; CryptoPunks.
Non-fungible tokens (NFTs) are assets that have a digital representation on-chain (i.e., a token). The underlying asset must be unique, or have a unique identifier, and can be either digital or an asset that exists in the real world. Art is probably one of the best known applications for NFTs, thanks in no small part to the now iconic CryptoPunks, a series of 10,000 pixel portraits. These tokens were initially offered for free, but hit seven figures on the secondary market within a year of their launch. The rarest now sell for tens of millions.
The initial NFT interest sparked by CryptoPunks and, to a lesser extent, similar projects such as Hashmasks, remained in relatively niche circles until the tail end of 2020. That year, the heady combination of lockdowns and stimulus cheques saw retail investors flock into both stock markets and crypto assets.
As speculation prompted a crypto moonshot, NFTs were back in the spotlight. In 2021, auction houses made record-breaking NFT sales and the marketing machines behind major brands cashed in on the NFT action with collectibles and giveaways. One of the biggest drivers of this trend was Bored Apes, a collection of NFTs representing a unique cartoon ape that provided access to an exclusive online community. Bought (and boosted) by celebrities as diverse as Elon Musk, Gwyneth Paltrow and Eminem, the hype around the Bored Ape Yacht Club helped to propel NFTs into mainstream awareness.
Getting serious
This history of gimmicks, fraud and speculation has detracted from the utility of tokenization; particularly in financial services and the realm of real world assets. Tokenizing assets – i.e, bringing them on-chain by creating a digital representation – enables faster settlement, simplifies operational and reporting processes, increases accessibility and enhances security.
NFTs, for example, guarantee exclusive ownership of an asset, can’t be forged and are indivisible. NFT structures also provide an opportunity to reference underlying information that may be recorded off-chain, such as previous owners, age or manufacturing information. They’re well suited to alternative investments such as classic cars or artwork.
By contrast, fungible tokens (tokens that are interchangeable) can be divided to facilitate fractional ownership. These tokens therefore have the potential to open up asset classes that have historically been inaccessible to smaller investors – such as real estate and infrastructure – improving liquidity as well as simplifying the asset management process through digitalisation.
A 2022 study of European fund managers found that 93% believe alternative asset classes are ripe for tokenization, citing the technology’s ability to tackle a lack of liquidity, transparency and accessibility as core reasons to embrace it. Most (73%) agree that private equity assets will be among the first to see significant levels of tokenization.
A coming of age moment
While there are increasing numbers of compelling use cases, much of the benefits of tokenization remain hypothetical. Yes, it has the potential to increase access to private markets through fractional ownership, could reduce the need for intermediaries and automate much of the asset management process. But tokenization also needs both appropriate regulation and the ability to integrate into legacy financial systems if it’s to be effectively leveraged at scale.
In the US, there’s an ongoing debate over whether tokens constitute digital securities and so should fall under the purview of the Securities and Exchange Commission (SEC). The SEC has brought over 100 enforcement actions against various companies alleging that digital assets are securities. This particular crusade suffered a knock back when a federal judge ruled in mid-July that Ripple’s token sales didn’t constitute securities.
By contrast, EU regulators were quick to experiment and are now already legislating for tokenization. The Markets in Crypto-Assets (MiCAR) legislation came into force last year and technically applies to all crypto assets, although it doesn’t cover all NFTs.
Reaching scale
Another key piece of the puzzle to scale this technology is distribution. While tokenization presents huge opportunities for financial institutions to streamline reporting and infrastructure, increase transparency, reduce the need for intermediaries and grow their investor base, this is still early stage tech and there are barriers to its widespread adoption that need to be overcome, namely:
Settlement: investors expect to receive assets as soon as they pay, as they would on traditional exchanges, yet this is far from guaranteed with existing solutions. The more transactions required, the greater the cost involved, which is usually passed on to the customer.
Adoption: most blockchain-based tech requires advanced technical skills from users who require complex software wallets, seed phases and private keys to access it.
Security: blockchain-based products often lack recovery mechanisms.
Flexibility: existing solutions lock users into specific providers and offer little opportunities for asset owners and distribution partners to customise or white label offerings.
What’s next?
Tokenization is now (rightly) coming into its own and starting to carve out a niche beyond simply ‘crypto’. There is still work to be done from both a regulatory and technical development standpoint, but interest in the technology is increasing as fund managers and institutions alike recognise the potential of tokenisation to unlock new investor markets, grow assets under management and reduce the operational burden inherent in private markets.
With all eyes focused on scalability and an inflection point that will signal broad adoption, now is the time for private market participants to consider the infrastructure they’ll need to support tokenization. This infrastructure upgrade – taking the sector from its offline past to a digital future – is the opportunity that motivates us at Hedgehog.
—
Nothing in this article constitutes financial advice or guidance. The content in this article is an opinion and is for general information purposes only. This article is not intended to be relied upon to make financial decisions. It is not intended to be financial advice. The value of your investment can go up or down so you may get back less than your initial investment. The article may contain links to third-party websites or resources. Hedgehog provides these links and resources only as a convenience and is not responsible for the content, products, or services on or available from those websites or in those resources, the links displayed on such websites or the privacy practices of such websites.
Industry
Tokenization glows up
Jul 31, 2023
Lumped into the nebulous and often disreputable bucket of ‘crypto’, tokenization has historically struggled to strike out on its own. There have been moments in its short history when the technology captured the public interest, but close association with fraudsters and gimmicks has often seen its fledgling reputation take a hit.
Welcome to the wild, wild west
The initial coin offering (ICO) boom of 2017 was one of the first hits. An ICO is a means by which to raise capital. Rather than selling equity as they would with a traditional raise, startups instead sell digital tokens that enable holders to interact with the company. Filecoin holders, for example, can save their files with its network of storage providers.
Since tokens are finite, investors bank on the value of the token going up as more people seek to use it and demand outstrips supply. CoinDesk estimates that ICOs raised over $12 billion throughout 2017 and into the first quarter of 2018.
The core weakness with ICOs is that anyone can create them. As 2017’s boom picked up pace, scammers jumped in to exploit a nascent market full of eager investors. Pump and dump tactics were wheeled out left, right and centre – tarnishing all things ‘crypto’ in the process.
Genuine ICOs are also hampered by a number of issues. Not least how easy the process is compared to a VC raise or initial public offering. ICOs require very little documentation, which means they are far more accessible for young businesses with experimental models or inexperienced leadership teams. Just as in traditional markets, many startups that raise through ICO fail.
Apes get bored, too
Alongside the ICO boom, 2017 also brought us the first non-fungible tokens; CryptoPunks.
Non-fungible tokens (NFTs) are assets that have a digital representation on-chain (i.e., a token). The underlying asset must be unique, or have a unique identifier, and can be either digital or an asset that exists in the real world. Art is probably one of the best known applications for NFTs, thanks in no small part to the now iconic CryptoPunks, a series of 10,000 pixel portraits. These tokens were initially offered for free, but hit seven figures on the secondary market within a year of their launch. The rarest now sell for tens of millions.
The initial NFT interest sparked by CryptoPunks and, to a lesser extent, similar projects such as Hashmasks, remained in relatively niche circles until the tail end of 2020. That year, the heady combination of lockdowns and stimulus cheques saw retail investors flock into both stock markets and crypto assets.
As speculation prompted a crypto moonshot, NFTs were back in the spotlight. In 2021, auction houses made record-breaking NFT sales and the marketing machines behind major brands cashed in on the NFT action with collectibles and giveaways. One of the biggest drivers of this trend was Bored Apes, a collection of NFTs representing a unique cartoon ape that provided access to an exclusive online community. Bought (and boosted) by celebrities as diverse as Elon Musk, Gwyneth Paltrow and Eminem, the hype around the Bored Ape Yacht Club helped to propel NFTs into mainstream awareness.
Getting serious
This history of gimmicks, fraud and speculation has detracted from the utility of tokenization; particularly in financial services and the realm of real world assets. Tokenizing assets – i.e, bringing them on-chain by creating a digital representation – enables faster settlement, simplifies operational and reporting processes, increases accessibility and enhances security.
NFTs, for example, guarantee exclusive ownership of an asset, can’t be forged and are indivisible. NFT structures also provide an opportunity to reference underlying information that may be recorded off-chain, such as previous owners, age or manufacturing information. They’re well suited to alternative investments such as classic cars or artwork.
By contrast, fungible tokens (tokens that are interchangeable) can be divided to facilitate fractional ownership. These tokens therefore have the potential to open up asset classes that have historically been inaccessible to smaller investors – such as real estate and infrastructure – improving liquidity as well as simplifying the asset management process through digitalisation.
A 2022 study of European fund managers found that 93% believe alternative asset classes are ripe for tokenization, citing the technology’s ability to tackle a lack of liquidity, transparency and accessibility as core reasons to embrace it. Most (73%) agree that private equity assets will be among the first to see significant levels of tokenization.
A coming of age moment
While there are increasing numbers of compelling use cases, much of the benefits of tokenization remain hypothetical. Yes, it has the potential to increase access to private markets through fractional ownership, could reduce the need for intermediaries and automate much of the asset management process. But tokenization also needs both appropriate regulation and the ability to integrate into legacy financial systems if it’s to be effectively leveraged at scale.
In the US, there’s an ongoing debate over whether tokens constitute digital securities and so should fall under the purview of the Securities and Exchange Commission (SEC). The SEC has brought over 100 enforcement actions against various companies alleging that digital assets are securities. This particular crusade suffered a knock back when a federal judge ruled in mid-July that Ripple’s token sales didn’t constitute securities.
By contrast, EU regulators were quick to experiment and are now already legislating for tokenization. The Markets in Crypto-Assets (MiCAR) legislation came into force last year and technically applies to all crypto assets, although it doesn’t cover all NFTs.
Reaching scale
Another key piece of the puzzle to scale this technology is distribution. While tokenization presents huge opportunities for financial institutions to streamline reporting and infrastructure, increase transparency, reduce the need for intermediaries and grow their investor base, this is still early stage tech and there are barriers to its widespread adoption that need to be overcome, namely:
Settlement: investors expect to receive assets as soon as they pay, as they would on traditional exchanges, yet this is far from guaranteed with existing solutions. The more transactions required, the greater the cost involved, which is usually passed on to the customer.
Adoption: most blockchain-based tech requires advanced technical skills from users who require complex software wallets, seed phases and private keys to access it.
Security: blockchain-based products often lack recovery mechanisms.
Flexibility: existing solutions lock users into specific providers and offer little opportunities for asset owners and distribution partners to customise or white label offerings.
What’s next?
Tokenization is now (rightly) coming into its own and starting to carve out a niche beyond simply ‘crypto’. There is still work to be done from both a regulatory and technical development standpoint, but interest in the technology is increasing as fund managers and institutions alike recognise the potential of tokenisation to unlock new investor markets, grow assets under management and reduce the operational burden inherent in private markets.
With all eyes focused on scalability and an inflection point that will signal broad adoption, now is the time for private market participants to consider the infrastructure they’ll need to support tokenization. This infrastructure upgrade – taking the sector from its offline past to a digital future – is the opportunity that motivates us at Hedgehog.
—
Nothing in this article constitutes financial advice or guidance. The content in this article is an opinion and is for general information purposes only. This article is not intended to be relied upon to make financial decisions. It is not intended to be financial advice. The value of your investment can go up or down so you may get back less than your initial investment. The article may contain links to third-party websites or resources. Hedgehog provides these links and resources only as a convenience and is not responsible for the content, products, or services on or available from those websites or in those resources, the links displayed on such websites or the privacy practices of such websites.
Industry
Tokenization glows up
Jul 31, 2023
Lumped into the nebulous and often disreputable bucket of ‘crypto’, tokenization has historically struggled to strike out on its own. There have been moments in its short history when the technology captured the public interest, but close association with fraudsters and gimmicks has often seen its fledgling reputation take a hit.
Welcome to the wild, wild west
The initial coin offering (ICO) boom of 2017 was one of the first hits. An ICO is a means by which to raise capital. Rather than selling equity as they would with a traditional raise, startups instead sell digital tokens that enable holders to interact with the company. Filecoin holders, for example, can save their files with its network of storage providers.
Since tokens are finite, investors bank on the value of the token going up as more people seek to use it and demand outstrips supply. CoinDesk estimates that ICOs raised over $12 billion throughout 2017 and into the first quarter of 2018.
The core weakness with ICOs is that anyone can create them. As 2017’s boom picked up pace, scammers jumped in to exploit a nascent market full of eager investors. Pump and dump tactics were wheeled out left, right and centre – tarnishing all things ‘crypto’ in the process.
Genuine ICOs are also hampered by a number of issues. Not least how easy the process is compared to a VC raise or initial public offering. ICOs require very little documentation, which means they are far more accessible for young businesses with experimental models or inexperienced leadership teams. Just as in traditional markets, many startups that raise through ICO fail.
Apes get bored, too
Alongside the ICO boom, 2017 also brought us the first non-fungible tokens; CryptoPunks.
Non-fungible tokens (NFTs) are assets that have a digital representation on-chain (i.e., a token). The underlying asset must be unique, or have a unique identifier, and can be either digital or an asset that exists in the real world. Art is probably one of the best known applications for NFTs, thanks in no small part to the now iconic CryptoPunks, a series of 10,000 pixel portraits. These tokens were initially offered for free, but hit seven figures on the secondary market within a year of their launch. The rarest now sell for tens of millions.
The initial NFT interest sparked by CryptoPunks and, to a lesser extent, similar projects such as Hashmasks, remained in relatively niche circles until the tail end of 2020. That year, the heady combination of lockdowns and stimulus cheques saw retail investors flock into both stock markets and crypto assets.
As speculation prompted a crypto moonshot, NFTs were back in the spotlight. In 2021, auction houses made record-breaking NFT sales and the marketing machines behind major brands cashed in on the NFT action with collectibles and giveaways. One of the biggest drivers of this trend was Bored Apes, a collection of NFTs representing a unique cartoon ape that provided access to an exclusive online community. Bought (and boosted) by celebrities as diverse as Elon Musk, Gwyneth Paltrow and Eminem, the hype around the Bored Ape Yacht Club helped to propel NFTs into mainstream awareness.
Getting serious
This history of gimmicks, fraud and speculation has detracted from the utility of tokenization; particularly in financial services and the realm of real world assets. Tokenizing assets – i.e, bringing them on-chain by creating a digital representation – enables faster settlement, simplifies operational and reporting processes, increases accessibility and enhances security.
NFTs, for example, guarantee exclusive ownership of an asset, can’t be forged and are indivisible. NFT structures also provide an opportunity to reference underlying information that may be recorded off-chain, such as previous owners, age or manufacturing information. They’re well suited to alternative investments such as classic cars or artwork.
By contrast, fungible tokens (tokens that are interchangeable) can be divided to facilitate fractional ownership. These tokens therefore have the potential to open up asset classes that have historically been inaccessible to smaller investors – such as real estate and infrastructure – improving liquidity as well as simplifying the asset management process through digitalisation.
A 2022 study of European fund managers found that 93% believe alternative asset classes are ripe for tokenization, citing the technology’s ability to tackle a lack of liquidity, transparency and accessibility as core reasons to embrace it. Most (73%) agree that private equity assets will be among the first to see significant levels of tokenization.
A coming of age moment
While there are increasing numbers of compelling use cases, much of the benefits of tokenization remain hypothetical. Yes, it has the potential to increase access to private markets through fractional ownership, could reduce the need for intermediaries and automate much of the asset management process. But tokenization also needs both appropriate regulation and the ability to integrate into legacy financial systems if it’s to be effectively leveraged at scale.
In the US, there’s an ongoing debate over whether tokens constitute digital securities and so should fall under the purview of the Securities and Exchange Commission (SEC). The SEC has brought over 100 enforcement actions against various companies alleging that digital assets are securities. This particular crusade suffered a knock back when a federal judge ruled in mid-July that Ripple’s token sales didn’t constitute securities.
By contrast, EU regulators were quick to experiment and are now already legislating for tokenization. The Markets in Crypto-Assets (MiCAR) legislation came into force last year and technically applies to all crypto assets, although it doesn’t cover all NFTs.
Reaching scale
Another key piece of the puzzle to scale this technology is distribution. While tokenization presents huge opportunities for financial institutions to streamline reporting and infrastructure, increase transparency, reduce the need for intermediaries and grow their investor base, this is still early stage tech and there are barriers to its widespread adoption that need to be overcome, namely:
Settlement: investors expect to receive assets as soon as they pay, as they would on traditional exchanges, yet this is far from guaranteed with existing solutions. The more transactions required, the greater the cost involved, which is usually passed on to the customer.
Adoption: most blockchain-based tech requires advanced technical skills from users who require complex software wallets, seed phases and private keys to access it.
Security: blockchain-based products often lack recovery mechanisms.
Flexibility: existing solutions lock users into specific providers and offer little opportunities for asset owners and distribution partners to customise or white label offerings.
What’s next?
Tokenization is now (rightly) coming into its own and starting to carve out a niche beyond simply ‘crypto’. There is still work to be done from both a regulatory and technical development standpoint, but interest in the technology is increasing as fund managers and institutions alike recognise the potential of tokenisation to unlock new investor markets, grow assets under management and reduce the operational burden inherent in private markets.
With all eyes focused on scalability and an inflection point that will signal broad adoption, now is the time for private market participants to consider the infrastructure they’ll need to support tokenization. This infrastructure upgrade – taking the sector from its offline past to a digital future – is the opportunity that motivates us at Hedgehog.
—
Nothing in this article constitutes financial advice or guidance. The content in this article is an opinion and is for general information purposes only. This article is not intended to be relied upon to make financial decisions. It is not intended to be financial advice. The value of your investment can go up or down so you may get back less than your initial investment. The article may contain links to third-party websites or resources. Hedgehog provides these links and resources only as a convenience and is not responsible for the content, products, or services on or available from those websites or in those resources, the links displayed on such websites or the privacy practices of such websites.