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Blockchain basics: Tokens and tokenisation explained

Here's an introduction to tokens and tokenisation, which are crucial elements of blockchain systems

bitcoin, blockchain
Tokenisation refers to the representation of a digital asset on a blockchain ledger

As debate rages over the future of Bitcoin, the so-called ‘smart’ money is now looking to other implementations for blockchain - the technology upon which cryptocurreny runs.

If like me, you’ve been following the blockchain and cryptocurrency headlines you will have come at least a passing reference to  ‘tokens’ and ‘tokenisation’.

Described in the simplest English the concept is quite easy to grasp. Basically, tokenisation refers to the representation of a digital asset on a blockchain ledger. Put another way, it is the process of mirroring and unlocking ‘real world’ assets into a digital form. Once ‘tokenised’, assets are essentially exchangeable, via a blockchain-based system.

It is, arguably, among the most fundamental aspects of blockchain. Indeed, cryptocurrency coins are themselves a type of tokens.

Familiar but different

Now, if you’re still something of a blockchain philistine, the subject of tokenisation may be slightly intimidating. So, to pre-empt some of the head-spinning jargon and millennial buzzwords lets step back a couple of decades, to something a little more familiar.

Anyone with knowledge of share trading in the decade following the City’s ‘big bang’ - i.e. the mid-80s through to mid-90s - will appreciate that settling an equities transaction was nowhere near as seamless than it is today.

Our contemporary ability to deal and, more importantly, settle stock market transactions quickly is largely down to the ‘dematerialisation’ of shares.

Whether those dematerialised (or electronically held) shares are held via a personal, corporate or nominee CREST account in London the concept is the same - messing around with share certificates was cumbersome, time-consuming and the admin was discouragingly costly.

The electronically held, or dematerialised representation of the equity, by comparison, is easier to store, transact and transfer.

London’s CREST system (which hosts most UK electronically held stock) is owned and operated by Euroclear. The presence of a maintained shareholder register and a functioning stock market listing were key factors in the system being viable as a decentralised, managed system.

It is, by definition, a centralised collection of databases.

Blockchain, however, is an open-source and decentralised system – moreover, it is the decentralisation that makes these network-based ledgers powerful.

In theory, at least, it means that there are likely to be many other new systems.

There are expected to be a great number of applications for the technology, and, in one way or another, they’ll involve tokenisation in one form or another.

Opening up asset classes

The wealth management industry has a tendency to narrow its focus solely to the types of assets that are exchange-traded – there are multiple reasons for this, but, centralised exchange and settlement are certainly among them.

One of the often presented possible futures of blockchain technologies foresees an opening up of alternative, less liquid or less accessible forms of assets.

Such examples are plentiful, albeit most are at a nascent phase - real estate, unlisted shares, physical commodities, carbon credits, art collections are among just a few that quickly spring to mind.

The idea is that with an ease of access, improved means to conduct transactions and an open system for digital ‘custody’ the spectrum widens significantly for wealth managers, and, at the same time, the traditionally less favours asset class see improved liquidity.

Tokens and ICOs

Venture capital and ‘pre-IPO’ funding have been among the first new areas to be opened up in such a way.

Indeed, the evident ‘explosion’ in initial coin offerings (or ICOs as they’ve become known) is the obvious case in point.

Over the past twelve months or so vast sums of capital have been raised, in exchange for one form of token or another.

Now, at this point it is worth explaining that what exactly a token consist of can vary materially from one blockchain system to another – apologies, it is about to get a little bit more complicated.

The actual parameters, meaning and function of a given token is defined intrinsically by the blockchain system within which it exists.

Arguably, in the context of Bitcoin, the ‘token’ (i.e. the BTC unit of bitcoin ‘currency) is among the simplest implementations of tokenisation. Each token represents a defined unit of the cryptocurrency, which itself has a predetermined maximum circulation.

Other tokens, for more specific and nuanced applications necessarily become more complex.

In the context of ICOs, an important point of nuance relates directly to the nature of the token that’s being issued - only some actually give the investor an equity stake in the company raising the capital.

Typically, there are ‘equity’ tokens which are classed as securities which in turn has implications for the regulatory position (for both the issuer and the ‘investor’), and, there are what are referred to as utility tokens which essentially redeem against the services being provided by the company.

Slightly more abstract, but not necessarily less significant, will be the other implementations of blockchain technology whereby tokens won’t actually represent a monetary or financial version of an asset.

Blockchain systems are also being put together to address identification, security and peer-based verification will, for example, have a functional use of tokens.

Understandably, it can feel like there’s so much to take in an know and, as so much of the technology is at such an early stage, there’s an awful lot more to come - if even a small proportion of what’s forecast comes to fruition, tokenisation is going to be a significant part of the future for the financial services sector and beyond.

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