In the economy of the not-too-distant future, tokenization will transform how we conduct asset valuations, transactions and ownership verifications. The revolutionary technology behind it encapsulates physical or digital assets as distinct cryptographic tokens on a blockchain. It is poised to optimize processes, enhance transparency and prevent the necessity for intermediaries, making it a major influence in various business sectors.
Despite the benefits, the widespread adoption of tokenization also entails a host of regulatory challenges that necessitate a thorough examination to harness its full potential – and Paxos is playing a lead role in this effort.
Defining tokens is just one regulatory challenge
One of the main regulatory challenges of tokenization is determining how it fits within the existing legal framework. In many jurisdictions, tokenization blurs the lines between traditional financial instruments and assets, making it difficult to apply current regulations. For example, tokens can represent ownership of a physical asset, such as real estate or art, but they can also describe purely digital assets, such as music or software.
A virtual currency token or denomination of cryptocurrencies representing fungible and tradable assets or utilities that reside on blockchains.1
1 Jake Frankenfield, What Are Crypto Tokens, and How Do They Work? https://www.investopedia.com/terms/c/crypto-token.asp
Clear regulatory guidance can create certainty for businesses and consumers, leading to less hesitancy in adopting and investing in tokenization. Many countries are developing new regulations specifically tailored to tokenization, such as the proposed ‘Token Taxonomy Act,’ which attempts to define different types of tokens and offers a framework for regulating them. However, some believe this regulation type is too ambiguous to be fully effective.
Another regulatory challenge of tokenization is assessing and addressing the potential for abuse, such as money laundering, fraud and other illicit activities. Without uniform oversight in onboarding, tokenization can enable anonymous transfers and the concealing of asset ownership, which criminal organizations can exploit.
The industry is trying to mitigate these risks. Still, it needs to implement robust Know Your Customer (KYC) and Anti-Money Laundering (AML) measures deployed at traditional banks and other security measures, such as secure storage of private keys.
A private key is a secret number used in cryptography, similar to a password. Cryptocurrency private keys are used to sign transactions and prove ownership of a blockchain address.1
1 Jake Frankenfield, Private Key: What It Is, How It Works, Best Ways To Store, https://www.investopedia.com/terms/p/private-key.asp
The upside of regulated tokens is enormous
While there are certainly regulatory challenges to be addressed in the tokenization space, the benefits are numerous and significant. With standard oversight, more participants will join networks and more activity will occur. The increased liquidity and secure accessibility of previously difficult or expensive assets to transfer or trade would benefit the economy, including those owning real estate, private company shares and art or collectibles. These assets can be difficult for individuals and businesses to access due to high entry barriers and transaction costs. By representing them as tokens on a blockchain platform, they can be bought and sold with less friction, making it easy for individuals and businesses to access capital and new investment opportunities.
Tokenization can do more than increase liquidity and accessibility. It can also help develop new economic models and opportunities for monetizing previously untapped assets. Most importantly, tokenization drives economic inclusion. For example, tokenization will one day enable the creation of fractional ownership of all high-value assets including gold or even jet planes, allowing more people to participate in the new economy. Compare the popularity of only a select few US equities available now in fractional shares with a future where all assets can be fractionalized and traded securely in real-time. This expands access to all assets and asset types, providing a new stream of revenue through the sale of tokenized ownership stakes.
Tokenization helps develop new opportunities for monetizing previously untapped assets and most importantly, drives economic inclusion
What enterprises considering tokenization should know
As one might guess, enterprise-level discussions about the value of tokenization are already occurring. Though each enterprise and situation is quite different, there are basic considerations that are relevant in these discussions.
- Revisit your company objectives. Whether your enterprise seeks to increase new customer acquisitions, expand cost savings or better control supply chains, tokenization is one way to help achieve all those goals.
- Learn about the differences in token standards and how each choice impacts your business goals. These standards differ across blockchain or even on the same blockchain – which ultimately makes adoption easier and increases interoperability.
- Understand regulatory requirements and constraints. This understanding is crucial as regulation and compliance are different in all regions and jurisdictions.
- Choose a platform based on these previous considerations. Note that tokenization will require substantial infrastructure and it’s often best to partner with a dedicated service provider who can issue tokens, execute transactions and help safeguard your assets.
One example of a major company seeing the potential for tokenization is Mercado Libre, Latin America’s most popular ecommerce platform with over 170 million users. Mercado Libre chose Paxos to power its crypto offering in its digital wallet, Mercado Pago. They also chose to offer Paxos’ stablecoin, USDP, to give seamless and secure access to the US dollar to their millions of customers.
Tokenization has the potential to facilitate more efficient and secure transactions, as the use of smart contracts can automate the execution of certain terms and conditions, reducing the need for intermediaries and minimizing the risk of fraud or errors. This can be especially beneficial in industries where trust and security are paramount, such as banking, the supply chain and the logistics sector.
Overall, the regulatory challenges and opportunities of implementing tokenization at scale are complex and multifaceted. We must employ a combination of new regulations and traditional industry best practices for tokenization to be adopted safely and effectively. The benefits of tokenization are clear, and it is an exciting area of innovation and growth, but it can reach its full potential only with prudent regulation.
Want to learn more about Paxos’ regulation-first approach to tokenization and how it can transform your business?