How Does Tokenization of Physical Assets Work?

During an interview with International asset management company ARK Invest, billionaire (and world’s richest man) Elon Musk revealed that cryptocurrency offers more security than conventional money. Mr Musk of course needs no introduction: at just 50 he is worth 264.6 billion USD, is the new CEO of Twitter and has more opinions on matters than we ever thought possible. And Musk is verbose on the subject of cryptocurrency. In the interview he said that “tokenization of assets is the future, it is an improved way, far more reliable than a plain piece of paper.” The founder and CEO of Tesla also added that the structure of cryptocurrency is “quite brilliant”.

There is no doubting Musk’s business acumen, and basically, if he believes cryptocurrency is the future then we do too. But we can’t help wondering if we shouldn’t educate ourselves on the worthiness of tokenization of assets, rather than following Musk’s (sometimes erratic) train of thought. Basically, would tokenization benefit its investor, in this case, the wine investor, or would it be lead to challenges that would make you regret your investment?

There are clear advantages and obstacles to the tokenization of assets. Yes, they are the future (we think), yes they are volatile and yes, no one really understands how powerful they really are. We’ve delved a little into the subject so you can make informed decisions and don’t have to rely on Elon Musk next time you get the bitcoins out.

What Is Physical Asset Tokenization?

The creation of Bitcoin by Japanese scientist Satoshi Nakamoto opened the doors to a new world. The decentralized digital currency came on the heels of the economic recession and allowed its users to have an electronic peer-to-peer cash system, comparable to gold. Nakamoto’s creation opened the gateway to a brave new world that could be controlled by technology. It offered new opportunities for investment as well as vast innovation in the management of assets. 

Clearly,  the invention of cryptocurrency transformed the economic world, but the tokenization of assets also played a role in the improvement of this discovery. Put simply(ish), tokenization of assets could be resumed by the process by which an issuer creates digital tokens on a distributed ledger or blockchain, which represent either digital or physical assets. This is where it gets interesting for the passion investor; this new method of wealth management is the guarantee of unchangeable ownership. 

The process of tokenization consists of the use of the issued tokens that can either be transferred, stored or even traded into the digital world. If you are wondering what happens to the physical assets that are given this famous tokenization, you’ll be pleased to know that they still exist in real life and are considered “off-chain”. In fact, the digital tokens that exist on chains carry the rights of the assets they represent. 

For non-financial wizards who might be unfamiliar with the jargon (and that includes us), there are simpler ways to define tokenization of assets which give a much clearer picture. All major airlines offer an air miles scheme for example, supermarkets to offer rewards programmes. Your air miles or your Clubcard points are in fact the embodiment of the tokenization process. The programme converts your points into “rewards”, which you then spend in a virtual way for real-life goods – flights,  groceries, fuel, days out, eating out etc. Digital tokens follow a similar pattern. 

What Are the Benefits of Asset Tokenization?

Which brings us to the real reason we’re here: could tokenizing our wine portfolios be profitable? And if yes, how? 

Traceability and Security

First of all, tokenizing assets guarantees both traceability and security. In addition to immutability, the data in the blockchain is protected by cryptography. Cryptography is used to ensure financial safety for both parties (buyer and seller). This is done by allowing everyone accesses to the data by using a unique verification code. This allows relevant financial information to be stored in complete confidence. Further security can also be found in the fact that the asset’s history is impossible to change, meaning investors are promised complete transparency. Almost every blockchain is an open-source software, allowing any developer, investor or user to view the source. It can be used for various reasons, to see vulnerabilities, to change the source code software or even just for curiosity. 

From a wine investors point of view, blockchain is tantamount. Apart from the obvious financial history of your bottle, the certitude of provenance is a major asset. Additionally, there is the potential for geolocalisation – meaning winemakers can gain a greater understanding of where and when their wines are being enjoyed and can adjust their marketing and export schedules accordingly. 

Increased Liquidity

Tokenizing your assets could also benefit on higher ground, in that it could very rapidly increase the liquidity of an asset, which is surely a good thing for those who want some ready cash. The illiquid asset can speedily metamorphose into a liquid one by the fractional ownership of the asset in question within the parties. This offers a great advantage, as the eventual loss of value incurred with possessing illiquid assets will no longer frighten you. When the proprietorship is divided, the asset becomes tradable on the secondary market, opening up a new market which was hitherto unobtainable. This is essential as it allows a larger number of investors to participate in the development of the ecosystem. 

Lower Minimum Investment

But perhaps tokenisation’s crowning glory is that it is accessible to all. This lower level entry point opens the market to a far younger audience, most likely digital natives who are comfortable with cryptocurrency. While traditional financial investment requires high entry points – we are not all able to invest in Monet’s or Manet’s or villas in the South of France. With the help of tokenization, a doorway into the previously exclusive investment market is now a reality. This is made possible by  tokenization, which lowers the minimum investment threshold, giving small investors the possibility to invest 

Which Assets Can Be Tokenized?

Basically, how long is a piece of string? If you’re wondering to what extent we can tokenize assets, in 2022 the possibilities seem to be endless. With both fractional ownership and proof-of-ownership, every asset under the sun will soon be able to be tokenized. Starting from banal assets such as real estate and commodities and extending to more extravagant possessions such as jewellery, sports teams, fine wine, yachts or even horses. With the speed with which tokenization is evolving one might believe that in a short period of time we will be able to tokenize everything from pencils to Picassos.

Tokenization in Wine Investment

But how does this affect today’s current investment climate? With the arrival of cryptocurrency came NFTs, or non-fungible tokens. 

Non-fungible tokens (NFTs) seem to have exploded out of the ether this year. This new digital asset took the virtual world by storm last year, and it doesn’t show any signs of slowing down. The NFT represents real-world objects that can be bought and sold online and are encoded with the same underlying software as many cryptocurrencies. The art world has taken to NFTs like Banksy to his spray cans – a staggering  $174 million has been spent on NFTs since November 2017.

The fine wine market is moving with the times; Australia’s Penfolds, one of the world’s most respected wine estates, has launched a limited edition NFT tied to its rare Magill Cellar 3 barrel of wine, made from the 2021 vintage, available for purchase for US$130,000. The single barrel NFT will be converted into 300-bottle NFTs at the date of bottling the wine in October 2022 with each bottle being identified with both a barrel and bottle number. So far Penfolds is the only estate to venture into NFTs and cryptocurrency, but depending on their success, others will certainly follow. 

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