Distributed Ledgers Part III: Tokenization of AssetsTags: blockchain, distributed ledgers, tokens
“All things bright and beautiful” Anglican hymn, Cecil Frances Alexander.
I have written two posts already, one on the limitations of the bitcoin blockchain, see here, and one on how distributed ledgers can play a part in clearing and settlements in the capital markets, see here. This post is a natural follow up on the bitcoin blockchain vs distributed ledgers as solutions for the financial services industry narrative.
Readers will no doubt have heard of the term “tokenization of assets” as applied to the bitcoin blockchain. To the best of my understanding, a token – BTC or fraction of BTC, or colored coin, on the blockchain or a side chain attached to the blockchain – represents an asset and who owns the asset. The questions we should ask ourselves are whether a) a blockchain using tokens is the right solution to model real world assets and b) a single blockchain can cover all assets?
Assets are not a homogenous bunch. Let’s look at equities, bonds, dividends, coupons, corporate actions, insurance premiums, insurance claims, derivatives, annuities, a collateral, a lien. First some of these asset classes are heterogenous, e.g. bonds with zero coupon, convertibles, floating rate note… Second each one of these assets brings its own set of complexities – how it is described, how it behaves, which rules it behaves under.
A mere token serving as a representation of the asset is not nearly enough of a solution. How would a colored coin reflect a stock split for example? How would a colored coin represent a convertible bond that is called? Amending a ledger with transactions that reflect new assets or new ownership of an asset needs to be specific at a very granular level. The scripting of a transaction to the ledger needs to accurately represent all the nuances of a specific asset. Having said that I understand that many people use the word token differently depending on context. I am genuinely interested in learning how a “token” could accurately represent a financial asset in all its nuances, and how it could have legal standing, see my previous post in this series on legal challenges.
Let’s suspend disbelief and do away with the basic limitations of bitcoin in the context of the financial services industry. We are still faced with basic technology limitations such as the inability to write complex scripts due to space constraints on a block or transaction level. Common sense dictates specialized distributed ledgers will better address specific assets via specialized algorithms and specialized scripting frameworks.
If a distributed ledger of tokens is not the solution then what is? A Turing-blockchain like Ethereum? A consensus computer? I expect many startups to deliver elements of responses in the next twelve months.