The Process and Challenges of Asset Tokenisation

Every asset tokenisation process is unique and comes with its opportunities, challenges, and risks depending on the type of asset, jurisdiction, and more. Nevertheless, every asset tokenisation process consists of the same 3 phases. This article outlines these 3 phases, the main activities in each of these phases, and the various considerations for each of these phases and will also consider the potential disadvantages and risks associated with transforming physical assets into digital tokens. 

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The articles in this series are extracts from the E-book: Asset Tokenisation unpacked, Now available for download.

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The 3 phases in every tokenisation process can be summarised as follows:

• Pre-tokenisation: The initial phase involving asset evaluation, ownership verification, legal due diligence, and strategic preparations for entering the digital realm.
• Tokenisation: The conversion stage where a digital twin of the asset is created, relevant information is encoded onto the blockchain, and digital tokens are minted.
• Post-tokenisation: The final phase that encompasses the distribution and management of tokens alongside the perpetual management of the underlying asset and digital asset.

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Pre-tokenisation

This phase grounds the tokenisation process in a secure legal and practical foundation, ensuring that all real-world considerations are addressed systematically.

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Key activities

• Asset valuation: Conducting appraisals to determine the market worth of the asset.
• Ownership verification: Collecting and verifying all documentation to proof ownership rights of the asset.
• Legal footwork: Performing research on the legal side to futureproof the tokenised asset against potential disputes or liquidations. This can also help identify potential deal breakers early on. Additionally, part of this step is assessing which legal structure fits best with the situation, considering the asset type, jurisdiction, etc.
• Process implementation: Outlining vital management procedures for the asset’s physical (or digital) care, such as maintenance and insurance strategies.
• Tokenisation partner: Researching and selecting the right tokenisation provider or platform is an important step before proceeding to the tokenisation phase. Less experienced asset holders will benefit from working with tokenisation providers whereas more experienced asset holders enjoy cost reductions by working together with tokenisation platforms directly.

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Tokenisation

Transition from the tangible to the digital is the essence of this phase, as the asset becomes encoded and represented within the blockchain environment.

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Key activities

• Token creation: Mint tokens that encapsulate the asset’s value and the rights of token holders.
• Data integration: Incorporate core and static asset data and use oracles as necessary to connect external dynamic data sources to the tokenised asset, guaranteeing up-to-date information flow.
• Legal structure: Set up the legal structure of your tokenised asset. The legal structure of a tokenisation process can be done in multiple ways. One of the most common ways is creating an entity which will hold the asset getting tokenised, after which ownership of this entity is tokenised.

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Post-tokenisation

The essence of this phase is the perpetuation and monetization phase, where tokens gain liquidity and the asset is managed both tangibly and digitally.

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Key activities

• Token distribution: Employ targeted strategies to introduce the tokens to the market, leaning on niche exchanges or bespoke marketplaces for visibility.
• Asset oversight: Carry out the previously made strategy for physical asset management, ensuring alignment between the token's promise and the asset's condition.
• Token management: Administer the flow of information to token holders and manage the tokens' lifecycle, including updates to ownership and stakeholder rights.

While the benefits of tokenising real-world assets are numerous, it's essential to acknowledge that the introduction of any ground-breaking technology comes with its own set of challenges. Tokenisation is no exception. 

The most prominent challenges and disadvantages can be summarised as follows:

• Fragmentation
• Regulatory uncertainty
• Technical complexity
• Counterparty risk

Let’s take a deeper look at each of these.

Fragmentation

The process of fractionalisation, while broadening access to asset investment, inherently leads to the dispersion of ownership. This diffusion can complicate consensus-building among stakeholders, especially when it comes to decisions on asset management, disposal, or restructuring. With an increased number of voices and interests at play, the risk of conflicts and deadlock scenarios rises, potentially impacting the asset's strategic direction and, ultimately, its market value.

Fragmentation can also translate into complexities in asset management. The underlying asset—be it real estate, art, or intellectual property—might require more elaborate governance structures to accommodate the multitude of shareholders. These structures will need to be transparent, fair, and efficient in managing the diverse expectations and rights of token holders.

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Regulatory uncertainty

Tokenisation exists at the intersection of technology and financial regulation—a sphere fraught with grey zones. Stakeholders may find themselves parsing through an array of national and international directives to decipher applicable laws, leading to ambiguities in compliance and increased due diligence costs.

Given the pace at which regulations can change, especially in a field as dynamic as digital assets, companies and investors must stay nimble to adapt to new legal frameworks. The possibility of stringent future regulations looms as a threat, potentially imposing additional compliance burdens and altering the tokenisation landscape.

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Technical complexity

Tokenisation platforms, while groundbreaking, present a considerable learning curve that could deter asset owners unfamiliar with blockchain technology. The intricacy of deploying smart contracts, ensuring interoperability between blockchains, and safeguarding digital assets requires a degree of technical literacy that many potential users may lack.

Insufficient technical knowledge can have severe repercussions, including the risk of flawed smart contract code. Poorly executed code is not only a beacon for malicious activities—such as hacking and fraud—but can also result in substantial financial losses. Additionally, token holders may lack the cybersecurity savvy needed to protect themselves against novel forms of scams and phishing attacks that target digital wallets and exchanges.

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Counterparty risk

While tokenisation can reduce the need for intermediaries, it can also create new forms of counterparty risk. As is the case with any type of marketplace or exchange, if the tokens are held on that marketplace or exchange, you do not control the funds yourself. If one of these exchanges goes bankrupt or gets hacked, it can become difficult to recover the investments on that marketplace or exchange.

While this can of course be mitigated by taking the tokens out of the platform, history has shown that many people still prefer the convenience of keeping their tokens on an exchange, despite the possible risks. Furthermore, if organisations want to manage their tokenised assets themselves they might require specific roles and functions to manage the relevant wallets which hold the tokens.