Everything You Need to Know about Tokenization in Crypto

Authored by Makara
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Makara

Published November 3, 20214 mins
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There’s a lot of tokenization in the crypto world, and that’s because the word "token" can mean a lot of things. NFTs, for example—those one-of-a-kind digital assets that people with way too much money seem to enjoy collecting—are tokens. Real estate tokens allow companies to raise capital for projects (and allow investors, whether they have a lot of money or a little, to be a part of those projects). It’s a broad category, so we’ll just put it this way: A token is anything that represents something else, and in crypto it allows nearly any asset, from bars of gold to stocks to Kings of Leon albums, to become tradable and traceable on a blockchain. 

While lots of things can be tokens, it’s important to point out one thing that cannot: cryptocurrencies. Many people use the terms interchangeably, but that’s a mistake. A cryptocurrency is issued by its own blockchain, and its value is based on how that particular blockchain operates. For instance, Bitcoin (BTC) exists on the Bitcoin blockchain. Much of its value comes from the amount of BTC that’s been mined, the way it’s mined, and the speed at which it’s mined. It’s the same with Litecoin, and Terra, and so on. A token, however, is built on top of a preexisting blockchain.

On the blockchain, a token is defined by an algorithm that gives it a specific set of qualities. That may include how the token can be spent and what it is worth. But it also may include the rights that the token gives whoever possesses it, whether that’s ownership over something tangible (like in the real estate example above or a physical artwork) or intangible (like Paris Hilton’s NFT drawing of her cat). It can also give you the ability to vote on, say, what a DeFi app develops next. To help make sense of all the options, here’s a closer look at the tokenization categories you should be most familiar with.

NFTs

By now you’ve heard of NFTs. (We’ve mentioned them twice in this post already.) Unlike other tokens, NFTs are one-of-a-kind or at least super scarce—a single image of a Bored Ape or some rare album artwork nobody else has access to. Their value comes from their uniqueness.

Tokenized Securities

These are traditional securities (like stocks or bonds) that exist on a blockchain. In that state, along with benefiting from the added security and decentralization of the blockchain, they also can be easily subdivided to allow access to smaller investors. So if you wanted to invest in Amazon but can’t afford the single-share price of more than $3,000, you could buy only a fraction instead. Tokenizing securities also expands the stock market beyond the traditional financial world and into the 24/7 crypto trading space, which is available to anyone in any part of the world. 

Security Tokens

These are similar to tokenized securities in that they tend to represent fractional ownership of an asset—like a share in a company or a real-estate investment—boosted by all the benefits of existing on the blockchain. But security tokens have bonus benefits: They can be programmed via smart contracts to do unique things that traditional securities can’t, offering unique automatic payouts or built-in compliance with regulations. 

Asset-Backed Tokens

These tokens essentially represent some degree of ownership over a tangible asset that actually exists in the real world. For instance, PAXGold is backed by physical gold stored in vaults in London. Its value is linked to the traditional gold market, but it operates on the blockchain. Tokenizing something like physical gold makes investing in the gold market far easier. Gold is difficult to divide—and its markets are only open at certain times of the day. By tokenizing it, however, you can trade 24 hours a day—while still being able to redeem PAXGold for actual gold bullion, if you want.

Utility Tokens

These tokens are not inherently concerned with making a profit (though that doesn’t stop people from trying). They get their value by giving someone access to a network, product, or service that they couldn’t otherwise get, or by giving them certain rights within a network or an app, like voting on its future. 

Why You Would Invest in Different Types of Tokens

There are multiple reasons to invest in a particular type of token. Sometimes it’s straightforward: You want a shot at profiting off of a security token or a securitized token. Maybe you love that ape NFT—and maybe think it could be worth even more someday. Or you just want the privileges that a utility token offers. People also invest in, say, utility tokens because they believe that the ecosystem they exist in will become more popular. Which could make it more valuable over time—and, eventually, worth selling.