October 12, 2018
Digitization and Tokenization with the BitShares Blockchain
How to make anything tradable on the BitShares Decentralized Exchange?
In this document, we describe how any asset can be made tradable on BitShares – may it have a physical representation such as Gold bullions and air miles, or merely exist in digital form, such as crypto-currencies like Bitcoin (BTC) or Ethereum (ETH). Since the actual form is irrelevant, the term tokenization was established. It describes how any tangible or intangible asset (including commodities) could be transformed to a fungible token. Said token could be some kind of certificate in the real world, or be represented digitally on a blockchain. Special consideration might be required to conduct a legally binding asset tokenization.
Tokenization of assets
- Intangible assets exist only due to a assumption made by law and there is no physical object. Examples of intangible assets include patents, carbon credits, brand names, copyrights, etc. Clearly, they lack a physical form and can be trivially tokenized on digital blockchain-based systems.
- Tangible assets are assets that have a physical form. This includes:
> Fixed assets that are not interchangeable such as immobile machinery, buildings and real estate;
> Current assets that are either distinguishable (such as any type of mobile inventory) or indistinguishable in each unit (commonly called commodity, such as raw materials) or primary agricultural products of which each unit is interchangeable, e.g. gold, oil or coffee.
In the process of tokenization, a fungible token is created that represents any type of asset. Fungible means that each token of the same asset is indistinguishable, i.e. the owner of the token does not need to make sure which exact token he owns. As a real world example think of wheat, gold or water.
Fungible assets are trivial to tokenize because the general set of tokens are linked to a general set of interchangeable asset components (e.g. a gram of gold, or one litre of water). This property makes them enumerable and enables an easy tokenized representation.
Assets that aren’t fungible require an abstraction layer in order to be tokenized. For example, think of a warehouse full of unique works of art. A company could bundle all assets together and tokenize them as a package, i.e. every token would represent X% of the whole package in some sense.
Transfers of ownership vs. transfer of limited rights
There are many kinds of transfers of assets and many types of asset rights. Sometimes only limited rights connected to an asset are transferred, such as a lease to use land for a limited time, rather than a transfer of land ownership. Thousands of years of property ownership has led to a wide variety of types of ownership and control, such as holding property on behalf of another person (“bailment”). The details depend on the jurisdiction, type of law (common law vs. civil law), asset, and the rights intended to be transferred. In consequence, tokenization can generally be divided into those that involve tokenizing limited rights (such as music licensing), and those that involve tokenizing full ownership (such as selling real estate). In both ways, the tokens represent some form of real-world item(s).
Example: Music rights are intangible assets that can be licensed out to millions of people at once. When a customer “buys” a song from iTunes, they’re not gaining ownership over the song (a change in ownership) but are merely granted a license to listen to the music, under certain conditions.
Legal framework of tokenization
Anyone can create tokens and make any promises about them, but very few will go through the effort to make legally binding agreements. This includes identifying and designing the required legal framework behind it to harden the tokens such that they withstand in the court of law as proof of ownership of whatever the token represents. An asset should not be tokenized if there is no tokenizable legal contract behind it. The most well-known contract for this is a custody agreement.
In case of a custody agreement, tokens have value since there is legal binding in place that they can be redeemed for the underlying assets that are held in custody by a third party (the custodian).
Obviously, the total amount of tokens in existence should represent exactly the asset(s) held in custody to guarantee that every token holder can redeem the represented value. However, in the real world, there are often exceptions when it comes to upholding said guarantee. Gold bars are stolen, houses burn down, commodities fail to be delivered, and, most importantly, humans sometimes do not obey the rules. Therefore, the key challenge for any system that involves tokenizing real-world assets is to ensure that the token stays linked to the real-world asset.
Digitization of tokens
The realization of digitization and tokenization of an asset requires to answer the question how one can actually hold a digital token, i.e. proof ownership of said digital token. In general, the blockchain technology allows for this proof of ownership by using cryptographic algorithms and public/private key pairs. The question that remains is how to initially purchase those digital tokens.
The central authority that creates the tokens is the one that puts it on a legal framework where it is bound to the underlying asset. Any blockchain technology could be used, and this document emphasizes why the BitShares Blockchain is especially suitable for that endevor.
Some blockchain technologies not only come with one crypto-token, like BTC on Bitcoin, but allow to set up custom tokens that merely use the blockchain to track account balances. A business that wants to outsource the accounting of above mentioned assets to a blockchain, needs to be in full control of the corresponding token on the blockchain (e.g. to be able to create, issue, re-issue and destroy them).
Example: tokenization of physical gold
For instance, someone may want to tokenize a single Gold bullion and create 100 units out of it, each representing 1% of the entire Gold bullion. First, a token needs to be created, with a maximum supply of 100 units. These units can then be transferred on the blockchain from the creator (the issuer) to anyone else on the blockchain.
Example: tokenization of deposit receipts
In this example, the asset that is to be tokenized is a FIAT currency such as U.S. Dollar or Euro. Instead of representing a percentage of the underlying asset with one token like with the previous physical Gold example, 1 unit of the underlying asset is now represented with 1 unit of the digital token on the blockchain. This means that for every U.S. Dollar that a customer sends to the businesses’ bank account, one unit of the digital token is given to the customer on the blockchain.
Those tokens can serve as deposit receipts. In essence, a deposit receipt has the same look and feel as a custody agreement but comes with different legal implications. Either way, the tokenized deposit receipts change hands and the new owner may eventually wish to redeem the corresponding amount of the underlying asset. Thus, the tokens are used to claim the real item or parts of it through a withdrawal procedure. Obviously, the amount of funds in custody by the business should be equivalent with the sum of tokens handed out to customers, otherwise, the custodian would run a fractional reserve.
It is left up to the reader as an exercise to apply this setup to digital assets like crypto-currencies, such as the Bitcoin (BTC).
Example: tokenization for exchanges
An exchange is a service that allows its customers to trade different kinds of assets and goods. In order for the exchange to be able to deliver after a trade has taken place, customers are usually required to deposit funds prior to being allowed to trade.
After the funds have been deposited, the exchange tracks the deposit accordingly by means of deposit receipts that are stored in databases internally. The accounting system ensures that when clients trade with each other, the seller is debited and the buyer is credited the assets in question, while the seller is credited the corresponding amount of value by the buyer. The accounting system ensures that the totals are kept in balance. Each user can naturally have multiple different amounts of different assets.
Many existing blockchain technologies already deliver an accounting system such that users can have accounts/addresses which can then hold multiple units of different tokens independently. The blockchain ensures that the balance sheets are kept consistent whenever users make transfers or trade with each other.
That said, an exchange could instead of tracking deposits via an internal database, also track deposits by means of tokens. These tokens still serve as deposit receipt and correspond to a custody agreement. Hence, the tokens are custodian-specific.
In this case, an exchange would merely operate as – what is called – a gateway and operates deposits and withdrawals, only. The order book management and order matching can be performed autonomously by the blockchain. Of course, the exchange can still dictate fees for withdrawals and deposits but can also ask for a percentage on trading volume of its gateway token (such as for Bitcoin). This means that an exchange outsources the resource intensive orderbook management and matching to the blockchain while it is still earning revenue from the trading corresponding volume.
The BitShares Blockchain
- Multi-token accounting system;
- 1.5 second (average) confirmation time;
- Named accounts (instead of error-prone addresses);
- Option for sophisticated account access control;
- Encrypted memos for transfers;
- Order book management (place sell, and buy limit orders);
- Autonomous and transparent order matching;
- Most reliable and proven distributed governance system;
- Extensibility through approval voting;
- Developer community with comprehensive knowledge and budget through workers, and ongoing improvement efforts therewith;
- Global community that assists with bootstrapping markets;
- Already deployed and proven to run reliably since 2014;
- Block producers already exist and are paid by the BitShares Blockchain;
- Proven economics around the BTS core token and BitAssets like bitCNY (a price stable cryptocurrency);
- Existing infrastructure with access nodes and block producers already deployed all around the world;
- Developed and deployed, as well as projected businesses that bring synergy. For example, direct benefit of any and all marketing efforts, or growing jointly by having the same user base.
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