What It Takes To Tokenize the World
A look at how tokenization will change the stablecoin ecosystem
In this Stabilize Money, Stabilize the World series, we have explained why we need a new monetary system and why it needs to be able to import the inflation resistance of hard assets into a useful, fungible stablecoin. But to achieve this grand objective, we need to tokenize real-world assets. Despite the challenges ahead, Reserve, the protocol for launching asset-backed stablecoins, believes this future is possible.
Part 1: What’s broken
Why unstable money isn’t safe for the world and how to understand monetary policy
Part 2: What are people doing today about it?
A dive deep into the types of monetary policy alternatives that stablecoins offer
Part 3: What is the right way forward?
A guide to the various inflation hedging tactics and how they can be used in stablecoins
Part 4: What will the future look like?
A look at how tokenization will change the stablecoin ecosystem
About our sponsor: Reserve
A video explaining the Reserve Protocol
Assets like carbon credits and real estate are already moving on-chain. Even car loans now exist on the blockchain. As this ecosystem matures and finds some regulatory harmony, these tokens may provide the portability and stability needed in backing stablecoins that can retain greater purchasing power than fiat currency.
But this technology has central points of failure. Like fiat-based stablecoins, tokenized assets need a third-party intermediary to guarantee one-to-one backing and price equivalence. For example, the Venezualen government attempted to create an oil-backed currency called the Petro. But it failed to match the price of oil because the government had no redemption policy or market mechanism that would allow them to maintain a peg.
Despite these obstacles, the number of innovative solutions is endless — from using Chainlink price oracles to make synthetic assets, to tokenizing fractional ownership of real assets, and even issuing tokenized securities and treasuries. The number of potential approaches makes predicting the future of asset-backed stablecoins hard to predict.
The future can go one of two ways. In this article, we will explore the different approaches to tokenization and how they could fit into a monetary system of asset-backed stablecoins.
The real estate market is an industry primed for tokenization. Historically, buying real estate is one of the best financial decisions anyone can make. The problem is that rising house prices have outpaced wages and subsequently put buying a house out of reach for many people across age and demographic spectrums.
Tokenized real estate can allow people to own a share of a piece of real estate for as little as $1. As the price of that piece of real estate rises and falls, owners of the token are free to buy and sell as they please. A buyer may even, overtime and on their own schedule, purchase all the shares of a home and own it outright.
There is, however, a downside to this. It can further exacerbate the over-financialization of the real estate market by inviting more speculation from both retail and institutions. It is still in a nascent stage, so it could prove the opposite by providing greater price discovery.
How it works
Fractional ownership and synthetic assets are two popular approaches to real estate tokenization. In the first approach, companies like RealT fractionalize property entities into tokens on the Ethereum blockchain. Those tokens then entitle the owner to a share in revenue generated from that property. The fractionalization requires a formal legal process that employs a property manager to maintain properties on behalf of investors. They are responsible for finding tenants, collecting rent and paying the investors.
Synthetic assets, on the other hand, have no real world collateral backing. Platforms like Synthetix combine decentralized price oracles like ChainLink with a system of overcollateralization to imitate the value of physical products on digital exchanges. Even though the collateralization is different, protocols like Parcl use their secure price feeds to track the real world value of real estate.
Pros and cons
Fractional ownership and synthetic assets have their advantages and disadvantages when it comes to their utility as stablecoin collateral. Fractionalized ownership requires more counterparty risk. And if a stablecoin commits to using these assets in a portion of the collateral basket, the stablecoin issuer needs to rely on companies like RealT to enforce contracts between multiple parties.
Synthetic assets have less counterparty risk; however, they are not backed by hard assets and have their own set of smart contract and platform incentive challenges. Synthetic assets use yield farming incentive mechanisms and gamification to provide stabilized value. These assets may work well in bull markets because there is less sell pressure on the crypto being used as collateral. In bear markets, liquidity providers face greater risk of liquidation and possibly impermanent loss. So if platforms become illiquid, their synthetic assets may lose value.
Another example of real estate assets might also include land in the metaverse. Similar to synthetic assets, and the 1990s explosion of dot-com real estate valuations, metaverse land value would be inherent to incentive mechanisms and network effects of the digital world they inhabit. A big unknown is the price stability of metaverse land in the future.
If price speculation is the fundamental force driving demand of a tokenized asset, then it will pose greater risk to stablecoins. Ideally, the issuer of an asset backed stablecoin would be able to collateralize tokens that have ample liquidity and direct utility in the real world. Tokenized energy may offer the best of both worlds.
Gas and energy has proven to be one of the greatest inflationary hedges post-pandemic lockdowns. As of Nov. 18, 2022, the United States Brent Oil Fund LP (BNO) is up 36% over one year. In comparison, the Nasdaq Index 100 (NDX), is down 29%.
This inverse relationship to the stock market could provide great stability to a basket of diverse assets. But as previous attempts such as Venezuela’s oil backed Petro has shown, tokenizing oil is very difficult. The market is more restricted than gold and real estate.
Tokenized energy could offer a more portable alternative that not only offers an inflationary hedge, but also incentivizes green energy. Powerledger.io is working on a way to tokenize green energy into granular credits that can be exchanged across the energy grid. For example, someone with a private solar panel would earn these credits for contributing green energy to the power grid. In return, the owner could use the credits to pay for their own energy usage and then sell any excess tokens back to the grid or another exchange.
If the energy grid was properly decentralized across many public and private energy producers, this type of tokenization could offer the least counterparty risk to any of the alternatives. However, in a future where energy is monopolized, this type of tokenization could provide centralization risks.
For a stablecoin to capture the inflationary hedge of a diverse investment strategy like the dragon portfolio, it needs access to tokenized assets like securities, bonds and loans. All of these require centralized issuing mechanisms like fiat-backed stablecoins and tokenized commodities, but they vary in their degree of centralization and risk.
Tokenized securities and Treasurys
Tokenized securities, for example, are dependent on companies using them to raise funds. And unlike ICOs, they are done in a regulatory environment. A few popular security token platforms are INX and Oasis Pro Markets. Companies can use these platforms to access liquidity and raise funds in a similar way to how they issue shares in a public offering.
The risks associated with the investment are similar to purchasing shares from a stock exchange.
In addition to tokenized securities, companies like Backed Finance have started tokenizing Treasurys. Their approach does add risk because they tokenize the Treasurys through purchasing them and promising to hold a one-to-one backing. The tokens are only sold to participants who pass full know-your-customer (KYC) and anti-money laundering (ALM) checks and will have the ability to mint and redeem token securities for the underlying asset. Backed’s method of tokenization enables an asset-backed stablecoin protocol to allocate a portion of its collateral to short-term bonds.
In addition, Frigg.eco is tokenizing green bonds. They also require KYC/AML for purchases and have created the ability to buy and sell tokens in a liquid secondary market. They are working with Norwegian-government-backed developer Malthe Winje to refinance the Agatobwe hydroelectric plant in Rwanda, with debt on Ethereum.
Real-world credit can also be tokenized through lending platforms such as Goldfinch and TrueFi. These platforms can offer access to yields from real companies that are vetted at rates meaningfully higher than in core DeFi. This could offer yields uncorrelated with the crypto industry and potentially offer the fixed income needed to make up a dragon portfolio.
Property, energy, Treasurys, securities and credit are a few of the possibilities that could complement core DeFi assets in diversified, asset-backed stablecoins.
While the tokenization of global assets is only beginning, the potential to return safe asset backing to the global monetary system is promising.
In a future where stable currencies compete in the open market, participants will be able to choose their preferred monetary policy regime. The future could host lots of different stablecoins, pegged to dollars, euros or an index like the CPI or the S&P, with unique features targeting different “jobs to be done” and maybe eventually a global reserve currency that retains its value indefinitely and isn’t too volatile.
The permissionless Reserve Protocol enables this asset-backed currency revolution, for idealists, heroes and capitalists.
This content is sponsored by Reserve