Concept of Tokenization

Tokenization can be seen as the process of creating singular identifier on a distributed ledger in form of a token. This technology is known as Distributed Ledger Technology (DLT) and this provides a new technological paradigm that is unique and is established to digitally represent anything such as financial assets, arts, real estate, supply chain and so on. DLT does not rely on trusted third party’s mediation because it causes delays in the issuance, transferring, and storage of tokens on decentralized platforms. Cryptocurrencies are examples of DLT, in which its transactions are characterized by peer-to-peer transfer of ownership without confirming its legitimacy via a third party. And this is known as “Trustless” in the blockchain industry, and made possible by smart contracts that are code into the blockchain.

Tokenization did not just occur around the same time as cryptocurrency, in fact it has been in existence since the 1970s and was used to safeguard data security in financial services. Also, in terms of safeguarding the security of sensitive and confidential information, such as credit card numbers and financial statements, many conventional businesses have been using tokenization in order to reduce the vulnerability of data hacking.

Types of Assets Tokenization

There two types of tokenization, off-chain and on-chain world. For the off-chain Tokenization, the assets exist in the real world, while the on-chain one is virtual. 

• On-chain Tokenization

The on-chain tokens are native to the blockchain because they are built directly on the chain and are made live on the distributed ledger. Examples of on-chain tokenization (known as “native” tokens) are Bitcoin, other cryptocurrencies and payment tokens. These tokens are generated digitally and are issued to investors (by startup companies) as initial Coin offerings (ICOs) in exchange for funds in order to raise capital.

• Off-chain tokenization

This has to do with a representation of the real-world assets, such as real estates, arts, cars, intellectual properties, commodities such as gold and many more on the Distributed Ledger Technology (DLT) by embedding the economic value of these assets in digital tokens created on the blockchain. So, these tokens exist on the chain and carry the rights of assets they represent. Thereby acting as a store of value. The real world or physical assets are placed in custody to ensure that the tokens are constantly backed by these assets. It is important that for the continual custody of these assets, there is a need consistent communication between the off-chain (traditional financial infrastructure) and the on-chain platform. One example was in Real Estate. A development project (luxury condo) that was worth $30 million in Manhattan was tokenized on the Ethereum blockchain in 2018. The aim was for the investors to buy the digital tokens, thereby raising funds to finance the project. This is supposed to automatically give the investors right to the underlying revenue pool of the property.

Benefits of Tokenizing Payment Card Industry

• Through tokenization, the processing of accepting payments is made easier and more secure. The security technology behind tokenization is now being applied to secure in-store point of sale acceptance to payments on-the-go. Ecommerce is now transitioning from the traditional payment methods to a new generation of in-app payments, through devices and it is very safe and easy. This makes sense especially with the fact that MasterCard, the credit card company has applied tokenization to digital ecommerce marketplace. The first network to add tokenization support for private label (store branded) credit cards was Mastercard. And the first retail companies to participate were BJ’s wholesale club, JCPenney and Kohl’s.

• Tokenization reduces the risks of data breaches. Data breaches could be a real issue especially when customer data is stolen. With tokenization, the risks of data breaches are drastically reduced. Here, cryptographic is used to convert the original data into tokens. This makes it hard to recreate the original data without gaining access to the tokenization system’s resources. Many criminal hackers target businesses that accept credit and debit cards. These stolen cards that contain a wealth of intelligence in payment information are the sold or used to make fraudulent purchases. Tokenization systems are validated using security best practices applicable to sensitive data protection, audit, secure storage, authentication and authorization. Tokenization can reduce the financial fallout from any potential breach, but it cannot totally protect a business from a data breach.

• Tokenization help reduce red tape for businesses: Especially when it comes to maintaining industry regulations, such as complying with the Payment Card Industry Data Security Standard (PCI DSS). PCI DSS ensures that the retention of customers’ sensitive data by businesses is reduced by safeguarding the storage of these data and proper deletion.  What Tokenization does here is to never let cardholder information touch the systems of businesses by replacing it with tokens and encrypting original data.

• Tokenization drives payment innovations: using tokenization technology as we have seen makes payments these days faster, convenient, easier, on the go and more secure. We are gradually stepping away from the usual secure in-store point of sale acceptance to payments on the go, from traditional ecommerce to a new generation of in-app payments, such as paying with mobile devices. Tokenization has given birth to mobile wallets which make payments much easier, such as apple pay, Samsung pay, Google pay, Android pay. All these mobile wallets use tokenization to protect transactions. The process is very easy and secure. When using apple pay for instance, your personal credit or debit card information is uploaded, then your data is sent by Apple to your card’s network. Your card data is then replaced with a token, which is then sent back to your mobile wallet to be used to make transactions.

Disadvantages of tokenization

• The technology of business tokenization has not yet been accepted or adopted worldwide, so there is lack of uniform standards and legal infrastructure around the globe. Lack of uniform standards and legal framework of business tokenization and its associated processes round the globe has given rise all sorts of scams. So, businesses are extremely careful to venture into tokenization so as to avoid possible legal pitfalls.

• Another very important disadvantage of tokenization is that, using tokens requires one key. Json web token only uses one key. In this case, the services of an expert developer are needed and the business must apply powerful security procedures to provide the greatest degree of security in order not to jeopardize sensitive information of clients.

• Thirdly, tokenization uses blockchain technology and blockchain employs asymmetric cryptography to provide consumers with ownership of their cryptocurrency units. Every blockchain has an address and every address has a private key. Consumers need their private keys to access their assets, and if the private is misplaced, the individual can lose all their money or digital assets.

In conclusion, although business tokenization is very useful, in that it creates new investment opportunities for varying projects, it has its drawbacks. Its drawbacks are related to lack of adoption, global recognition, loss of keys could lead to permanent loss and legal infrastructure not put in place round the globe.