What Is Tokenization In Blockchain Technology? - The Ultimate Guide
By Nerly Shammah Dec 11, 2022
The expansion of the digital economy by blockchain technology has brought light to diverse tech structures, tools, and algorithms. Tokenization happens to be one of them as it serves as a pillar to major programs of this ecosystem.
What Is A Token?
A token is a crypto asset whose transaction records are stored and protected by blockchain technology. A token value is defined, as such, it can be used to settle financial contracts on the distributed ledger.
What Is Tokenization In Blockchain?
Tokenization in blockchain refers to the process of assigning a known value to given data or asset. The tokenization of these digital items allows them to be fully leveraged with all features of blockchain technology.
Crypto assets are tokenized assets, each representing unique data or rights, like in the case of governance rights in decentralized finance, tokenization allows the blockchain to bundle up what would naturally be too data-extensive and possibly "centralized" into what can be flexibly utilized within a network and cross-platform.
Tokenized assets are simply called Tokens, all crypto assets are generally considered a token because each represents a data set or right. Though the complications come in when coins are brought up against tokens, two are only different from a few network usage.
Bitcoin is an example of a tokenized asset just as Ether of the Ethereum blockchain is, but the difference between the two crypto assets is in how both are used differently, Ether possesses network governance rights while Bitcoin does not, this can be explored deeply by understanding bitcoin mining and how it differs from proof of stake blockchains, a consensus mechanism recently adopted by Ethereum that enables Ether to attain governance influence on the network.
How Does Tokenization Work?
The process of tokenization differs depending on the network in use. For example, tokenizing an asset on the Ethereum blockchain would require choosing if the asset will be an ERC-20 token or an ERC-721 contract token. The end product is having a newly created crypto asset that is protected by the cryptographic algorithm of the network in use.
A token in a blockchain is created using a cryptographic hash function and these algorithms differ from blockchain to blockchain. When an asset is tokenized with blockchain technology, it generally allows it to be utilized more flexibly, and have more advanced products deployed over it.
What are the advantages of tokenization in blockchain?
With the knowledge of blockchain technology, one can easily identify the merits of tokenization, however, the following are advantages of tokenization in blockchain technology:
Data Security: Tokenization is majorly utilized as a means of security, similar to encryptions but different given that encryptions change the initial length or size of data.
Flexibility: Tokenization enhances operations within a system. It is rather easy to move tokenized data than it is to move raw data. To be more precise, the facilitation of cross-border payments is highly rigid because the system lacks the merits and build-ups of blockchain-based tokenized assets. Assets managed by the distributed ledger can easily be moved from one location to the other without the need for an intermediary.
Efficiency: Generally, blockchain-based products are considered highly efficient given the lack of a central point of failure. The blockchain is able to manage data in quite an efficient fashion as long as people are willing to participate. Tokenized assets benefit from this and are frankly why building on the blockchain is becoming a nationwide urgency.
Incentive: tokenized assets can yield incentives, depending on the initial design, taking points from decentralized finance, the large attention that has been given to it has been because of the tokenized assets dominating the space and incentivizing individuals to participate.
With this, blockchain becomes a more powerful technology and positions itself to redefine Fintech.
Types Of Tokenization In Blockchain Technology
The following are the types of tokenization options present in blockchain technology:
- Fungible Tokenization
- Non-Fungible Tokenization
These are commonly called "Fungible Tokens" and represent tokenized assets that can be exchanged for another with both sharing the same value. Examples of fungible assets are:
Utility Tokens: a typical crypto asset that can be used to derive value from a network. Sometimes a discount on sales or a cashback for simply holding the token.
Frankly, Utility is much bigger than that, in decentralized finance, many tokens are utility tokens as they can be used to extract value from the platform either through liquidity mining or joining a lock-up vault( a typical smart contract that locks up tokens for a period of time and pays the participants for contributing to sustaining the platform).
Reward Tokens: Reward tokens are used in gamification. It is a kind of replacement to "point systems" where people are rewarded for perhaps completing a certain task. A lot of Gamified assets or rewards tokens are present on Hive blog, a decentralized social platform. A notable example is the POSH token, a gamified asset that rewards you for simply sharing a link on Twitter.
Although not many people are aware, Bitcoin is somewhat a reward token, not a utility token or a governance token. Miners are rewarded in Bitcoin for completing a task, that is finding the target hash to verify a block of transactions created.
Governance Tokens: As the name implies, governance tokens are leveraged to govern an ecosystem. Crypto projects are largely governed by their governance tokens, oftentimes called "native tokens or currencies". The process includes using various consensus mechanisms like Proof of Stake(PoS) and Delegated Proof of Stake(DPoS). Hive is an example of a Fungible token that is a governance token on the Hive blockchain. 1 Hive can be easily exchanged for another 1 Hive, like exchanging $1 for another $1 maybe because the paper note isn't clean? The value doesn't change, but they are interchangeable.
Hive as a governance token is leveraged via Delegated Proof of Stake consensus algorithm to govern the network.
Fun Fact: On the Ethereum blockchain, Fungible Tokens are identified as ERC-20 tokens, the token contract for Fungible Tokens on the world's first smart contracts compatible chain.
Mining Tokens: Mining tokens are simply tokenized assets that can create other tokenized assets, often themselves than others. This is seen much in DeFi single-staking pools. The fun fact about mining tokens is that they can be Fungible or Non-fungible.
Non-fungible tokenization involves creating tokens that cannot be replicated or counterfeited. These classes of crypto assets are commonly called NFTs which is an acronym for Non-fungible Tokens.
Non-fungible Tokens can typically do a lot of things, they can be utilized for network governance and mining fungible tokens. NFTs are ERC-721 token contracts on the Ethereum blockchain and have exploded in utility in blockchain games and Metaverse projects.
It is speculated to be a revolutionary asset class that will aid a lot of businesses retain brand uniqueness and also serve as a means of content monetization. The nature of NFTs allows them to be vastly used in many business fields, industry comments believe it can help limit product infringements across all business markets.
Is Tokenization Limited To Blockchain Technology?
No, tokenization actually began in the legacy system as a means of securing transactions. More specifically, tokenization was leveraged from way back in 1970 in the payment card industry to draw and secure user information in a separate database. As time went on, it was redesigned to fit more into the system and avoid data breaches by ensuring that user information is not stored on a retailer's terminal or database.
Then came blockchain tokenization which not only increases security but also ensures that every centralizing factor to data movement is removed. Tokenization is speculated to be the new front line for business building, given the flexibility and ease to build, integrate with whatever, and even deploy incentivization in the process.