Tokenization

A token is a representation of an object. We use tokens in many different fields, including economics and computing. In daily life, tokens have been used to represent something of value, such as a gift voucher that is redeemable in exchange for items. In computing, different types of tokens are used, which can be defined as objects that represent eligibility to perform some operation. For example, an access token is used to identify a user and its privileges on a computer system. A hardware security token is used in computer systems to provide a means to authenticate a user (verify their identity) to a computer system. Tokens are also used in computer security mechanisms to substitute sensitive data with non-sensitive equivalents to prevent direct access to sensitive information. For example, in mobile payment systems, tokens are used to safeguard credit card information, which is represented by a token on the mobile device instead of the actual credit card data...

Tokenization on a blockchain

Tokenization, in the context of blockchain, is the process of representing an asset digitally on a blockchain. It can be used to represent commodities, real estate, ownership of art, currency, or anything else of value.

Remember, for the rest of the chapter when we refer to tokenization, it is in the context of blockchain.

After this brief definition, let's explore how tokenization can be beneficial.

Advantages of tokenization

Tokenization provides several benefits, including faster transaction processing, flexibility, low cost, decentralization, security, and transparency. The following are some of the most important of these benefits:

• Faster transaction processing: As transactions and all relevant parties are present on the blockchain and readily available, there is no need to wait for a response from a counterparty or to wait for clearing and settlement operations. All these operations can be performed...

Types of tokens

With the rapid development of blockchain technology and the related applications, there has been a tremendous increase in the development of various types of token and relevant ecosystems. First, let's clarify the difference between a coin and token. Is a Bitcoin a token? Or are tokens and coins the same thing?

A coin is a native token of a blockchain. It is the default cryptocurrency of the blockchain on which it runs. Common examples of such a token are Bitcoin and ether. Both of these tokens or coins have their own native blockchain on which they run: the Bitcoin blockchain and the Ethereum blockchain.

On the other hand, a token is a representation of an asset that runs on top of a blockchain. For example, Ethereum not only has its own ether cryptocurrency as a native token (or coin) but also has thousands of other tokens that are built on top of Ethereum for different applications. Thanks to its support of smart contracts, Ethereum has become a platform...

Process of tokenization

In this section, we'll present the process of tokenization, discuss what can be tokenized, and provide a basic example of the tokenization of assets.

Almost any asset can be tokenized and presented on a blockchain, such as commodities, bonds, stocks, real estate, precious metals, loans, and even intellectual property. Physical goods that are traditionally illiquid in nature, such as collectibles, intellectual property, and art, can also be tokenized and turned into liquid tradeable assets.

A generic process to tokenize an asset or, in other words, offer a security token, is described here. Note that there are many other technical details and intricacies involved in the process that we are skipping for brevity:

• The first step is to onboard an investor who is interested in tokenizing their asset.
• The asset that is presented for tokenization is scrutinized and audited, and ownership is confirmed. This audit is usually performed by...

Token offerings

Token offerings are mechanisms to raise funds and profit. There are a few different types of token offerings. We will introduce each of these separately now. One main common attribute of each of these mechanisms is that they are hosted on a blockchain and make use of tokens to facilitate different financial activities. These financial activities can include crowdfunding and trading securities.

Initial coin offerings

Initial coin offering or initial currency offering (ICO) is a mechanism to raise funds using cryptocurrencies. ICOs have been a very successful but somewhat controversial mechanism for raising capital for new cryptocurrency or token projects. ICOs are somewhat controversial sometimes due to bad design or poor governance, but at times some of the ICOs have turned out to be outright scams. A list of fraudulent schemes is available at https://cryptochainuni.com/scam-list/. These types of incidents have contributed toward the bad reputation and controversy...

Token standards

With the advent of smart contract platforms such as Ethereum, it has become quite easy to create a token using a smart contract. Technically, a token or digital currency can be created on Ethereum with a few lines of code, as shown in the following example:

pragma solidity ^0.5.0;
contract token { 
    mapping (address => uint) public coinBalanceOf;
    event CoinTransfer(address sender, address receiver, uint amount);
 
  /* Initializes contract with initial supply tokens to the creator of the contract */
  function  tokenx(uint supply) public {
        supply = 1000;
        coinBalanceOf[msg.sender] = supply;
    }
  /* Very simple trade function */
    function sendCoin(address receiver, uint amount) public returns(bool sufficient) {
        if (coinBalanceOf[msg.sender] < amount) return false;
        coinBalanceOf[msg.sender] -= amount;
        coinBalanceOf[receiver] += amount;
        emit CoinTransfer(msg.sender, receiver, amount);
        return...

Trading and finance

Before we move onto exploring one of the largest ecosystems based on tokenization, decentralized finance (DeFi), let's first look at some traditional finance and trading concepts. This will provide a solid foundation for the material presented in the next section and will covers token trading and related concepts such as decentralized exchanges and asset tokenization.

Financial markets

Financial markets enable the trading of financial securities such as bonds, equities, derivatives, and currencies. There are broadly three types of markets: money markets, credit markets, and capital markets:

• Money markets are short-term markets where money is lent to companies or banks for interbank lending. Foreign exchange, or forex, is another category of money markets where currencies are traded.
• Credit markets consist mostly of retail banks who borrow money from central banks and loan it to companies or households in the form of mortgages...

DeFi

DeFi stands for decentralized finance, which is the largest application of tokenization. It is an ecosystem that has emerged as a result of the development of many different types of financial applications built on top of blockchains. With blockchains being decentralized and the applications being related to finance, the term emerged as decentralized finance, or DeFi for short.

DeFi is an umbrella term used to describe a financial services ecosystem that is built on top of blockchains. Centralized finance, or CeFi for short, is a term now used to refer to the traditional financial services industry, which is centralized in nature, while DeFi is a movement to decentralize the traditional centralized financial services industry.

We covered the concept of decentralization in Chapter 2, Decentralization, which readers can refer to for review.

Tokenization plays a vital role in the DeFi ecosystem, which is the largest use of tokenization. DeFi is a vast subject...

Building an ERC-20 token

In this section, we will build an ERC-20 token. In previous chapters, we saw several ways of developing smart contracts, including writing smart contracts in Visual Studio Code and compiling them and then deploying them on a blockchain network. We also used the Remix IDE, Truffle, and MetaMask to experiment with various way of developing and deploying smart contracts. In this section, we will use a quick method to develop, test, and deploy our smart contract on a Goerli test network. We will not use Truffle or Visual Studio Code in this example as we have seen this method before; we are going to explore a quicker method to build and deploy our contract.

In this example, we will see how quickly and easily we can build and deploy our own token on the Ethereum blockchain network.

Pre requisites

We will use the following components in our example:

• Remix IDE, available at http://remix.ethereum.org. Note that in the following example...

Emerging concepts

With the advent of blockchain and tokenization, several new concepts have emerged over the last few years. We will introduce some of them now.

Tokenomics/token economics

Tokenomics or token economics is an emerging discipline that is concerned with the study of economic activity, economic models, and the impact of tokenization. It deals with the goods and assets that have been tokenized and the entities that are involved in the entire process of token issuance, sale, purchase, and investment.

You might have heard another term, cryptoeconomics, which is a related but slightly different term. Cryptoeconomics is concerned with the same topics but it is a superset of tokenomics. In other words, tokenomics is a subset of cryptoeconomics. Tokenomics is only concerned with tokens and tokenization ecosystems, but does not include the broader blockchain networks, protocols, and cryptocurrencies.

With the use of the proof of work (PoW...

Summary

In this chapter, we covered tokenization and relevant concepts and standards. We also covered different types of tokens and related token standards. Moreover, a primer on trading and finance was also provided to familiarize readers with some standard finance concepts, which help us to understand the DeFi ecosystem too, as most DeFi terminology is borrowed from traditional finance.

Also, we introduced a practical example on how to create our own ERC-20-compliant token using the Ethereum platform. Finally, we introduced some emerging ideas related to tokenization.

In the next chapter, we will explore how blockchain can be used outside of the context of its original usage, that is, cryptocurrencies. We will cover various use cases, and consider in particular detail the use of blockchain in IoT.