What Are Asset-Backed Tokens and Why Do They Matter?

Bitcoin, which came out more than ten years ago, is the first use case of blockchain. However, as of today, blockchain’s list of use cases is not capped at cryptocurrencies, as many features have been elaborated to address the various needs across different industries. Currently, the number of utility tokens prevails, though the greatest share of market capitalization value is still in the hands of cryptocurrencies.

A lot of traditional traders consider crypto assets to be “high-risk” investments and prefer to invest in more traditional assets like the highest volume stocks in the market, Tesla Inc. (NASDAQ:TSLA), Apple Inc. (NASDAQ:AAPL), Alphabet Inc. (NASDAQ:GOOGL) and Amazon.com Inc (NASDAQ:AMZN) or different commodities like Gold, Silver, Oil etc. Diamonds and other precious gems are also considered to be a rather safer investment that is not very “high risk” and can make sense if you’re a risk-hating trader.

Enter Stablecoins, which are blockchain-based tokens pegged to the price of a fiat currency like USDT (pegged to USD), have secured a decent place in the industry as well. Nonetheless, one of the most significant categories of digital assets is represented by asset-backed tokens, often referred to as security tokens.

What Are Asset-Backed Tokens?

For those unfamiliar, asset-backed tokens are blockchain-based units of value that are pegged to real-world assets, such as company shares, real estate, diamonds, or commodities. They represent a large subcategory of security tokens and allow users to hold ownership rights over a physical and tangible asset in a digital form. Recently, the US Securities and Exchange Commission (SEC) released a new document that defines digital assets and elaborates on how issuers and investors should treat them. The regulator’s framework is regarded as an analytical tool to determine which digital assets behave as securities and fall under SEC’s radar. When a fully operational legal framework is developed around security tokens, they might slowly but steadily replace many of the traditional trade operations by bringing more automation and transparency.

Thus, asset-backed tokens are an important type of token as they represent real physical assets. But why would investors switch to security tokens anyway? Some of the reasons refer to the increased level of automation, security, and transparency, and also the fact that the markets become more accessible to investors. Many experts anticipate that the traditional markets will adopt tokenization at a global scale, which will form blockchain-oriented ecosystems fueled by security tokens.

Some relevant examples of asset-backed tokens are DIAM and tokenized stocks. The former is a token issued by diamDEXX, which is backed by physical diamonds. diamDEXX built a trading ecosystem that allows professional and retail investors to purchase real physical diamonds with DIAM coins, at manufacturer discounted prices, through the diamDEXX platform.

“Asset-backed tokens, at least when they’re done right, offer back-and-forth convertibility, an extremely useful financial tool.” Says Jeremy Dahan, CEO of diamDEXX. “They enable people to own assets in a liquid form, and when redeemed, function as a tool to acquire valuable goods”. The DIAM Coinsistent, as diamDEXX refers to its coin, is backed and audited by the International Diamond Exchange (IDEX) and has issued more than $150 million worth of diamond-backed tokens.

Diamond Token

As for tokenized stocks, it is a way of increasing liquidity and provides the ability to purchase a fraction of a share. On top of that, while regular stock market trading is restricted only to working hours, tokenized shares are not, and can be traded after-hours as well. As of January 2019, publicly traded stocks such as Tesla Inc. (NASDAQ:TSLA), Apple Inc. (NASDAQ:AAPL), Alphabet Inc. (NASDAQ:GOOGL) and Amazon.com Inc (NASDAQ:AMZN) are being traded as ERC-20 tokens on the Ethereum blockchain, powered by DX.Exchange.

So Why Do Asset-Backed Tokens Matter?

Security tokens, mainly driven by asset-backed tokens, are a huge trend today, especially after the hype over utility tokens, issued through initial coin offerings (ICOs), is fading away.

This unique group of tokens is of great importance because they enable investors to store value that is not related to the US dollar or other fiat currencies, most of which are prone to inflation. Besides, security tokens ensure higher liquidity, as they permit the fractionalization of ownership of valuable assets, like houses, so that more investors could own portions of the same asset. For example, the DIAM token allows holders to own fractions of diamonds, as it would be very expensive to purchase an entire diamond. A blockchain-based infrastructure aimed at security tokens would be quite welcomed by retail investors, who can get exposure to various markets by investing small amounts in fractionalized assets. For instance, they can choose to buy 0.1 tokenized Amazon.com stock.

Another important advantage is that asset-backed tokens allow a higher degree of compliance. Financial regulators such as the SEC will soon be able to track security tokens much easier than regular securities. This is because the distributed ledger technology (DLT) ensures a high level of transparency. Regulators may join the blockchain network where the given securities are issued and traded and verify whether the transactions are in line with the requirements.

Blockchain doesn’t just ensure a convenient way to hold ownership over a physical asset, but it also helps the relevant parties to automate transactions. We might see more institutional investors and platform providers turning to asset-backed tokens, and the motives are clear – they represent a much better alternative to the current ecosystem built around traditional assets.

Disclosure: None. This article was originally published at Insider Monkey.