Author: James Smith, CoinTelegraph; Translated by: Wuzhu, Golden Finance
1. Analysis of Tokenized Commodities
Tokenized commodities represent fractional ownership of real-world assets using digital tokens on a blockchain while retaining their tangible value.
Tokenized commodities are digital versions of real-world items (such as gold, oil, or crops) recorded on a blockchain. Each token represents a portion or all of a commodity, making it easier to divide and trade. This simplifies the buying and selling of small portions of commodities for investors, provides more liquidity, and offers access to markets that are typically difficult to trade.
Imagine you have a giant pizza that one person can't finish. Instead of giving the whole pizza to one person, you cut it into slices. Now everyone can buy and enjoy the right amount of food that suits their appetite.
Tokenizing physical commodities works similarly. Commodities like gold or oil are giant pizzas. Instead of buying the entire commodity (which can be very expensive and impractical), you divide it into small pieces called tokens. Each token represents a small portion of the commodity.
Tokenization Process
Have you ever thought about owning a fraction of a barrel of oil or a small portion of a gold bar? These are tokenized commodities, a combination of blockchain technology and traditional assets.
Tokenized commodities become digital tokens, opening up new trading and access channels for investors. Here are the steps involved in the tokenization process:
Token creation: Create a token that represents the good. One way to do this is to establish the identity of the property owner as a legal entity. The token enables the holder to share in the value of the good.
Execution of smart contracts: Smart contracts enable the allocation, monitoring, and payment of digital token rewards. Once initiated, these programs run without human intervention.
Token Distribution and Sale: Tokens are distributed to investors through smart contracts via a combination of private sales, public sales, or a whitelist model. A whitelist is a setting that only allows pre-approved or trusted users, entities, or operations to run.
Asset Management: After the token sale, new holders can participate in the management of the underlying commodity. Smart contracts specify the scope of control and decision-making process for token holders.
Secondary Market Trading: After the tokens are issued, they can be traded on the secondary market, creating liquidity. Unlike traditional commodity investors who may find it difficult to sell their assets, token holders can sell their shares more easily.
Types of Tokenized Commodities
Blockchain technology can help tokenize a variety of commodities, including energy resources, real estate, precious metals, and agricultural products.
Let’s explore the various tokenized commodities:
Precious Metals: Tokenizing precious metals such as platinum, gold, and silver allows investors to hold small amounts of precious metals without the need for physical storage. This helps with portfolio diversification and hedging, while also increasing the accessibility of these assets.
Energy resources: Tokenizing energy refers to converting actual energy (such as solar or wind power) into digital units on a digital platform. This facilitates new energy-related use cases, such as exchanging excess solar energy between neighbors, streamlining renewable energy credits, and improving grid management.
Agricultural resources: Blockchain enables the tokenization of agricultural resources, creating a secure record representing products exchanged on a digital ledger. This brings efficiency, security, openness and cost reduction to commodity trading for retail investors.
Real Estate: Investors can tokenize properties by dividing them into smaller pieces and automating operations using smart contracts. Records are stored in a secure digital system. Owners can prove their ownership using a private key. Anyone interested in buying, renting, or financing can easily view the history of a property using this system. Past transactions involving a property, including any outstanding debts, are displayed as a transparent, unchangeable record.
Tokenized Commodities and Commodity-Backed Cryptocurrencies
Commodity-backed cryptocurrencies are digital assets that are designed to be more stable than volatile cryptocurrencies. This stability is achieved by pegging their value to a tangible commodity such as real estate, gold or oil.
A company or organization holds a physical good and issues a token that represents a specific amount of that good. The value of the token fluctuates with the cost of the underlying good.
For example, commodity-backed cryptocurrencies Tether Gold and Pax Gold are both backed by actual gold. Similarly, other cryptocurrencies can also be backed by commodities such as oil reserves or other precious commodities.
The following table explains the difference between tokenized commodities and the cryptocurrencies that back them:
5. Benefits of commodity tokenization
Commodity tokenization clarifies ownership, enables fractional ownership, simplifies transactions and facilitates market activity.
Let’s take the example of gold-backed tokens to understand the advantages of commodity tokenization.
Enhanced liquidity: One of the major advantages of tokenized commodities is enhanced liquidity. By converting commodities such as gold into digital tokens, these assets can be easily traded on blockchain platforms. This allows investors to buy and sell fractions of commodities without the need for an intermediary, thereby reducing transaction costs and transaction times.
Fractional Ownership: Fractional ownership is another important advantage of tokenized commodities. It allows more investors who may not have the funds to purchase full units to purchase the commodity. This makes commodities more accessible to investors, allowing them to diversify their portfolios.
Better security and transparency: Tokenization uses blockchain, which is like a digital notebook that records every transaction. This notebook cannot be altered, ensuring transparency and security because everyone can see who owns what.
Easier to trade: Traditional methods of commodity trading can be time-consuming and complicated. Digital tokens allow users to trade conveniently anytime, anywhere, making the investment process much simpler.
6. Risks of Tokenized Commodities
While promising, tokenized commodities also face challenges. The rules are not always clear, as existing rules may not fully cover them. The technology behind tokenized commodities must be properly tested to handle the complexities of creating and trading these tokens.
Continuing with the example of gold-backed tokens, let’s dive deeper into the risks associated with tokenized commodities.
Liquidity: Tokenization is of little use if the secondary market is not large enough to handle the volume. Building market depth requires trust between institutional investors and traditional market participants using blockchain technology.
Standardization and interoperability: The smooth integration of tokenized commodities with the existing financial system requires standardization and interoperability. Compatible token standards, smart contracts, and data formats between various blockchain platforms and commodity markets are essential for efficient transaction settlement and asset transfer.
Cybersecurity: Protecting the integrity of tokens, private keys, and sensitive transaction data requires strong security measures such as encryption and two-factor authentication (2FA). Constant monitoring is required to prevent theft, hacking, and exploitation.
Regulatory challenges: Tokenized physical commodities are subject to securities, commodity trading, and financial market laws. In order to comply with these laws, strong governance mechanisms must be in place to prevent fraud, market manipulation, and regulatory violations.