Blockchain Expert Reveals Everything You Wanted to Know About Tokenization

An interview with Pavel Kravchenko, Founder of Distributed Lab.

CryptoNews had the opportunity to sit down and talk with Pavel Kravchenko, one of the world’s leading experts on blockchain and decentralized systems. We discussed the intricacies of tokenization in an interview setting. Together we have created a short, but comprehensive guide to understanding tokenization in the blockchain industry.

Pavel Kravchenko is a leading expert in blockchain development and cryptography, who does a lot of activity in the space. For over 4 years, he and his team have been working on projects to implement blockchain on an enterprise level.

As a result, they have obtained vast expertise, which they continuously invest in conducting education in the space (conferences, workshops, online courses, etc.).

Mr. Kravchenko is the founder of a software company which has launched a solution for fast deployment of blockchain applications for businesses and enterprises called TokenD.

Also, Pavel is a published author who has written a great book for understanding blockchain technology. It has been recently posted on Amazon and is called “Blockchain and Decentralized Systems”.

• Most of our readers are well versed in everything that has to do with blockchain, but it’s always good to start at the beginning. For starters, let’s define the term. What is tokenization?

This is a good question. Most people consider tokenization as the process of issuing tokens, which are backed by some asset, on a blockchain. While this is particularly true in the context of today’s trending blockchain-and-tokens-related topics, the value that the tokenization concept brings to businesses is, evidently, higher than simply issuing a nominal unit backed by something on a blockchain. Understanding what is tokenization is essentially about knowing this value.

In a single, strict definition, tokenization is the process of transforming the accounting and asset management processes that involves the usage of cryptography for protection of digital records and the consensus mechanism for the real-time settlement of financial transactions. In fact, this combination (cryptography + consensus mechanism) is essentially what blockchain is all about. Hence, you can make a conclusion that tokenization uses blockchain; it’s not really strict but could quite work on a superficial level of understanding.

In fact, to understand new concepts, people always find it much easier when you add context—to see what this concept presentes from different viewpoints. Therefore we have formulated four different perception levels on which tokenization can be reviewed.

At the business level, tokenization is the transformation of accounting that is aimed at introducing a number of benefits to business; some of them are:

• Increase of asset liquidity as a result of reduced trading frictions (sometimes the result could even be an increase in the price of the asset itself, but that’s a separate topic, which we can talk about in the future.
• Improvement of investment attractiveness of an asset, which as a result of a number of factors (easier control, transparent provenance tracking, lowered investor threshold, etc.)
• Ability for instant audit for regulators and compliance procedure
• Reduction of total cost of ownership of an accounting system

At the user experience level, a user (asset owner) is provided with a legal title to a corresponding asset and is also able to quickly and reliably transfer this right to other users directly (via their digital key) without having to transfer the asset physically. Unlike traditional systems of ownership rights, tokenization systems allow for a better level of user experience: all types of assets can be stored in one user wallet and are interchangeable, avoiding the need for a user to have separate applications for each system.

At the IT infrastructure level, tokenization presumes that there are separate entities, each having their nodes (servers), which all perform only the permissioned set of functions (e.g., one of the consortium companies has a node that maintains the system and performs the decision making, while an auditor only conducts an audit of the system and cannot change the records in the database; etc). This allows building a sustainable system which is reliably maintained by the needed parties and which is cheaper to maintain thanks to the new technological solutions.

At the technological level, tokenization presumes that—unlike traditional systems, where there is a single party maintaining an accounting whom every other should entrust the entire process—the system can be maintained by the needed parties mutually (this is highly valuable for the business world, where obviously entities do not trust each other to maintain the financial accounting). To make this possible, parties use cryptography for the protection of digital data and consensus mechanism to settle and reconcile the financial data in real time.

• It seems that tokenization has a lot more depth than simply creating digital certificates for assets. What does it make sense to tokenize then?

Tokenization makes sense when you deal with any tradable assets which it makes sense for you to own in the form of a title and not necessarily having to own it physically.

The most evident examples are gold, dollars, etc. The less evident are real estate and art pieces. Interestingly, tokenization could allow making previously illiquid assets (such as, again, artwork and real estate) liquid. This is generally achieved through two advances: the ability of fractional ownership (e.g., splitting the ownership of an art piece into thousand fractions decreases the investor entry threshold, effectively introducing new players to the market) and an efficient secondary market.

The word efficient in such context means faster transactions on the secondary market. For example, a traditional transaction for selling a piece of the real estate property requires an in-person meeting, tons of stamped paper, etc.; this can take up from a couple of days to weeks or months. At the same time, a digital transaction can be processed within seconds. Worth noting, tokenization doesn’t enable a secondary market (it existed long before it and would have existed without it as well), but rather it creates the necessary conditions (provable provenance, fully-fledged digital identity, easily and reliably regulated digital environment, etc.) that make the secondary market efficient.

• What are some bad examples of tokenization?

Bad examples are 99% of ICOs, which use the newest technological basis of blockchain and try to fit it to an unviable business model of a utility token for a centralized business: in most cases, what they do could be compared to as if Apple would sell iPhones with 50% discount for those who pay with Apple stocks.

• In which aspects can a company expect savings by implementing blockchain?

Specific figures are extremely dependent on the size and current inefficiencies in a particular company whose assets you are trying to tokenize. It’s much better to focus on two very important parts of one company, whose efficiency is severely improved by tokenization. Those two parts are security and automation.

Security

What I mean is that things have changed since, for example, 2005 when the internet was no more than about exchanging emails, chatting on social media and googling things. Now the internet is where we do most of our social activity (buy/sell commodities, send money, etc.). So, at one moment, it turned out that traditional methods of providing security lag behind the expansion of the internet.

As a result of this, the amount of money an entity spends on providing security increases dramatically, while the effectiveness of this security decreases.

“Annual online payment fraud losses from e-commerce, airline ticketing, money transfer, and banking services, will reach $48bn by 2023; up from the $22bn in losses projected for 2018” (Juniper Research)

Such a situation is a clear indicator that something has to be changed. What will be changed is that online security will no longer be focused only on the straightforward methods of protection.

To understand the basic idea, take a look at Bitcoin. It is the first ever accounting system which is secure, but which doesn’t use direct protection—having bypassed which you gain access to controlling the system—(physical vaults, firewalls, security administrators, crocodiles etc.). Instead, it uses cryptography for data protection, while the entire database is maintained by parties who are dispersed in different places.

Similar techniques could be applied to the business world (ERP systems, logistics, supply chains, identifications, etc.), and more on that, with even higher efficiency since in the business world you don’t have to provide the features of the full anonymity and permissionless operation, which are the basic reasons of why Bitcoin consumes an immense amount of energy.

Automation

In our case, many things will be automated, but one of the primary ones is the process of the financial data reconciliation, which, thanks to tokenization, will occur in real time and without trusted parties.

What reconciliation means. Reconciliation of banks is needed when Alice who is the customer of Bank A sends money to Bob who is the customer of Bank B. Since these are two different systems, they have to somehow both update their accountings accordingly: Bank A needs to decrease the money balance on Alice’s accounts, while Bank B needs to accordingly increase it on Bob’s account. This is a problem since banks do not trust each other.

So, having armed with traditional methods, which are being used today globally, banks technically have two options:

1. Reconcile in real time but via a third party they both trust (e.g., Swift), who will pass messages about who owns how much in real time.
2. Reconcile without a third party but not in real time: This is how it mostly occurs today: both Bank A and Bank B independently of one another compose files where they specify who owns how much and then, at the end of the day, they exchange these files. If the files match, the reconciliation process can be considered successful. If not, then, Houston, we have a problem:)

Today, the entire banking system works in such a way. This consumes a lot of time and money. The usage of blockchain would allow these two banks in our example to both agree on who owns how much in real time and without a trusted third party.

• You’ve done a lot of work with helping companies and businesses take their first steps towards tokenizing their process or assets. What are the most promising results for tokenization?

There are many results that we are looking to see when supporting our clients with their tokenization efforts. The variety is based on the nature of a particular business or organization. Anyway, before I outline some of the basic innovations of tokenization, it’s worth noting that not all of them will be manifested right off, due to a number of challenges (I believe we will cover some in this interview).

General benefits:

• Creation of the necessary conditions for the secure digitization of processes and ownership rights (leading to much higher automation within an organization, company, etc.)
• Introduction of the new security standards, which will not only make the digital ledger maintenance more secure but also cheaper
• Increasing the liquidity of assets (not all but many)
• Democratization of finances by introducing smaller investors to markets that were previously controlled by whales (real estate, art, etc.)

Business benefits:

• Possibility to work in a consortium mode where all data is securely synchronized between companies in near real time, without a trusted party in-between;
• Real-time audit with an ability to check the authenticity and integrity of the received data (i.e, an auditor will be able to make sure that he/she doesn’t receive counterfeit data from the system, for example, that Alice has balance “3”, while in reality, she has “30”)
• Storing and transferring assets in different systems with the guarantee of authenticity and finality of transaction;
• Transparency and higher automation of decision-making as well as of other business processes;
• Implementation of a full-fledged digital identity.
• Technological basis for the introduction of entirely new business models (sharing economy is one example)

Blockchain technology and tokenization are helping international shipping providers and customers get more data regarding the shipments, conditions, and can help save a lot of time and effort along the supply chain.

• There is a lot of excitement around tokenized assets. What do you think, what kind of role will tokenized assets play in the future?

I would say that it’s not about the role of tokenized assets but about the role of tokenization itself.

In some sense, you could say that it will play the role of a “bridge” in the process of transformation of digital systems backed by stamped papers (the way things are today) and digital systems which are no longer backed by papers and which become the primary source of information for people. This is a period in the future when authenticity of data is being proved not by a piece of paper with a signature on it, but by a sustainable shared digital ledger with transparent provenance history.

This will lead to the higher automation of processes which are currently manually performed. Interestingly, even today, many of these processes can already be transformed, but there are many challenges preventing this step in societal evolution.

• What are the main challenges for implementing tokenization?

They mostly relate to the legal aspects. Tokenization is only the technological basis for the bridge I was talking about in the previous question. As it always happens with such technological enhancements, it takes time for people to accept the “new rules” both in legal and conceptual terms (especially when we talk about decentralization in the decision making process).

Tokenization and blockchain have a place in real estate. There are already existing implementation which have enabled real estate owners to make their property available to a variety of investors, both big and small, with the help of tokenization.

• Would you be available to answer future questions from our community regarding the topic?

Yes, I would be happy to support your community with more targeted insights into anything related to this topic.

• Thank you very much for your time Mr. Kravchenko. It’s been a pleasure speaking with you today! We are sure that many of our readers appreciate learning more about tokenization from such an experienced and knowledgeable individual in the industry such as yourself.

You are welcome. It’s been a pleasure to share my experience with you, and I am grateful that you have invited me to do so. We are looking forward to any and all questions about tokenization, and hopefully we have started a beneficial discussion which will attract many of your crypto and blockchain enthusiastic readers.

As we mentioned in the beginning, Mr. Kravchenko is a real expert in the field. Today, together with his team at Distributed Lab, they are using all of this experience to create a white label product that takes away the complexity of implementing blockchain solutions for enterprises as well as for small and medium businesses. If you want to learn more about his latest project, feel free to visit TokenD’s official website.