So far commodities like stock, bonds and real-estate have emerged as a perfect gateway for investment diversification and a tool to beat inflation. But despite this fact, they are yet to be categorized as a super investment because of a few of their pitfalls. For example, you cannot expect your stocks to yield the desired price whenever you wish to sell them.
Likewise, for lands/real-estate, you cannot expect them to fetch liquidity on an ad-hoc basis. To be categorized as a super investment, it must meet two high grounds: (i) Instantly liquidity (ii) Better strike price. Commodity tokenization caters to this. In this article, we shall see a few things: is commodity tokenization the magic bullet we think of or are there pitfalls yet to be explored in hindsight. But before we do that, let’s scratch with the basics first;
What is Commodity tokenization?
Commodity tokenization refers to the process where you are tokenizing real world assets, which cannot be fractionated in its entirety. For example, assets like land, antiques, gold cannot be broken down into smaller pieces and made available for sale. But when you are using commodity tokenization powered by blockchains for transparency, verifiability and ownership transfer, you can easily do that.
Why Commodity Tokenization is A Big Opportunity?
Driving Affordability
One of the key reasons tokenizing commodities is taking the market by storm is because for the first time, it is becoming very easy to afford things that you cannot in the past. For example, in Dubai the DAMAC group and Mantra merger is all set to bring $1 Billion real-estate onchain.
Through this initiative, investors can trade in real-estate tokens in Dubai and buy luxurious properties at petty entry tickets as low as AED 2,000 or $500. That’s simply out of the box, which means, if any store or property in Burj Khalifa is up for sale using the DAMAC platform, you can make purchases with even a $500 ticket.
Lowering Cost
Incurring high costs while moving real world assets is a major deterrent for innovation. For example, if any SME wants to take loans from banks, they have to go through a lot of two and fro like verification of credibility, credit worthiness and others. Now to do all of that, it would amount to a lot of money spent. Centrifuge is tokenizing this process to make assets available to SMEs without the hassles of intermediaries and undergoing high corruption in the process.
Diversification
Commodity tokenization can also help diversify asset classes. For example, if you want to bring different asset classes together for participation via a share form, there are multiple challenges to cross.
To put that into perspective, suppose you want to bring derivatives like ETF, gold, rare metals, antiques, paintings, and other assets into a stock-like tradable form from a single platform. If you are going with traditional ways, to make them public from a single platform, you need legal infrastructure in the form of Special Purpose Vehicles (SPV), broker-dealer licensing, custodians and so on and so forth. But commodity tokenization via blockchain abstracts all of these because through a single wallet you can access a long list of diversified assets unified on top of a single platform with blockchains to validate for the same.
Amplifying Access
Access is another major bottleneck that commodities face when they want to enter a new market. For example, if you have a land or a property in a particular geographical region, you can allow access only within that jurisdiction and not beyond. But commodity tokenization simply makes the whole world your new market for the asset despite geographical boundaries. Propy is a major project which is doing the same by amplifying real estate property access via tokenization at a global level. And due to this giant leap, the WEF has identified Propy as 100 best technology pioneers.
When Does It Become a Headache?
It can become a headache when you fail to acknowledge the following barriers;
1. Regulatory and Legal Barriers
Compliances /Laws
At the moment, only in Switzerland, Abu Dhabi, Dubai, European Union and Hong Kong, you can find specific laws and orders governing asset/commodity tokenization, in other parts of the world, there’s a lot of catching to do. For example, even in the United States, in pursuit of transforming into a crypto capital of the world, the country has failed to abide by any laws enforceable on crypto trades and transfers. Due to this, if there are any unforeseen challenges while dealing with tokenized commodities, there wouldn’t be a refuge available for the investors
Jurisdictional Challenges
Jurisdictional challenge is a major threat when you are tokenizing commodities because if the issuers are based out of two different regions, it becomes very difficult to enforce rules on exchange of the tokens. For example, even if the issuer has acquired the licensing while operating in a particular jurisdiction, when the tokens are transferred to a different jurisdiction, they may face an imminent challenge. DigixDAO (Singapore) vs. U.S. Regulatory Scrutiny (Tokenized Gold) is a prime example to quote here because the DGX tokens were considered securities in the United States, leading to problems for those holding the tokens.
2. Security Barriers
Cyber Threats
Cyber threats are another major deterrent when you are tokenizing commodities on top of a blockchain because of the limitations of smart contracts audits. At the moment, more than $2.2 Billion have been stolen from crypto platforms and the numbers are on the rise when you look at the chart below.
Due to limitations in auditing the smart contracts because of availability of developers well versed in that programming language, exploring the roads of tokenization commodities has its own fair share of challenges that one has to cross nonetheless.
3. Economic Barriers
Liquidity Bottlenecks
In the very beginning, it was said that tokenized commodities would bring in liquidity but there couldn’t always be ready markets available for buyers and sellers and if there are other irregularities like whale attacks, it could be devastating for the tokenized commodity market.. MANTRA ($OM) project experienced the same fate when whales had withdrawn liquidity, forcing the token to lose value by 80% to 90%, which could be a big threat to the markets planning to build tokenized commodities for better accessibility and upsides.
Price Discovery
Inability to trigger price discovery is the reason which leads to the above mentioned problem which is liquidity bottlenecks. Why? Because when you are buying in a traditional market, there’s continuous interaction with the buyers and sellers balancing the prices, but fragmented markets built on-chain like a tokenized commodity market, the tokens are traded on multiple platforms and exchanges causing significant price discrepancies leading to liquidation and other pitfalls.
This happened with a project named Bext360, a coffee token aiming to solve transparency and traceability problems in the coffee distribution globally. But the project was met with failure because it was limited to a single platform and when these tokens were introduced to a different market, they failed to deliver because it was hard to evaluate the value backing these tokens.
4. Technical Barriers
Scalability Dilemma
When you are tokenizing commodities, for example oil, stocks, ETFs, bonds, perishable goods and others. These commodities would be transacted at a massive level and your underlying technological infrastructure should be robust enough to cater to the demand. But when you are building solutions on L1 blockchains, you cannot go beyond the block size limitations. Which means, if the network activity increases, the transactions will be holding back or you will have to bid premium for the block space to let your bids for buy and sell go through.
Interop
Now, even if you are able to meet with the scalability challenge by pushing computations offchains, you will have another problem to address, which is interoperability because different blockchains will have different rules and governance models. That said, if you are introducing your commodity token on such blockchains, you cannot interact due to asynchronity. Paxos Gold project suffered due to this interop challenge because it was designed exclusively for Ethereum, which means, users couldn’t send such tokens on the Layer 2s, Solana, Binance Chain and others because it would require wrapping up tokens and locking in liquidity on the mainchain.
How Prolitus Can Help In This Regard?
Prolitus has hands-on expertise with the blockchain technology needed for building your tokenized commodity project acknowledging regulatory loopholes, economic barriers, technology readiness and security concerns. This happens because we are under the tokenized commodity market and provide the best solution that can help you meet the desired outcomes. We can help build the stack for your tokenized commodity project where you do not face liquidity challenges through liquidity hubs, interop through gateways and even help you in meeting with near infinite scalability using a modular stack as per your project requirements.
So far, we have been serving clients of all shapes and sizes scattered across various geographical locations. Using our seasoned professionals with years of experience, we have provided the best outcomes to clients. If you are looking for expertise, innovation, and comprehensive support to streamline a smooth digital transformation, we are always eager to help.
For queries about how we can streamline the process and help you with developing your carbon market on top of blockchain for your specific business goals, we are just a call away from you.
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