What is a Tokenized Contract?

Investing has already changed a lot with the introduction of cryptocurrencies. However, this is far from all of the changes we can expect with blockchain technology. This is due to a process known as tokenization. Tokenization is the process of turning the rights to something or securitizing something into a digital asset. More specifically, a blockchain token. The item you can decide to tokenize can be any valuable asset. This includes something financial, private, intangible or fungible like gold. It could even include a contract, which we will refer to as a tokenized contract.

The concept itself might sound new, however it is actually far from it. Rather, it stems from the securitization process. This is the process where various types of contractual debts are pooled together and sold as securities. 

Tokenization Contract Defined

With this concept, tokenization was born. To see the comparison, imagine you own a home (with a nice pool like the one pictured). However, this month you are a little short on cash. So although, you have this sweet house you may not be able to make your car payment. One option could be to sell your home and use some of the proceeds to pay for your car. But then you would have nowhere to live. Instead, you might decide to tokenize your home. By selling fractions of your home you could own the majority of the property. You will also be able to pay for your car payment this month.

This is the same principle that is carried out to any valuable contract. Therefore, a tokenized contract is one that is seen as valuable and can be purchased in part by tokens.

How To Tokenize an Asset

Perhaps this example made sense and now you are wondering how you can tokenize one of your assets. To do so, you will be required to follow a couple of key steps.

Identifying Your Asset

This might seem like a given. However, before tokenizing anything you will need to consider if your asset is worth something. More importantly, you will need to find out if there are buyers that are willing to pay for it.

The Blockchain

You could start from scratch and create a private blockchain. But, this is a complicated and expensive endeavour. Instead, most organizations decide to use the Ethereum blockchain for asset tokenization.

Type of Token

Next you will need to decide which token you want representing your product or service. There are three kinds including a currency token. However, when representing an asset you will need to decide between the other two types. First, you can opt for a utility token that will allow purchasers to access the product or service. Each utility token represents access to a network to buy services offered. Alternatively, you might opt for a security token that simply provides ownership of it. Security tokens have more restrictions set on them based on identity, jurisdiction and asset category.

Token Standard

Next is selecting a token standard. A token standard is a set of rules that apply to a given group of tokens. It also defines the principles that allow the coins to interact with each other. The ERC20 token standard is the most common in Ethereum blockchain development. However, other options include ERC-1400, ERC-1450, SRC20 or ERC-1404 all of which have different and unique features.

Tokeconomics

Your token economics (tokeconomics) will also need to consider how many tokens will exist. Keep in mind that too many tokens may detract from the value of your asset and drive investors away.

Token Distribution

Finally, you will need to decide how you will distribute tokens to interested investors. This may require legal advice. With the help of a professional, you can ensure you are distributing tokens in a way that meets government standards in your area.

Pros and Cons of Tokenization

Tokenization has several pros and cons. On the positive side, tokenization is immutable. This is a fancy way of saying each transaction is stored forever and can’t be changed. This means you will own your asset forever, the contents are even locked in the blockchain. Tokenization also allows for transparency. This is because the details of a transaction can be quickly reviewed on the blockchain. Most importantly, allowing any asset with value to be tokenized will free up the amount of capital that is available to trade. This amount is believed to be in the trillions of dollars and with more “free” money comes more trades.

This is an exciting thought. But, there are a couple of hurdles tokenization must overcome before it becomes a mainstream practice. First, there are no regulations to govern the widespread use of tokens. Additionally, there are a number of security risks including hacks that continue to occur for digital assets. At early stages of this process, proper safeguards to prevent hacking might not always be in place. This means one large hack can greatly hurt investor trust in the industry as a whole. Finally, since there exists centralization with the assets we currently own, tokenizing them introduces these same middlemen. This is problematic . Especially, since blockchains are attempting to eliminate centralization rather than build off of it.

Tokenized Contract Applications

This concept continues to find new benefits and challenges, but that hasn’t stopped different organizations (and key players – literally) from trying out the concept. To further show how tokenization of contracts has been used, we will first delve into a recent example of an NBA player’s contract and how smart contracts are tokenized on Hedgetrade.

Tokenized Contract Example

Athletes might see the appeal of tokenizing their contract since this means instead of receiving a monthly salary payment, the majority of their salary is received as a lump sum. This can prove to be more beneficial if the payout can be used to invest for an even greater return. This is likely what NBA player Dinwiddie from the Brooklyn Nets was thinking. Back in September 2019, his intention was to issue tokenized shares of his NBA contract. Sad to say, the NBA gave him strict opposition. This included an initial threat to the termination of his contract if he went ahead with this token sale. Fortunately, the token sale still occurred, and concluded almost one year later. Each token represented a fraction of Dinwiddie’s NBA contract. These tokens were known as the SD26 Professional Athlete Token and represented a $150,000 stake.

While this makes sense for the athlete, where does the investor come in? In the example of Dinwiddie, he might end up taking a paycut to receive all of his funds at once from outside investors. This means the NBA will still pay out his planned pay. Therefore, their investments would give the paid capital back while also receiving the difference from the NBA’s pay and their pay which could be distributed across all of the people who had shares. Depending on the country, the regulations for who can invest into a sports team will vary. For Dinwiddie, tokens could only be purchased by accredited investors who had already passed various SEC and legal standards.

Smart Contracts Tokenized with Hedgetrade

We might not all be athletes, but there are other applications of tokenized contracts. As a recap, on a blockchain, the tokenization of assets occurs when an adequate amount of reasonably priced shares (or tokens) equals the cost of an object. On Hedgetrade, this object is a smart contract that holds the contents of a prediction. This prediction will execute automatically with the contract, since the terms of the agreement reside in the code. Users can then purchase Hedgetrade tokens and use them towards a blueprint smart contract

In reference to how to tokenize an asset, Hedgetrade works by attributing value to blueprints. The Hedgetrade Platform Utility Token was then created on the Ethereum blockchain and follows ERC-20 standards. There are 1,000,000,000 tokens total that are distributed through private and public sales, partnerships and community building and seed rounds.

Amateur traders can choose to buy into this prediction to see the contents of it and decide whether or not they are going to act on it. Depending on the outcome of the prediction, the contract will then execute an outcome when specific parameters are carried out. 

Furthermore, with HEDG if the Blueprint is false, the smart contract will execute a ‘false’ outcome and return the tokens to the purchaser. HEDG tokens are issued on the Ethereum blockchain, which is one of the top choices when it comes to asset tokenization. By using smart contracts that are integrated into the Blueprints, the Hedgetrade team is able to ensure a higher level of validation, verification and transparency of analyst performance, which in turn affects their ranking and reward.

A Financial Industry Driven by Tokenization

Tokenized contracts are just one aspect of tokenization. However, they also represent the creation of a whole new financial system. One that will offer greater democracy and efficiency. This means even if you or your organization are not ready to take the plunge into tokenization, this trend is not one that should be overlooked. After all, the organizations that leverage tokens to their advantage may be able to create a unique competitive advantage in their market.

The first step might be to get comfortable with this concept and use of tokenized smart contracts. If this is the case, Hedgetrade can be a great place to get started. To do so, visit app.hedgetrade.com/signup and browse through the available blueprints that you can purchase. We promise, it is that easy.

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