Tokenization is a notion that predates blockchain technology. Since the 1970s, the financial services sector has used some sort of tokenization to secure the personal information of its clients. This method often entails converting sensitive information such as credit card numbers, social security numbers, and other personally identifying information into a string of alphanumeric characters. It then goes through a cryptographic procedure to generate a unique token.
To some extent, this procedure is similar to the tokenization process made possible by blockchain technology. However, previous tokenization systems largely aim at safeguarding sensitive data, blockchain tokenization allows for more secure yet flexible asset tokenization. It considerably broadens the potential uses of digital tokens across a wide range of sectors.
What is Tokenized and its benefits?
A token, in general, is a representation of a certain item or function. Tokenization, in the context of blockchain technology, is the process of transforming anything of value into a digital token. You can use these tokens on a blockchain platform. They can symbolise actual goods such as gold, real estate, and art, as well as intangible assets such as voting rights, ownership rights, and content licencing. Almost anything may be tokenized if it is deemed an asset that can be possessed, has value to someone and can be included in a broader asset market.
Crypto tokens offer a variety of user benefits
Increased Liquidity
Tokenization makes bitcoin accessible to a much larger audience. It increases the market liquidity and eliminates the “liquidity premium” associated with investments that are usually more difficult or time-consuming to sell, such as fine art or real estate. Tokenized assets are freely exchangeable online. It allows investors to get fractional ownership of the underlying asset of a token.
Faster and less expensive transactions
Using cryptocurrency tokens, investors may avoid market intermediaries and other middlemen who are generally involved in the traditional asset management process. Furthermore, because crypto tokens reside on the blockchain, they are tradeable throughout the world at any time.
Transparency and Provability
Because the blockchain stores the crypto tokens, users can readily track their origins and transaction history in a cryptographically provable manner. Blockchain automatically records each and every transition. The immutability and transparency made possible by blockchain technology help ensure the legitimacy of each token’s stated history. These characteristics allow crypto tokens to attain a degree of dependability that few other digital assets can match.
Tokenized Bitcoin
Tokenization works by storing a certain quantity of bitcoin and issuing an equal number of tokens on Ethereum. The bitcoin-backed tokens are linked to the price of bitcoin, but they may also be used on DeFi platforms and in other protocols. The tokens are destroyed and the bitcoin is released to complete the procedure.
The vast majority of tokens have been converted into wrapped bitcoin (WBTC). WBTC accounts for 80% of the tokens wrapped around Ethereum, and these tokens alone account for 1% of Bitcoin’s circulating supply.
HBTC, renBTC, imBTC, sBTC, and tBTC are some other token forms of bitcoin. HBTC is Huobi’s form of tokenized bitcoin. The other four run on protocols that let users transfer to and from their tokenized bitcoin equivalents.
A significant portion of Bitcoin’s circulating supply is now for use on the Ethereum network. 240,000 bitcoins have now been wrapped onto Ethereum, according to the Block’s Data Dashboard. This amounts to 1.3 percent of Bitcoin’s current circulating supply (and 1.1 percent of its ultimate total supply). Since the beginning of the year, the number of tokenized bitcoin has surged by 100,000 BTC and has been rapidly increasing.
Also read: What is Stablecoin and What Makes It Better?
Why use Ethereum to tokenize Bitcoin?
The Bitcoin design is purposefully basic. It does a few things, and it does them really well. These features, however, have inherent restrictions. While Bitcoin has the highest value, it cannot profit as much from the innovation occurring in other parts of the digital currency business. While smart contracts may potentially be implemented on Bitcoin, they are relatively restricted in scope when compared to Ethereum or other smart contract platforms.
Tokenizing bitcoin on other chains may boost the network’s usefulness. How? It may provide capabilities that Bitcoin does not natively offer. At the same time, Bitcoin’s essential functionality and security mechanisms remain unaltered. Additional benefits might include faster transaction rates, fungibility, and anonymity.
Here’s another possible explanation. The concept of composability is one of the most important parts of DeFi. It implies that because all of these apps are operating on the same public, open-source, permissionless base layer, they may communicate with one another in real-time.
Many people think that bringing Bitcoin to this composable layer of financial building blocks is an attractive proposition. It has the potential to enable a wide range of new applications that would not be possible otherwise.
How does the process of Tokenizing Bitcoin work?
There are several methods for tokenizing Bitcoin on Ethereum and other blockchains. They all have varying degrees of decentralisation, different assumptions about trust and risk, and may keep the peg in a different way.
There are two primary types: custodial and non-custodial. The first form entails a central custodian. The custodian can issue tokens as well. As the entity holding the bitcoins must be trusted, this increases counterparty risk. However, this implementation is more secure than the alternatives.
The other options are slightly different. There is no requirement for a trusted entity because the whole minting and burning process is handled by automated on-chain procedures. The collateral assets are locked, and tokens are produced on the other chain using on-chain processes. The money is locked on-chain until the tokens are destroyed, at which point they are unlocked. While this reduces counterparty concerns, it also raises the possibility of security issues. Why? In this instance, the responsibility for risk is totally on the user’s shoulders. If a user or contract error causes a loss of cash, they are most likely gone forever.
Custodial tokenized bitcoin
These constitute a sizable chunk of the presently tokenized bitcoin supply. Wrapped Bitcoin has the most value locked up (WBTC). How does it function? Users submit bitcoin to a centralised custodian, who stores it in a multi-signature cold storage wallet and mints WBTC tokens in exchange. It’s important to note that this procedure necessitates them establishing their identification in order to comply with KYC/AML rules. This technique necessitates faith in the entity minting the token, but it also provides certain security benefits.
Binance also offers a tokenized form of Bitcoin known as BTCB. It is a BEP-2 coin on the Binance Chain. If you want to give it a go, you may do so on Binance DEX.
Non-custodial tokenized bitcoin
Non-custodial systems operate entirely on-chain, with no intervention from a centralised custodian. In a nutshell, you may think of them as wrapped BTC. Instead of a centralised custodian, a smart contract or a virtual machine is in charge of safeguarding cash and issuing tokens. Users may deposit their BTC and mint their tokenized bitcoin without the need for trust or authorization.
Some of these systems may also need over-collateralization. It implies that users will have to deposit more value than they intend to mint. The aim is to prepare the system for black swan events and major market collapses. Even so, if the collateral value falls dramatically, these systems may be unable to cope.
RenBTC is the most popular non-custodial implementation. The bitcoins are transmitted to the Ren Virtual Machine (RenVM), which holds them on a decentralised network of nodes. It then creates ERC-20 tokens based on the amount of bitcoin provided.
It’s important to note that they are cutting-edge technologies. It’s no surprise that centralised, custodial systems are more popular; they’re generally more secure. Naturally, there is a greater risk of bugs and user error, which could result in a loss of funds. Nonetheless, as the technology improves, this might be the future of tokenization.
Automated procedures regulate these non-custodial solutions, therefore, only expert users should use them. However, if you want to experiment with these tokens without having to worry about the minting process, you may buy and sell them on cryptocurrency exchanges.
Tokenization’s Impact on Bitcoin
It undoubtedly improves Bitcoin’s usefulness. While many may claim that Bitcoin does not require more features, it might benefit from some. As previously noted, the benefits might include faster transaction speeds, fungibility, anonymity, and lower transaction costs. With the release of ETH 2.0, we may anticipate Ethereum transactions being quicker and cheaper. This might also assist the tokenized bitcoin scenario on Ethereum.
Some believe, on the other hand, that this is potentially problematic for tokenized Bitcoin holders. Tokenizing BTC also requires giving up some of Bitcoin’s most desirable qualities, such as its high security.
What happens, for example, if the bitcoin tokens are stolen or lost as a result of a smart contract bug? There may be no way to unlock the bitcoins that have been locked on the Bitcoin blockchain.
Fees are another factor to consider. Some suggest that if a large number of users begin trading using tokenized BTC on the Ethereum blockchain, transaction costs on the Bitcoin network may decrease. In the very long run, Bitcoin aims to run solely by transaction fees. If the majority of people enter the Ethereum ecosystem, the network’s security may be jeopardised. This, however, is a long way off and will not be a major concern for a long time.
Effects of tokenization on Ethereum
If Ethereum acquires a significant portion of Bitcoin’s value, it may improve Ethereum’s utility as a worldwide network for value transmission. According to Etherscan analysis, a significant percentage of 15,000 BTC is a part of the Ethereum DeFi ecosystem.
Tokenized bitcoin has the potential to significantly boost the utility of DeFi on Ethereum. How? Decentralized financial services based on tokenized bitcoin might exist. BTC-based DEXes, loan marketplaces, liquidity pools, and anything else in the DeFi space may all be denominated in BTC. The success of tokenized bitcoin might lead to the migration of other sorts of assets to the Ethereum network.
The majority of the projects are still in their early phases, and the technology underlying them has a lot of room to grow. Still, there are some intriguing improvements to look forward to on this front.
Tokenization of Cryptocurrency in the Future
Tokenization—from asset tokenization to real estate tokenization—is fundamentally altering how we interact with valuable assets. Blockchain can store and represent any asset or service. Tokenization can democratise asset access while providing an unparallel degree of online transparency and security.
However, because the regulations regulating the sale, distribution, and maintenance of crypto tokens continue to differ by nation, it will require a large-scale, multilateral effort to establish the worldwide, borderless value transfer networks that crypto tokens may one day enable. As more individuals and governments across the world come to terms with blockchain’s extraordinary potential and value, the tokenized future is rapidly becoming a reality.
Also read: What is The Ethereum Virtual Machine?
