The Rise of Tokenization
UDC Story — Insights from UDC 2018
It was 1937 on the docks of Hoboken, a small harbor in New Jersey, just across the Hudson River from New York. A trucker named Malcolm McLean, his truck loaded with bales of cotton, was waiting for his cargo to be loaded. He sat in his truck the whole day, waiting for his turn to arrive. He had a front row seat to the tedious process of cargo being repeatedly loaded and unloaded on to the pier. He thought it would be much more efficient if the trailer itself could get loaded onto the ships.
That was the moment that gave birth to the idea of ‘containerization,’ which revolutionized shipping. McLean did not invent containers; they had been around since the 1800s. However, all of them had different sizes, which meant that it required hundreds of dock laborers to load and unload them. It got to the point where it cost more to unload the cargo than to move it across the Pacific. The shipping industry was a thoroughly labor-intensive business.
In April 1956, McLean’s first container ship ‘Ideal X’ left Newark, New Jersey for Houston, Texas. It had 58 containers measuring 9 meters in length on board. There were concerns that the containers loaded on deck would get washed away by the waves, or that the storms of the Pacific would sink the old ship. The ship completed its voyage without issue, marking a new page in the history of marine shipping.
Loading became much simpler, and the ships stayed at the docks for only a very short time. Crewmen could pilot the ships, so the shipping cost was much lower. By McLean’s calculations at the time, the loading cost for Ideal X came to 16 cents per ton. The loading cost for a similar mid-sized vessel was $5.86.
What McLean established was standardization. He chased bureaucrats down and tried to change the differing standards for each company and country. Public officials refused to meet with him, saying that he was creating pointless work. Dock laborers strongly opposed the implementation, arguing that containers would steal their jobs.
The Vietnam War in the 1960s helped expand the use of containers. Military munitions had to be loaded quickly and McLean’s loading operation was superior to other methods. The US government adopted McLean’s container standards, and McLean forfeited his patent and focused his efforts on supplying the military with containers.
The reduction in shipping costs tied the global economy into one, making it a much more influential invention than the Free Trade Agreements (FTAs). The sole reason Barbie dolls sold in the US can have hair made with Chinese nylon and bodies made with Taiwanese plastics is this crude metal box. Over 90% of global freight trade involves containers.
In 2007, Forbes chose McLean as one of the 15 people who changed the world in the latter half of the 20th century. Those selected alongside McLean include Tim Berners-Lee, the father of the world wide web; Francis Crick, who uncovered the mystery of life by discovering the double helix structure; and Mikhail Gorbachev, the former General Secretary of the Soviet Union who helped end the Cold War.
◇ Blockchain tokens are the containers of the industrial revolution
During UDC 2018, NEO founder Hongfei Da brought up the container story in his speech.
“Reduction of loading time, automation, and an astounding reduction in shipping costs were all realized through containers. However, during implementation in the 1950s, labor unions, other companies, and regulatory authorities all hated it. There’s a similarity with today’s blockchain industry.”
Da likened tokens created with blockchain technology to “containers of business and finance.” His idea is that a ‘Smart Economy’ can be realized through tokens, making them more powerful containers than their physical counterparts.
This ‘Smart Economy’, as envisioned by Da, is a world where all assets can be digitized, and everything can be managed by codes. Decentralization and distribution would make technology and codes more trustworthy than governments, in effect creating new establishments and governments.
After asking the audience what they thought blockchain was, he provided his assessment. “It’s more than just software. It allows apps to be developed and mounted, but it’s more than just an operating system. It’s comprised of protocols and networks, like the Internet, but it’s more than just an Internet-like network. A blockchain is an Internet of value that delivers value, but it is so much more than that.”
Stating that he first became interested in Bitcoin in 2012, Da described blockchain as a new institutional tool that will allow people to enter into a new ‘Smart Economy’, with tokens serving as the containers that can hold different assets and values. Tokenization is possible for all assets, including stocks, bonds, options, and real-estate. Through tokens, assets can secure liquidity 24–7, unencumbered by boarders.
Founded by Da in 2014, NEO is an open network ‘Smart Economy’ project where digital assets can be registered, transmitted, and traded via blockchain. If you can imagine a future actualized by NEO’s ‘Smart Economy’, the current debate regarding the cryptocurrency bubble may seem silly.
“Governments or traditional companies consider NEO’s market capitalization of USD 1.2 billion as a bubble because we only have 30 ~ 40 employees,” said Da. However, when you look at the scale of the Smart Economy, it’s not so easy to dismiss it as a bubble.
Da confidently stated that “Apple’s market capitalization surpassed USD 1 trillion, but the total cryptocurrency market size is less than USD 220 billion. In 5 or 6 years, I believe blockchain technology and the industry as a whole will have a more significant effect on society than other tech companies such as Apple, Amazon, Microsoft, Google, and Facebook.”
◇ The tokenization of everything
If you think of buses when you hear the word token, that means you are from the previous generation. Token, a word usually heard when riding buses, is now much more closely associated with blockchain.
‘A certificate of rights for a specific or pre-promised commodity or service’ is probably the most common meaning for a token. It’s a type of ‘bond-debt certificate.’ The token issuer has a responsibility to provide the promised commodity or service to the token purchaser, similar to bus tokens or casino chips. Only a person holding chips can be allowed to participate in the casino games. Because the ownership physically changes hands, they are also called ‘physical tokens.’
If digital means are added to physical tokens, they become ‘digital tokens.’ Digital tickets with limited features, such as mobile movie tickets which only have one function, would be considered digital tokens.
If exchange or buy/sell features are added to digital tokens, they become ‘digital currency.’ Digital tokens can only be exchanged for pre-promised commodities or services, but digital currencies can perform a relatively large range of exchange and buy/sell features. Online vouchers provided by credit card companies and online gift vouchers fall under this category. They can also be exchanged for legal tender through offline markets.
If digital tokens are generated on blockchain platforms such as Ethereum, they become decentralized application tokens (DApp tokens), and these DApp tokens are again categorized into ‘utility tokens’ and ‘security tokens.’
Utility tokens are tokens that grant access rights to the various services and networks provided by a DApp. If you have utility tokens, you can use them to use the services provided by the token issuers. Security tokens also signify the ownership rights of the DApp, just like securities. The revenue of the relevant DApp is distributed in the form of dividends. It is the form of a token but underneath it all, it’s similar to stocks, except that the circulation is more convenient compared to stocks.
The majority of the market is comprised of utility tokens. As of July 2018, 337 projects out of a total of 413 ICO projects (82%) issued utility tokens. Security tokens accounted for only 14 projects (3%).
Utility tokens are popular because it is easier to avoid regulatory issues. The Swiss financial market supervisory organization FINMA split tokens by these categories and announced guidelines for each. FINMA stipulated that security tokens are tokens that have the same rights as bonds or equity interests. As such, security tokens are considered stocks and must follow financial market regulations. That means a securities report must be issued whenever a token is issued. Utility tokens can operate outside of the regulatory system.
The US applies the Securities Act for security tokens. As Jay Clayton of the US Securities and Exchange Commission pointed out, “If the revenue for the investment is returned, these will be considered to be stocks and are therefore subject to regulations.” Only one project amongst all US ICO projects has issued a security token. If the token is categorized as a security token, it must register with the SEC, and since the customer’s identity can’t be anonymous, a release of information (KTC) process is required as well.
The US evaluates security tokens based on the ‘Howey Test,’ a test created by the Supreme Court to determine whether oranges should be considered stocks when the Howey Company distributed orange revenue to land purchasers. (A precedent was set that if investors were guaranteed revenue from oranges, oranges could take on the characteristics of stocks.)
The Howey Test standard must fulfill the following conditions:
1. Money has been invested.
2. Profit was expected from the investment
3. Invested companies have shared goals.
4. Profit is generated from third party individuals or personnel related to the company, not the investors.
Even if the token claims to be a utility token, it will be considered a security token if the above conditions are met according to the ‘substance over form’ principle.
Security token status may also be determined by whether it has sufficient value as a cryptocurrency if the issuer is decentralized or if there is labor involved. The token will be determined to have the nature of a stock if the investor has made a profit without any labor. Due to these conditions, some security tokens are falsely issued as utility tokens by adding a condition where rewards are provided for participating in at least one survey per month.
Despite the regulatory restrictions, the industry is expecting security tokens to be more prevalent in the future. This is because assets can be digitized with security tokens. For example, if real estate is tokenized, token holders can enjoy profits when real estate prices rise. If the asset is a work of art that can be exhibited, investors can receive profits when the price of the artwork has risen as well as from lending fees to exhibitors.
The most attractive point for security tokens is that everything is automatically processed through smart contracts. Voting on company operation decisions or the date and amount of dividend per share are all automatically and transparently processed through smart contracts.
“All stocks will be converted to security tokens within five years and the scale will be hundred times that of the current stock market,” stated Overstock CEO Patrick Byrne during a press conference last April when he visited Korea. Before that, former NASDAQ CEO Bob Greifeld anticipated that all stocks and bonds would be converted to security tokens within five years. At a blockchain event held in Toronto last August, cryptocurrency project Polymath CEO Trevor Koverko asserted that “Security tokens will save the cryptocurrency market.”
Blockchain-based investment bank platform Finhaven CEO DH Kim gave a presentation on the utility of security tokens at UDC 2018. He introduced a number of cases where blockchain technology could positively impact the capital market, including global market expansion, different cost reduction opportunities, high asset liquidity, fast balancing, and safe and uncorruptable data.
※ Referenced speeches (The speeches can be viewed in their entirety on the UDC 2018 YouTube page)
- ‘Blockchains and the Smart Economy’ by NEO founder Hongfei Da
- ‘Security Tokens and Blockchain Technology’ by Finhaven CEO Kim Dohyeong
*This post is a translated excerpt from Proof of Report UDC 2018 written by Ran Ko, CCO of Join:D, a blockchain media affiliated with JoongAng Daily.