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The toys will be tokenized first

TL;DR

  1. Everyone loves toys
  2. Toys are easy to tokenize, because (i) they don’t hold legal fees and potential legal liabilites (ii) no one expects nothing from them other than to have fun
  3. Conclusion: the toys will be tokenized first

“the next big thing will start looking like a toy” (Chris Dixon)

“the tokenization of everything”

The concept of the tokenization of everything was a prevalent thesis in crypto during 2017/18. Yet, during the last crypto cycle of 2021, this term wasn’t mentioned as much.

This thesis broadly posits that in the same way the internet shifted the world from being offline to online, blockchains will transform the world from being off-chain to on-chain. In practical terms, this indicates we should see the tokenization of real-world assets. Assets like real estate, stocks, bonds, and any physical asset could gain digital representations on blockchains as tokens. I aim to explain why this thesis hasn’t fully materialized yet, and how I envision it most likely playing out in the coming years.

The concept of tokenizing everything does make a lot of sense. Using blockchains like Ethereum, one can have 24/7, permissionless global markets that are composable and standardized. They’re open to everyone worldwide, maintaining neutrality without ownership by any specific nation state. This represents the most compelling embodiment of the globalization vision - global neutral markets serving everyone.

Over the past two years, DeFi protocols have demonstrated that we can construct financial primitives we know from traditional finance on blockchains, such as exchanges, swaps, borrowing and lending markets, and derivatives.

We’ve seen they can operate at scale without breaking down, even under extraordinarily high usage and adverse conditions. They provide a robust system for tracking valuable assets. For instance, Ethereum settled $11.6 trillion in 2021, more than Visa.

This vision for the tokenization of everything is undeniably captivating. Yet, if I’m being pragmatic, we’re not yet seeing many signs of this occurring. Currently, the only tokenized asset at scale is probably backed stable coins, with assets like USDC. USDC, a tokenized dollar, is operated by the company Circle. They lock dollars in a bank account and create a 1:1 token representation of a dollar on the blockchain called USDC. Right now, approximately $55 billion dollars of tokenized USDC dollars exist, alongside others such as Tether. But that’s about it. No other real-world assets are tokenized at scale.

So why hasn’t this thesis fully materialized yet? Let’s explore why, starting with an example.

If someone wishes to tokenize a real-world asset, say a building they own in Tel Aviv, they’d want to create a digital token that represents ownership in that building. The token should be transferable and compatible with any DeFi tool like decentralized exchanges. Perhaps you’d want to use this token as collateral and borrow against it. Hence, it should be compatible with DeFi tooling.

This person faces two primary challenges:

High legal friction and costs: Ownership of real estate is managed locally by nation states via somewhat isolated databases of property ownership, each with its unique set of rules. If I own a building in Tel Aviv, there’s a record with my name in the database of the Israeli Land Authority stating my ownership. To transfer this building, I need to comply with their rule set. They might require the asset transferee to be an Israeli citizen or undergo a complicated KYC process, among other rules. If I want to tokenize real-world assets, I inherit the properties and rules that these assets comply with. Therefore, I need the original rule set owner’s consent for a digital blockchain transfer to be acknowledged as a valid transfer. Even if authorities were open to the tokenization of real-world assets, which is generally not the case due to lack of understanding of blockchain systems, the process would be costly and set a high threshold for asset tokenization.

Lack of users: Even after overcoming legal costs and friction, the next hurdle is the lack of users. Few people want to invest in real estate on the blockchain. Traditional real estate investors generally don’t grasp the concept, often finding it odd and unclear.

This creates a classic chicken and egg problem. The vision of tokenization is compelling, but factoring in the legal costs and lack of users, how exactly do we practically transition to tokenizing everything? How do we progress from point A to point B?

I believe there’s a way this could unfold, and I want to share a mental model to help envision how this can happen. I’ll use two examples: Unisocks and a startup called Blockbar.

Unisocks

In 2019, Uniswap, currently the largest decentralized exchange, created 500 SOCKS tokens. The idea was that these tokens were “backed” by an equal number of physical, limited-edition pairs of socks. Unisock holders could convert their tokens into socks by redeeming them, effectively taking them out of circulation. Unisocks was a great success, trading at a peak of over $150 thousand per pair of socks, and generating millions in trading volume.

This was undoubtedly taken to an extreme with speculation, but I see no regulator chasing after tokenized sock creators. Hence, we have a perfect example of a tokenized digital artifact, free from legal costs, with speculation bootstrapping demand.

Blockbar

Blockbar is a startup that lets you purchase tokenized, high-end spirit bottles. They auction rare bottles such as 1973 Glenfiddich single malt scotch whisky, providing a redeemable NFT as a claim on the actual bottle. The NFT is fully backed, while the physical bottle is securely stored on their premises.

Blockbar collaborates with well-known brands like Glenfiddich, Hennessy, and Johnnie Walker. Tokenizing spirits is another excellent example of something regulators like the SEC don’t care about, and that people enjoy speculating with.

What I am attempting to convey is that we should start with tokenizing things that are easy to tokenize—the low-hanging fruit of tokenization.

Things that are easy to tokenize are those that regulators like the SEC don’t care about. These are items with no legal costs or friction associated with their tokenization; they’re toys in the eyes of regulators.

Chris Dixon has a famous quote: “the next big thing will start looking like a toy”. This concept will be taken to the extreme in cases like Unisocks.

When you tokenize toys, you overcome the problems of tokenization - no legal friction or costs - and you can bootstrap demand with speculation. Speculation for toys is easy, simple, and doesn’t require investors to adopt your technology. People will participate because it’s fun.

Adoption in crypto doesn’t start with the obvious use cases. It begins with the sidelines and speculation, then creates a rapid feedback loop, generating demand for tooling, which in turn creates more use cases and attracts more users.

At a later stage, this will enable real estate to enter the blockchain.

Adoption starts from things like Unisocks and whisky bottles and culminates with real estate and other real-world assets.

Obvious use cases are trading cards, collectibles, spirit bottles, expensive watches, and potentially cars at a later stage. The more toys get tokenized, the more infrastructure will be built, and the more users will adopt the core tech.

I believe we will see a lot of real-world assets get tokenized in the next few years - but they won’t be real estate or traditional assets with complex legal structures embedded in them.

The toys will be tokenized first.