Analysis of the Advantages and Disadvantages of On-Chain Physical Assets

This article was first published on June 1, 2020, in the Baihua Blockchain public account, authored by Yan.

1. What is the on-chain of physical assets?

For example, what would the process look like for Dabai to purchase a house in a blockchain environment? In this process, tangible assets are converted into a form that can be managed, stored, and traded in digital space. In short, this provides a way for Dabai to manage asset records instead of intermediaries. The software environment provided by blockchain includes custody, trading platforms, clearinghouses, and legal registries, all of which are embedded in the tokenization of assets.

Additionally, other participants on the blockchain verify and store information related to the asset in real-time and permanently, reducing the need to trust central authorities and third parties. Finally, tokenization can divide assets into multiple parts, allowing for multiple owners when needed; ultimately, this is the decentralized "securitization."

2. Tokenization Trends

In the past year, the tokenization of real-world assets has garnered a lot of attention. Actual physical objects do not change simply because they are on the blockchain, but tokenizing physical assets on the blockchain does enhance the transparency of "who owns the asset." It creates a decentralized source of truth for matters such as commodity trading, auctions, or real estate development.

Taking blockchain agriculture as an example, tons of corn, wheat, and other goods are traded and delivered between suppliers every day. These handovers typically involve contracts regarding quality, compensation, and delivery times. With tokenization, these contracts can be processed on the blockchain using a single source of real-time data regarding the status of wheat, corn, etc., at any given time.

3. Fungibility vs. Uniqueness

Assets and their tokens can be both fungible and unique. Fungibility refers to the ease of substituting tokens and assets for one another; for example, one pound of silver is equal to another pound of silver (as long as the quality is the same), and they can be subdivided and traded accordingly.

Unique assets cannot be easily subdivided or declared as equivalent assets. A ship is a unique asset because it cannot be immediately exchanged for another ship. While you can subdivide a unique token (e.g., owning one-third of a ship), it may not necessarily be traded in the same way as fungible assets. Both fungible and unique assets can exist on the blockchain.

4. Ownership vs. Limited Rights

Another way blockchain can simplify rights management is by clarifying ownership versus limited rights.

For example, a landlord owns a property and can rent it to a tenant, who does not have the same rights or responsibilities as the landlord; limited rights can be built into smart contracts. Limited rights apply to ideas such as streaming services or galleries renting artworks from private collectors. These types of smart contracts may be more complex, but they are easier to manage and understand on the blockchain compared to traditional written forms.

Benefits of on-chain physical assets:

1. The immutability of blockchain proves ownership

We already know that blockchain has an immutable characteristic, and this feature can be effectively transferred to tokenization. The digital historical record of transactions helps each stakeholder and investor prove their ownership.

At the same time, this structure also helps reduce opportunities for fraud. If a token owner attempts to sell a token multiple times or tries to transfer a token to multiple investors, this structure will display the exact historical record of ownership, making it impossible for them to forge transactions and deceive investors.

2. Programmability allows for automation, improving transaction and sharing management

The ability of smart contracts to incorporate different business logic refers to programmability, which helps establish automated events when certain conditions are met. This means better pre-established rules. Tokenization also makes management easier for investors.

By relying on third-party exchanges, secondary transactions can be tracked without introducing any complexity. Since tokens can contain built-in compliance, this programmability is very helpful for speeding up settlement times.

3. Improved liquidity

Tokenization itself increases the opportunity for fractional ownership. Legal tender like the dollar can only go as low as $0.01, but tokens can have up to 18 decimal places, meaning that unless certain restrictions are put in place, the price of tokens can be much lower.

This means that the opportunity for investors to enter the market is significantly lower, and there is much more room for ownership. For example, investors do not have to invest $100,000 in a specific real estate property but can pay $5,000 for fractional ownership of a tokenized asset.

However, there is also a fatal drawback. The real challenge of putting physical assets on the blockchain is the permanence of blockchain transactions. For instance, if the deed to your house is on the blockchain and your mortgage provider accidentally sends it to the wrong recipient address, this action cannot be changed. Worse still, if that address belongs to someone, they now own your house!

Even a court lawsuit cannot reclaim your house. The only way is to reach a consensus on a blockchain fork, solving such irreversibility issues is key to the success of physical assets on the blockchain.

5. Conclusion

On-chain physical assets can simplify many supply chain, logistics, and contract management issues. However, this technology has some drawbacks that may pose challenges to usability. Before such systems operate, we need reliable transaction methods to verify identities, avoid errors, and adjudicate disputes.