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What is tokenization?

Understanding Tokenization: The Future of Asset Ownership

Tokenization will fundamentally transform how we fund, trade, and manage assets, with the potential to disrupt nearly every industry and sector of modern society. Its implementation spans from investing and asset management to manufacturing, real estate, and even art. Conservatively, the total market value of tokenized assets is projected to exceed USD 10 trillion by 2030. In this article, we explore the fundamentals of tokenization, its challenges, and key Shariah perspectives on its implementation.


Key Highlight
  • Tokenization transforms real-world or intangible assets into digital tokens on a blockchain, enabling secure and decentralized transactions.
  • The process involves asset identification, token creation, issuance on a blockchain, and trading through secure digital platforms.
  • Tokenization applies to assets like real estate, currencies, securities, and utility tokens, expanding investment opportunities.
  • Tokenization enhances liquidity, accessibility, transparency, efficiency, and global market reach.
  • Regulatory uncertainties and technical issues such as scalability pose challenges to adoption.
  • Tokenization is permissible in Islamic finance if it adheres to Shariah principles, enhancing transparency and ethical financial practices.


What is Tokenization?

Tokenization is the process of converting real-world or intangible assets into digital assets tokens that exist on a blockchain or digital ledger. Each token represents ownership or rights to the underlying asset. These assets can range from tangible items like real estate and art to intangible assets like intellectual property or financial securities. Tokenization enables the creation of a digital representation of an asset, facilitating secure, efficient, and decentralized transactions.

Blockchain technology is the backbone of tokenization, offering a transparent and tamper-proof environment where transactions can be securely recorded. By leveraging blockchain, tokenization enables fractional ownership, making traditionally illiquid assets accessible to a broader range of investors.



How Tokenization Works

The process of tokenization involves several steps that transform an asset into digital tokens:

  • Asset Identification: The first step is to identify the asset to be tokenized. This could be physical assets like fiat money, asset waqf, real estate, commodities or intangible assets such as intellectual property, halal certificate.
  • Token Creation: A digital token is created (mirroring process) to represent ownership of the asset. Smart contracts, powered by blockchain technology, are used to manage the tokens and enforce the rules governing their transfer and ownership.
  • Token Issuance: Tokens are issued on a blockchain platform. These tokens are typically backed by the value or rights of the underlying asset.
  • Trading and Management: Once issued, tokens can be traded or transfered on digital platforms or exchanges. The blockchain ensures transparency and security by maintaining a decentralized ledger of all transactions.


Types of Tokenization

Tokenization spans various asset classes and purposes, enabling diverse applications:

  • Asset Tokenization: In real estate, tokenization allows property ownership to become fractional, enabling individuals with smaller budgets to invest in real estate. This democratizes access to an asset class that has traditionally been limited to those with substantial capital. A similar trend is emerging in the art world, where high-value artwork can be tokenized. This innovation enables people from diverse backgrounds to invest in pieces that were once exclusive to high-net-worth individuals.
  • Currency Tokenization: Cryptocurrencies like Bitcoin and Ethereum are prime examples of tokenized digital currencies. They serve as decentralized alternatives to traditional money, providing new ways to store and transfer value.
  • Security Tokenization: Security tokens represent ownership of traditional securities such as stocks, bonds and sukuk but in a digital form. They combine the transparency and traceability of blockchain technology with the regulated nature of traditional financial markets.
  • Utility Tokenization: Utility tokens provide access to specific products or services within a digital platform.


Benefits of Tokenization

Tokenization offers transformative advantages for businesses, investors, and markets:

  • Enhanced Liquidity: By enabling fractional ownership, tokenization revolutionizes markets like real estate, fine art, and collectibles, making traditionally illiquid assets more accessible and tradeable. This allows for greater flexibility in asset management and quicker conversion into cash.
  • Accessibility: Tokenization democratizes investment opportunities by allowing smaller investors to participate in asset classes that were once exclusive, such as real estate, art, or startups. This opens up new avenues for wealth creation and financial inclusion.
  • Transparency and Security: Built on blockchain technology, tokenization leverages an immutable ledger that records all transactions. This ensures complete transparency in asset ownership, provenance, and movement, while simultaneously reducing risks associated with fraud and mismanagement.
  • Efficiency: Smart contracts streamline and automate transactions, eliminating intermediaries and minimizing manual processes. This not only speeds up the execution of agreements but also significantly reduces the costs and time traditionally involved in completing transactions.
  • Global Reach: Digital tokens can be easily traded across borders without the need for intermediaries, enabling businesses and investors to access global markets efficiently. This connectivity fosters cross-border investment and international liquidity.


Challenges of Tokenization

Despite its advantages, tokenization faces significant two challenges [1]:

Regulatory Challenges: The tokenization of assets faces several regulatory challenges, largely due to the lack of clear and comprehensive legal frameworks. Tokenization involves transforming real-world assets into digital tokens, which introduces complex interactions between financial regulations and technology. One of the primary regulatory challenges is the lack of clear, globally unified regulatory frameworks for tokenized assets. Different jurisdictions have varying rules regarding the issuance, trading, and custody of digital tokens, leading to uncertainty and compliance risks for businesses and investors. Additionally, regulations related to anti-money laundering (AML), combating the financing of terrorism (CFT), and consumer protection need to be effectively applied to tokenized assets. The continuous evolution of these regulations means that businesses may struggle to stay compliant, potentially facing legal repercussions or fines.


Technical Challenges: Tokenization relies heavily on blockchain and distributed ledger technology (DLT), which, while efficient, presents technical hurdles. One major technical challenge is scalability—blockchain networks must be able to process large volumes of token transactions without compromising speed or incurring high costs. Additionally, interoperability between different blockchain platforms and the security of tokenized assets can be complex. Smart contracts, which are often used in tokenization, must be coded carefully to prevent bugs, vulnerabilities, and exploitation. Moreover, the technology requires a balance between decentralization and performance, which can lead to trade-offs that impact the overall efficiency and reliability of tokenization systems.


Insight: How Islamic Perspective See the Tokenization

In Islamic jurisprudence, transactions related to muamalah (worldly dealings) are fundamentally permissible unless there is specific evidence prohibiting them. When discussing tokenization, the halal or haram nature depends on the object being tokenized. A token becomes impermissible if it involves one or more of the following prohibited elements: riba (usury), gharar (excessive uncertainty), maysir (gambling), or association with non-halal (unlawful) products.

Conversely, tokenization that enhances transparency, traceability, authenticity, and sustainability aligns with Islamic principles and the objectives of Maqasid al-Shariah (the higher objectives of Islamic law). These objectives emphasize preserving wealth, ensuring justice, and promoting societal welfare.

For instance, tokenization can be utilized for recording physical assets such as real estate, waqf properties, and halal certificates. It also serves as an effective system for managing Islamic social funds, fostering transparency and accountability. Such applications not only comply with Islamic ethics but also embody the values of integrity and trust central to Islamic teachings.


Conclusion

Tokenization represents a groundbreaking shift in how assets are managed, traded, and owned. By enabling fractional ownership, enhancing liquidity, and democratizing access, it has the potential to reshape traditional financial systems. However, challenges such as regulatory complexities and technological dependencies must be addressed to unlock its full potential.

In Islamic finance, tokenization offers an exciting opportunity to align innovation with Shariah principles, paving the way for a more inclusive and transparent financial ecosystem. As technology evolves, tokenization is poised to play a critical role in transforming global economies.


AUTHOR(S)

Ganjar Primambudi is a Research Executive at iBantu.co , with a focus on the intersection of Islamic economics, sustainable finance, and technology.

What is tokenization?
Ganjar Primambudi February 4, 2025
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