Cryptocurrency

Benefits of Asset Digitalization |


In today’s world, everything is digitized. And that’s not just all our information; our books, news, movies, music, and paintings. Even our social connections, friendships (via social media), attention (content views), approval (likes), and support (crowdfunding) are digitized. Against this background, the digitalization of money, business processes, mutual obligations, contracts, and so on, already seems quite natural, necessary and even inevitable.

Digitalization of physical assets

It’s unsurprising, therefore, that digitalization is beginning to affect physical, and not just financial, assets. What does this mean in practice? Of course, unlike a book or a film, a material asset cannot (at least for now) be directly transferred from the physical world to a realm of pure information. But we don’t actually need to do that. What we really require, after all, is the ability to perform specific operations with an asset; for example, buying, selling, pledging, renting, etc. All of them are informational operations and therefore lend themselves perfectly to digitalization. That simply entails creating a digital equivalent of an asset; its counterpart or mirror in the world of information. Having done so, a house (for example) wouldn’t be significantly different from any computer file, or indeed merely a string of symbols: we could perform any operations with it that the underlying system allows.

Just imagine all the limitless possibilities that this approach enables!

From an economic and legal perspective, this equivalent would be a special digital commitment (IOU) backed by an external asset. We might describe it as a kind of “Gold Standard”; the monetary system in which each note is supported by a specific amount of gold stored in the state reserve, and can be exchanged for it. So here, we have a “banknote” — a digital equivalent — and the “gold” that backs it is the physical asset.

Moreover, unlike banknotes and gold, both of which are fungible, digital equivalents can represent both fungible (for example, grain) and unique, non-fungible assets (for example, a specific land plot).

Why do digital assets need digital equivalents?

In fact, equivalents’ usefulness isn’t restricted to physical assets. They can be used to facilitate operations with any assets, including those that already have a digital form. This could include, for example, cryptocurrencies or any other forms of digital money (including fiat money), or even documents and so on.

But why would we need to create a digital equivalent of a cryptocurrency? After all, you’d think cryptocurrencies are already sitting pretty squarely in the world of pure information. But in reality, this isn’t quite the case. Most crypto projects today are, in fact, enclosed in their own blockchain ecosystems, having very weak links (if any) with other ecosystems.

Yes, it is quite easy to send a Bitcoin across the world to another Bitcoin user. But at the same time, it’s quite difficult to send the same Bitcoin to, say, a Dash user. And even harder, for example, to safely lend your Bitcoin to someone — especially if that someone is not only on another continent but also uses a regional bank account in local currency only. And what if your recipient doesn’t have a bank account at all, instead of using sunflower seeds for all their transactions? And if we want to lend a Bitcoin to a user of sunflower seeds located on another continent — not now, but in a year, and only if by that time the price of sunflower oil is not less than $1000 per ton? How to do all this on the Bitcoin blockchain? Or on any blockchain, even one that offers smart contracts? Indeed, it’s one thing to make a smart contract for an ICO, and quite another for something like a situation described above, where the objects involved are completely different entities from completely different technological realms.

Of course, we exaggerate a little here, but we do it only to illustrate what uses equivalents can have in the modern world — where we deal not only in paper money, yields, and cryptocurrencies, but also real estate, credit cards, and ETH futures. In other words, we are talking about the possibility of transferring assets between incompatible platforms.

We would like to be able to manage all of this as easily and as freely as we now manage information on our laptop, tablet, or mobile phone, without thinking about the natural limitations of particular assets and native systems that support their existence. Moreover, it’s desirable to undertake this using a single, common, user-friendly interface, without thinking about the nuances of the underlying technology.

That’s exactly what equivalents are needed for: to gather it everything together, in a kind of unifying system that allows us to do all the above.

What other advantages does the digitalization of assets provide?

Another advantage of using equivalents is that this method of transferring assets can increase their turnover rate. In the first instance, of course, this concerns physical assets. But we’re not limited to them.

Let’s consider, for example, the case of securities tokenization. Tokens of a public company’s stocks can be easily exchanged on digital exchanges. And this is much easier and faster to do than to circulate the actual securities, even if we are talking about traditional stock exchanges. This ease and speed lead to an increase in the liquidity of securities. Liquidity inevitably leads to faster circulation, which in turn increases the overall economic effects.

Furthermore, the reliability and safety of such operations wouldn’t suffer. Rather, they’ll improve, because tokenization will minimize the human factor as much as possible, as well as removing the necessity of intermediaries, and therefore will drastically reduce possible errors and/or manipulations. After all, the records of all transactions will be reliably protected by a blockchain, transparent and public (if necessary), and all necessary restrictions — legal or otherwise — can be encoded in the logic of smart contracts.

Returning to physical assets, it’s worthwhile pointing out the possibility of their virtual fragmentation as another advantage. Just as an example, let’s say you have some kind of real estate with a total value of $100,000. But you urgently require funds, say, to the amount of only $10,000. Can you sell only 10% of this property in a traditional market quickly and without problems? That kind of feat would be extremely difficult, almost impossible.

Or take a look at the same problem from the opposite side: you have $10,000 and you would like to invest this money in real estate. Again, from the point of view of the traditional real estate market, this intention looks quite strange due to the relative insignificance of the amount.

How can digitalization help? You can issue a certain number of equivalents backed by the physical asset — in this case, the real estate. This number can be arbitrary; it could equally be, for example, 100 or 100,000,000 tokens. Furthermore, we can put all or part of them into circulation. Anyone who acquires a certain amount of these equivalents will receive a part of the rights to own this property. If we issued 100,000,000 tokens, then in order to get the necessary $10,000 we would sell 10,000,000 of our tokens.

Thus, the release of a digital equivalent of a physical asset makes it possible not only to perform unusual transactions, which would be very difficult or simply impossible to carry out using traditional means but also creates the possibility of involving a large number of small investors. In transactions with digitalized assets, the entry threshold could become much lower, both in price and in purely organizational terms (it is much easier to carry out operations with digital assets). And this, in turn, has very positive economic effects as well.

Is it really so seamless?

But, of course, there are still some issues to be overcome — particularly when it comes to the digitalization of physical assets. With equivalents of digital (crypto) asset, everything looks somewhat simpler: their circulation can be regulated, and the striсt fulfillment of transaction conditions by all parties can be enforced by smart contracts (using operations in the corresponding blockchains, which are trustless systems by design).

But in the case of physical asset equivalents, on the contrary, we face the problem of trust. After all, owning equivalents means we possess equivalents alone, and not the assets themselves nor any clearly legally certified rights to them. What happens if the company that holds the actual rights to the tokenized property (from the previous example) simply sells this property to a third party? How can the holders of the tokens, backed by this asset, guarantee their property rights?

This problem exists because there is no legal basis yet for providing such a business model in most countries. On the other hand, the introduction of such laws will mean the introduction of some degree of centralization into a decentralized model. Thus, in order for the model of digitalization and circulation of equivalents of physical assets to existing effectively and safely, we will either have to accept this element of centralization or carry out such operations at our own risk and peril. We would have to assess our trust in issuers of certain equivalents, and hence the degree of risk associated with transactions with them.

Essentially, the second option is quite viable and may well exist. Another issue is that true decentralization will inherently entail decentralized distribution of responsibility, as well as risks. One just has to be aware of all this.

There are mechanisms available for the implementation of trust-based operations; trustlines, for example. Moreover, this trust can also have a networked nature. Operations based on trust can well be carried out between two unfamiliar counterparties, provided that a transaction path is found that consists of other counterparties with pre-established trusting relationships. This is called the transitivity of trust.

What would technical implementation look like?

It looks like this: A user brings in a certain asset — for example, Bitcoin — into a network, by freezing this Bitcoin on his wallet and releasing its equivalent. Let’s call this equivalent #network_name #bitcoin, which will then circulate within this network and is equal to 1 BTC.

Another option could be a pledge of an asset (digital or physical) held by a third party that checks its validity, and guarantees the exchange of issued equivalents to it, thus acting as a kind of custodian.

One can create an equivalent of virtually anything. As we mentioned above, this is not limited to cryptocurrency but could include any object or asset. In addition to the backed equivalents, there may be non-backed ones (for example, you can create an equivalent of Bitcoin without freezing Bitcoin itself). But in this case, you will have to trust that the issuer can later exchange the equivalent directly for the asset.

All operations with the equivalent can be carried out outside the Bitcoin blockchain (off-chain), but only in a system that provides such functionality. This will not only lower the load on the main blockchain but can also significantly reduce the cost of operations while making it easier to exchange assets (or rather, their equivalents). After completing the desired transactions, it’s possible to perform the reverse conversion of equivalents into the corresponding assets.

Which projects are already implementing this?

The mechanism of multi-equivalence is used by a number of projects.

Ripple is one of them. This system allows payments to be made in the system’s native currency: XRP. In that case, transactions will have a trustless nature. But it’s also possible to create an IOU based on the issued equivalents backed by external assets. Trustlines are used for transactions and other operations involving them, as we already mentioned above.

Stellar also allows users to bring various cryptocurrencies, financial and physical assets into its system, convert them into equivalents and trade them (with essentially the same IOU obligations) on the decentralized Stellar exchange. The input of external assets is carried out through special mechanisms called ‘anchors’, which are responsible for storing the acquired assets, for converting them into equivalents, and for the reverse exchange.

Projects like Polymath, Harbor, and others could be reviewed separately. These projects specialize in the tokenization of digital assets, and, as a result, the transformation of stock markets, real estate markets, etc. These projects use tokens as the equivalent of securities, ownership rights for real estate, and so on.

GEO Protocol

GEO Protocol is a distributed peer-to-peer (P2P) network, which is not built using a traditional blockchain framework. Thus, all units of circulation within the GEO network are equivalents (IOUs), referred to as “asset equivalents”.

What is an asset equivalent? It’s not an asset itself, but its counterpart used within the GEO network (the backed asset equivalent), or the “native” unit of the GEO network (that is, created exclusively within the network, the non-backed asset equivalent).

Asset equivalents, whether backed or non-backed, can be created without limitation by any member of the GEO network, and then freely exchanged between users and members of the system.

The register of equivalents in the GEO system is created on the Ethereum blockchain. In order to prevent spam or the mass creation of unnecessary equivalents, a given fee is charged for creating a new asset equivalent, which is outlined in the corresponding smart contract.

All operations in the GEO network occur off-chain. The basis of the transport infrastructure in GEO Protocol is the so-called ‘сomposite channels’, a combination of trustlines and state channels. Non-backed asset equivalents, as well as asset equivalents backed by external physical assets, use trustlines to transfer from node to node. At the same time, state channels are used to transfer equivalents backed by external crypto assets, allowing GEO to interact with external blockchains through multisig transactions using multisig addresses.

Thus, in the case of crypto asset transactions, the default trust-based environment for the GEO network turns into a trustless transaction environment. However, the greatest advantage of GEO Protocol is that the equivalents of all possible types of assets can interact within the network, which provides the necessary flexibility, cross-chain interoperability, and scalability of the system.

The architecture of GEO Protocol provides for off-chain smart contracts involving several equivalents, which in turn allows the creation of complex systems of interaction. In its simplest form, this could involve decentralized asset markets (DEXs). In more complex cases, these can be programmable processes involving several asset types, as well as external conditions governing their interaction such as contract terms, legal rules, legislative restrictions, and so on — all of which, in turn, can also be digitized.

Conclusion

Digitalization of assets makes it possible to unify the exchange of assets from different “worlds” (digital and cryptocurrency, legacy financial, and even physical assets) into a single system. But it also has positive economic effects, such as an increase in liquidity and asset turnover, a lower entry bar for investments, higher investment volumes, and more.

However, digitalization is hampered by the challenge of protecting the property rights of physical and external financial assets holders, as well as the problem of guaranteeing equivalents’ liquidity in relation to the tangible assets that support them. So here we must choose either compulsory trust in issuers and the resultant shift of responsibility and risks onto end users, for the sake of maintaining greater decentralization of the system. Or allowing a degree of centralization by recognizing the need for external legal and legislative regulation, control, and audit.

But taken as a whole, the challenges are neither critical nor intractable, and therefore cannot prevent the further development and adoption of the technology described here.

Several projects are already trying to bring this (at least partially) to life, and GEO Protocol is one of the most promising among them.



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