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Tokenization: what is it, and how does it impact financial services?

Published on Jul 20 2023. 17 minutes reading

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The process of digitalizing data using blockchain technology, which was the technology that made it possible to create cryptocurrencies, is causing another revolution: tokenization.

With this innovation, multi-asset markets become more accessible, integrated, and extremely secure, allowing for the massive entry of new investors. Furthermore, in a context of high circulation of personal and financial data, security becomes a priority in all sectors, especially the financial sector.

The expected impact of negotiating tokens is immense. According to an estimate by MarketsandMarkets, asset tokenization will be responsible for expanding the market from US$ 2,3 billion in 2021, to US$ 5,6 billion by 2026.

On the other hand, tokenization is also a key factor in data protection in an increasingly digital world.

In this article, we will discuss what tokenization is and how it works, as well as explore in more detail its applications and its impact on financial services.

What is tokenization?

The tokenization process consists of transformation of an asset or data into a token. In others, it is the process of transforming an asset or data into a digital representation of it, which contains its essential information.

What can be tokenized?

It is possible to tokenize data, assets, and transactions, and this, in fact, defines the different types of tokenization: protection of personal data (such as CPF, email or bank details); financial transactions (payments by card or via apps); and asset representation (such as real estate, agricultural crops, or works of art).

Asset tokenization

Any asset or right that has financial value can be converted into a type of “symbol” or “token”, called a token.

Tokenization is the process of digitally representing an asset, whether it is originally digital or tangible. A token can represent the entire asset or just a fraction of the original asset.

Once an asset is tokenized, its "file" is public and verifiable. From that moment on, it is no longer possible to make any changes or trades on the tokenized asset without proper registration. This transparency provides excellent anti-theft security.fraude.

Data tokenization

McKinsey’s data tokenization consists of a technique that replaces sensitive data—such as CPF or card numbers—with tokens to protect them. In this case, randomly generated codes made up of letters, symbols, and numbers have no value outside the secure context in which they were generated.

Thus, if an attacker manages to access the environment, he will not have access to the real data, but to a random and indecipherable code.

What are tokens?

These are digital representations of an asset or piece of data. In the first case, the token is a virtual record containing all the essential information about the asset or product, used to facilitate its digital management and trading.

In the case of data, the token is, as we mentioned, a code created in the tokenization process that will be used to replace real information and prevent unwanted access to it.

How does tokenization work?

Tokenizing assets is like issuing shares of an asset, property, or right. The asset is tokenized using end-to-end encryption integrated with technology. blockchain.

The programming language that registers the token is where the asset’s characteristics, the rules for identifying its owners, and the ways the asset can be traded in smart contracts are defined.

Tokens can be classified as fungible or non-fungible (NFTs, or non-fungible tokens), depending on the asset they represent:

Fungible token: the asset represented may be replaced by another of the same type, quality and quantity.
Non-fungible token (NFT): In general, the asset represented has an exclusive characteristic, with no direct equivalence with another asset.

The simplest examples of NFTs are those associated with works of art. After all, a Picasso painting cannot be replaced by a Van Gogh painting, and vice versa. In other words, tokens representing these assets, while both correspond to highly valuable works of art, are not direct or equivalent substitutes.

What is tokenization for?

By converting data into a non-confidential digital substitute linked to the original – the token – the main purpose of tokenization is protect confidential information.

For example, when you make an online purchase and provide your card number, instead of transmitting and storing the actual number, the security system generates a token that specifically represents your card for the transaction. While the token is used for the transaction, the original data remains secure in the "token vault”, a kind of digital safe.

Tokenization and data protection

Card payments, Pix e digital wallets are already part of the daily lives of those who live in an increasingly “cashless” or no money. And all this financial digitalization requires a very large exchange of data in the virtual environment.

However, personal documents, banking or card information are considered sensitive data and need to be protected – especially in a context of greater sophistication of fraudyou adore

Tokenization is a key player amid the high circulation of personal and financial data. As an effective technology for ensuring the security and privacy of sensitive information, it guarantees the digital reliability of these processes, making the environment in which we live and transact more secure.

Tokenization for regulatory compliance

Another purpose of tokenization is to help companies meet industry standards and regulatory compliance requirements, such as LGPDTo comply with data privacy regulations, for example, organizations choose to transform this information into tokens.

Tokenization vs. Encryption

It is important to know that Tokenization and encryption are different technologies. A Encryption Scrambles data using complex mathematical formulas and algorithms that must be deciphered with the correct key. If that key is discovered, it's possible to reverse-engineer it to access the original data.

A tokenization, on the other hand, completely replaces sensitive data with code that bears no logical relationship to the original information. In other words, even if intercepted, the token will not be useful outside the secure system that created it.

Tokenization in different sectors

Since any asset with economic value and tradability can be tokenized, it's reasonable to assume that it's only a matter of time before tokenization becomes widespread. At the same time, tokenized assets open up possibilities for the emergence of new business models.

Some of the most common examples of sectors that can use tokenization include the real estate market, securities market (such as stocks and bonds), art and collectible works market, precious metals market, commodities market, etc.

In addition to traditional markets, asset tokenization also creates new opportunities for investments, such as negotiating rights to the future earnings of artists or athletes, for example.

In cases like this, the professional involved benefits from the possibility of “advancing” their income to the present time, and thus being able to invest in new training and materials, for example, contributing to their future success.

The Central Bank and tokenization in Brazil

In Brazil, the Central Bank has invested in initiatives that will help promote tokenization in the country. One of the Central Bank’s main projects that seems to be accelerating tokenization is the “Digital Real.”

The Digital Real, also known as the Brazilian CBDC, will be a digital currency: a token issued by the Central Bank backed by deposits received. The advantage of a CBDC over cryptocurrencies is that it will be backed by the Central Bank, which can intervene to prevent excessive volatility, as seen with Bitcoin, for example.

The Central Bank’s efforts to create a digital currency are focused on stimulating tokenization of the Brazilian economy. At Febraban Tech 2022, the president of the institution, Roberto Campos Neto, said that tokenization “is here to stay,” increasing the efficacy and competitiveness of the financial system. He also said that the banking system is expected to gradually migrate to a tokenized system in which there will be “fewer accounts and more tokens.”

Regulation is the biggest challenge facing asset tokenization today.

The biggest current obstacle to tokenization, not only in Brazil but worldwide, is the deficient legal framework needed to regulate its operations. There is a legislative gap to be filled regarding cryptoassets: a lack of regulatory definition and the appointment of competent bodies to oversee them.

Until the challenge of regulation is overcome, tokenization initiatives might not advance, depending on the business model of the traded asset and its respective regulator.

However, once this difficulty is resolved, tokenization will lead to an explosion of new opportunities, mainly in the capital markets, in which it will be possible to tokenize companies, receivables, and securities.

In addition, the traditional market as we know it could be entirely transformed due to the agility, automation, decentralization, and transparency that blockchain technology provides.

The Regulatory Sandbox in Brazil

One action to help solve the difficulty of creating appropriate regulation for operations involving tokens is called the “Regulatory Sandbox,” organized by the Brazilian Securities Commission (CVM).

The Sandbox functions as a testing environment monitored by the CVM, in which previously authorized participants receive temporary permission to develop innovations in regulated activities.

In the Sandbox, the CVM, in collaboration with some of its regulated entities, closely observes what initiatives need to be taken to improve the regulatory framework of transactions involving tokens.

Tokenization in the sector banking and payments

The transition from using physical currency to digital currencies have been progressive and consistent in recent years around the world. Even in regions such as Latin America, where cash is still the most widely used means of payment, digital initiatives such as Pix have found surprising adherence.

This transition to digital currencies tends to accelerate with the tokenization of assets. Cryptocurrencies, in parallel with the advancement of Open Finance, will be increasingly used in token trading. Over time, it is also expected that tokens themselves will become used as a means of payment, in a sort of "modern barter."

What are the benefits of tokenization for the payment methods market?

Currently, the tokenization method is already being used in the segment of payment methods to bring greater security to the processing of digital payments, keeping the user's sensitive information confidential. This is an even more efficient method than common cryptography as a barrier in antifraud solutions.

Some of the benefits brought to the banking and payments sector by tokenization include the following:

Reduced use of physical currency, resulting in savings for countries;
Greater security in financial transactions;
Faster and simpler settlement;
Reduced brokerage costs;
Greater efficiency through the use of smart contracts.).

In addition, new products and financial services tend to arise from the consolidation of asset tokenization, promoting the expansion of the potential for raising funds, especially for small and medium-sized companies, as well as financial inclusion of the still-unbanked population, especially in scenarios such as that of Latin America.

Today, for example, banks are already exploring the issuance of debt in blockchain structures in Europe. Tokenization is also expected to reduce currency exchange fees for transactions in which funds move between countries.

Tokenization brings numerous advantages to society and financial services

Tokenization is the subject of the day all over the world, not only because it is a transformation that is currently under way, but also because it brings with it countless advantages. Democratizing access to investments in various segments is one of those advantages. With tokens, fractions of an asset can be traded, which allows investors with less purchasing power to have access to markets whose entry cost would be too high without tokens.

Another benefit is diversification of investment portfolios, because investors with very different profiles can have more asset options in which to invest their funds. By increasing the range of alternatives, the total risk of the portfolio tends to fall.

In the payment and financial services market, tokenization leads to expanded financial education content, as the population has more incentive to learn about new market segments and financial services that were inaccessible before.

Furthermore, we will have faster, safer, and more transparent transactions, as tokenization combined with blockchain keeps transaction data secure, which further facilitates and drives the use of the virtual environment for financial services.

Finally, we can cite the lower costs, because since we are talking about digital records in smart contracts, all settlement and back office services are simplified. This tends to reduce operating costs significantly, ensuring that those involved pay lower fees.

Dock: tokenization for payment cards

A Dock, a leader in technology for financial services in Latin America, offers a complete tokenization solution for card issuers, digital wallets, and businesses looking to operate payments securely and scalably. The technology was developed to serve everything from large banks to fintechs seeking agility, compliance, and trust in their payment methods.

Among the main features of the solution, the following stand out:

Protection of sensitive data based on international safety standards, such as PCI DSS and EMVCo standards, which ensure regulatory adherence and robustness against leaks;
Direct integration with market-leading digital wallets, such as Google Pay, Apple Pay and Samsung Pay, enabling seamless payment experiences and omnichannel for end customers;
Generation of dynamic tokens, linked to specific devices, applications or channels, ensuring that tokens can only be used in authorized contexts, reducing the possibility of fraudare;
Complete management of token lifecycle, with issuance, automatic update (e.g. in case of card renewal) and secure revocation features, which allows respostrespond quickly to incidents without compromising the customer experience.

The infrastructure of Dock It also offers scalability, real-time monitoring, and API integration, facilitating adoption by companies and ensuring consistent performance. With this solution, our customers have seen an increase in transaction authorization rates and a significant reduction in transaction failure rates. chargeback and improved perception of security by end users.

Talk to our team to understand how to protect card transactions..

Tokenization: what you saw in this article

Tokenization is the procedure for digital representation of an asset using blockchain technology.
A token is registered in a programming language in which the asset’s characteristics, the rules for identifying its owners, and the ways that asset can be traded in smart contracts are defined.
A token may represent the whole asset, or just a fraction of it. The represented asset may be fungible —it can be replaced with another of the same type, value, or quality— or not fungible (known as an NFT), which is the case of exclusive assets, such as works of art.
Any asset that has economic value and can be traded can be tokenized, such as: real property, works of art, precious metals, commodities, collectible objects, copyrights, etc.
In the banking and payments market, tokens decrease the cost of transactions, increase the security of confidential information, and improve competitiveness of the sector.
The Central Bank of Brazil has invested in creating the Digital Real to stimulate tokenization in the Brazilian economy.
The greatest obstacle to tokenization worldwide is the development of an adequate regulatory framework. The Brazilian Regulatory Sandbox, monitored by the CVM, is an important initiative by the regulator to find solutions to this challenge.
Once the regulatory issue has been overcome, tokenization may be expanded in various segments, especially in financial services and products.
Tokenization encourages the democratization of investments, allows safer and more transparent transactions, reduces risks, costs, and the bureaucracy of middlemen’s back office services.