How Tokenized Commodities Work
Commodity tokenization is revolutionizing the finance world by converting assets like gold and crude oil into blockchain tokens and giving investors fractional ownership of them.
This shift is signaling a migration of commodities onto the blockchain, democratizing the financial ecosystem with a more liquid and democratic and transparent approach.
How Commodity Tokenization Works
The process of tokenization starts when a physical asset like a gold bar is placed into a highly secure, insured and audited vault managed by a custodian.
These commodities have to be tested and their purity verified before a smart contract is deployed to mint a number of digital tokens corresponding to its worth.
Each token then acts as a programmable title of ownership, giving you as an investor legal claim to a portion of the vaulted commodity.
This digital representation is governed by blockchain’s immutable ledger, so that every token in a digital wallet has a verifiable gram of metal or barrel of oil sitting in a vault.
The lifecycle of your token is also integrated with decentralized oracle networks, which serve to provide the proof of reserve by constantly collecting real-time data from auditors before publishing it on-chain, ensuring that the system cannot become over-leveraged.
The biggest advantage compared to standard commodity trading comes from the liquidity of the market, as you can trade your token 24/7. Whenever you wish to exit your position, you can also burn your token to physically redeem your asset and get it delivered to you.
Types of Tokenized Commodities
Tokenization is growing rapidly across multiple market sectors, especially in real estate, but in the commodity market, it is still highly concentrated in three main markets.
Precious metals are the most popular and widely accepted voice, due to the fact that gold, silver and platinum have standardized purity and high value-to-weight ratio. These assets can be a valuable tool for portfolio diversification and hedging.
- Energy resources such as crude oil and natural gas are also seeing increasing levels of tokenization in recent times, as the logistics of standard energy trading is quite difficult. Among the growing sectors in this area are green commodities like carbon credits, which use the blockchain to make sure that environmental offsets are not falsified or double-counted.
- Agricultural products like coffee, soybeans and wheat are also seeing a rise in popularity when it comes to tokenization, with farmers using their harvests as on-chain collateral and investors hedging against inflation through the food supply chain.
- Soft commodities like wheat, coffee, and soybeans are the next frontier. Tokenizing these assets helps farmers access better financing by tokenizing their harvests and using them as on-chain collateral, while giving investors a way to hedge against inflation through the food supply chain.
Advantages and Challenges
As we stated above, the primary advantage of tokenization in the commodity market comes from a massive improvement in liquidity and accessibility, allowing you as an investor to own high-value assets for as little as few dollars, opening the doors that were once reachable only by institutional traders.
Another advantage comes from the fact that settlement times and friction costs usually associated with clearinghouses and brokers are drastically reduced or removed by cutting out these intermediaries.
The potential risks are mostly based around the reliability of oracles, as any delay or error in their data can drastically affect the price of your token. The vault your tokens are held in also has to be highly secured.
Lastly, as this is an emerging market based on the blockchain, it still faces regulatory hurdles in different jurisdictions, mostly due to the debate around classification of these assets, as many countries are still determining if they should be classed as commodities, securities, or a new hybrid classification.
Final Words
The tokenization of commodities represents one of the biggest reorganizations of the market in recent years, providing more diversification opportunities than ever before.
The infrastructure is maturing, the audits are becoming more frequent, and the transparency is undeniable.
While the transition won't happen overnight, the trend towards a decentralized and more democratized commodities market is quickly becoming a reality.a
FAQ
Is tokenized gold functionally different from a Gold ETF?
It is, very much so. Tokenized gold assets represent direct legal ownership of specific, vaulted bars, while a standard gold ETF usually settles in cash. Tokenized gold can also be traded 24/7, while ETFs only trade during standard operating hours of traditional stock exchanges.
What happens if the issuer of my commodity tokens goes bankrupt?
Your commodity tokens are legally owned by you, and not the custodian holding them in a vault. Still, you should always carefully read the legal disclosures of any platform you trade on to ensure that this protection and a path for redemption are clear in cases of platform bankruptcy.
Can I trade tokenized commodities for other digital assets?
You can. Commodity tokens are identical to the standard of other large tokens like ERC-20, and can be freely used in the DeFi ecosystem, so you can swap your commodity tokens instantly, or use them as collateral on most major decentralized exchanges.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.
