Why Non-Fungible Tokens From Physical Collectibles Are Strengthening Asset-Backed Securities

Fungible and non-fungible may sound like terms you should remember from high school biology, but they actually have very simple explanations — and many implications for blockchain, tokenization and investments.

Every time you make a transaction with bitcoin, you’re using a fungible token. Each bitcoin is interchangeable, much like a dollar bill. None of them are special or distinguishable from other dollar bills in any way that would create more or less value.

On the other hand, non-fungible tokens are distinguishable from one another — and purposefully so.

Each token is unique, which creates digital scarcity since there are only so many tokens to go around. And everyone knows how many there are and how to distinguish them.

But until recently, there was no standard for linking a physical object to a unique token.

Then came the launch of ERC 721 in 2017. This is the standard on Ethereum that allows the creation of non-fungible tokens, and it opened up the possibilities for digital collectibles. CryptoKitties is the best example of how the token can be used to create scarcity — and hence, value — for a digital asset.

But digital collectibles aren’t the only option for non-fungible tokens. In fact, tokenizing physical objects makes more sense from an investment perspective.

Here’s why and how it works:

Non-fungible tokens are unique investments when tied to a physical object.

Today, there are plenty of examples of brilliant, beautiful digital art people can invest in. But the reality is, most of what is being tokenized does not fit that description.

Many of the digital collectibles being traded on today’s exchanges are, to be frank, crap. People are creating things with no real value and attempting to bring value to them through tokenization.

Think of the current overabundance of digital art. Unfortunately, the amount of demand is nowhere near the supply.

That’s because an item only has value in the context of its ecosystem.

So instead of continuing to push for tokenizing anything and everything, the better path forward is working with physical objects that have existing ecosystems built around them — ecosystems in which they hold value. A few examples of these objects are shoes, artwork, wine or memorabilia.

And once those items become tokenized securities, they create new opportunities for investment.

Tokenizing physical assets gives investors more liquidity.

Imagine someone passes away and leaves a singular physical object to be split between multiple people in the will. Of course, the beneficiaries could sell the item and split the money between themselves.

But what if the object is an appreciating asset, such as a rare painting?

If it’s left to several siblings, they may want to hold onto it. Instead of storing it away, they can tokenize the artwork. This allows them to all own equal “shares” of the painting and benefit as it grows in value over the years.

Likewise, the owner of an appreciating asset may want to liquidate some of an item’s value but still control the physical asset itself.

In this scenario, the owner of a painting could sell a minority of the shares in the artwork but maintain physical control over it. The idea here is that the owners of the minority shares would see the value of their shares increase as the painting continues to appreciate.

Tokenizing physical objects gives investors a chance to expand their portfolio, and owners more potential liquidity when they need it.

This will allow for more flexible classes of securities.

Let’s say you’re tokenizing a building. Ideally, not all of the tokens offered will be fungible.

Some of the tokens may grant strict ownership of the building and facilities, while others may only grant access. It’s a very similar concept to creating different classes of stock.

The same idea could be applied to the artwork example. People with different levels of investment have different levels of control over the object. In theory, a museum or foundation could allow the public to purchase shares in an artwork in order to raise money to buy a new piece. The museum wouldn’t hand over control of the piece, but they would offer people the opportunity to invest in it.

Of course, while tokenization and fractional ownership is a possibility for larger, more durable goods, it’s not right for every situation.

People may not be as interested in purchasing shares in a bottle of wine, for instance — unless there’s some guarantee the physical holder of the wine won’t be pairing it with a mushroom risotto anytime soon. A case of wine or a vineyard’s annual yield may be worth the investment, though.

One way to test a market is to open up a platform completely and let ecosystems form organically. But the best results will come when organizations help usher in an environment where markets for digital and physical collectibles can thrive.

At Chronicled, our team is supporting the creation of a marketplace and ecosystems for the secure exchange of physical assets. We originally supported the collectible sneaker market in 2014 and have since expanded into global supply chain management for high-value assets. A subset team is currently building a platform and ecosystem, Chronicled Collectibles, for tokenizing and investing in physical art, sports memorabilia and wine.

One company that has developed out of our expansion into fine art is Blockchain Art Collective — a team that provides art provenance and authentication through blockchain and IoT technology.

For any physical item, it’s important to choose the right asset classes to ensure there’s both supply and demand within the marketplace. Otherwise, the market may be flooded, as in the case of the virtually unlimited amounts of digital art and collectibles that are being created.

This article originally appeared on Forbes.com.

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