The token is a receipt for an off-chain asset

Graduate · enrolled learners

This lesson opens with The Qingdao port metals fraud, 2014.

What happened

At the port of Qingdao in China, a metals trading company used warehouse receipts, documents certifying that specific quantities of copper, aluminum and other metal were held in a warehouse, to raise money, and it pledged the same metal to multiple lenders at once. In some cases the metal in the warehouse was not there in the quantities the receipts claimed. Banks and traders, foreign and domestic, had lent against these receipts believing each one was backed by its own metal, and when the fraud surfaced in 2014 they found their collateral was double- and triple-counted or simply missing, with exposure and losses running into the billions of dollars. Nothing was wrong with the concept of a warehouse receipt; the failure was in the link between the receipt and the metal, that the same metal backed many receipts, and that some of the metal did not exist. A tokenized real-world asset is exactly a receipt of this kind, a token certifying that an off-chain asset is held on the holder's behalf, and Qingdao is what happens when the certificate and the asset come apart: the paper says the asset is there, uniquely yours, and it is neither.

The decision point

A token that represents a real-world asset is a receipt: it certifies that an off-chain asset, a bond, a building, a bar of metal, is held on the holder's behalf, and the token is worth that asset only if the asset is real, is actually there, and backs that token and no other. This receipt-to-asset link, not the blockchain, is where a tokenized real-world asset most often fails, because the chain can flawlessly record and transfer a token whose underlying does not exist or is pledged to ten other people. Qingdao is the case from before tokens that shows the failure in its purest form: warehouse receipts, the paper ancestors of tokenized-asset certificates, pledged many times over metal that was double-counted or absent, so the receipts were perfect and backed nothing. So the decision anyone tokenizing a real-world asset makes is to treat the soundness of the receipt-to-asset link as the foundation of the whole structure, that the underlying genuinely exists, is genuinely held, and uniquely backs the token, because a token is only a claim on an off-chain asset, and a claim on an asset that is not there, or is claimed by others too, is worth exactly what Qingdao's receipts were worth when the metal was counted: nothing.

Recorded loss

$3,000,000,000

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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