Rethinking public blockchains to protect the fragile future of tokenization

Tokenization has taken center stage in Web3 over the past year, drawing immense investment and attention from BlackRock, JPMorgan, and other key players. Despite a ‘slow start’, analysts predict asset tokenization will reach a $2 trillion market size by 2030. Its momentum is evidenced by the surge in popularity of tokenized US treasuries during the recent bear market, with market capitalization soaring by 782% in 2023 alone, from $104 million to $917 million.

At the same time, the global blockchain gaming market is expected to reach $614.91 billion in 2030. The advantages are clear. Increased liquidity, enhanced transparency, heightened security, and seamless global access and ownership. Beyond finance and gaming, tokenization also holds the potential to revolutionize real estate, gaming, and supply chains; indicating a new era of accessibility and efficiency.

Public Blockchains and Their Limitations… The Big Problem

Despite these promising developments, the path to a fully tokenized world is fraught with challenges, particularly caused by public blockchains. Professor of Financial Regulation at American University, Hilary Allen, has previously warned of the “fragility” and inefficiency of public blockchains in the case of mass tokenization.

The issue? Scalability. Scalability issues plague popular public blockchains, hindering their ability to manage high transaction volumes. A Bitcoin transaction takes about an hour on average to be validated but this depends heavily on network congestion. Ethereum faces a similar scalability hurdle.

An uptick in transactions on the chain caused gas fees to skyrocket to record-breaking levels in the first quarter of 2024, slowing the network to a crawl and making it effectively unusable. Yes, gas fees have dropped since, but these issues remain a problem to be solved, and they extend beyond transactions into the minting and tokenization space.

The current infrastructure cannot support widespread mainstream tokenization adoption. Just like a crowded highway, most public blockchains like Ethereum that face these scalability issues can become overwhelmed by too much traffic, hindering their ability to house and scale tokenized assets efficiently and cost-effectively.

Security vulnerabilities further complicate things. The potential for hackers or nefarious groups to gain majority control of a blockchain’s consensus mechanism, often dubbed a ‘51% attack’, poses significant risks. Blockchain tech was specifically designed to prevent this from happening but, such an attack can lead to double-spending or transaction reversals, which for tokenized assets, could mean reversing ownership transfers that would cause chaos and a loss of confidence in the system.

However, obtaining a majority on either Bitcoin or Ethereum now would be cost-prohibitive: it would cost around $20 billion on Bitcoin. Bridges that connect different consensus systems and transfer value between them are also a chink in tokenization’s armor; unless these are extremely carefully constructed, they are at risk of hacks and exploitation.

Smart contracts are also vulnerable. If these are exploited, it can directly result in the loss of tokenized assets.

For tokenization to fulfill its transformative potential in areas like gaming and finance, it must be capable of scaling to tokenize a vast array of assets. The reality is that the current state of most public blockchains makes this infeasible.

Imagine if Minecraft was a blockchain-enabled game and every item a gamer crafted needed to be tokenized. Minecraft has over 166 million monthly active players. The sheer volume of in-game items that would need to be tokenized per day for each player would drastically impact blockchains like Ethereum, not to mention how the high levels of congestion would drive up gas fees.

Are There Robust Alternatives Beyond Public Blockchains?

‘Layer 2’ solutions that build on top of existing blockchains have often been touted as a fix for scalability and security issues facing tokenization at scale.

These solutions take much of the strain away from public blockchains, processing transactions off-chain or bundling transactions together before submitting them to a Layer 1, vastly reducing congestion and facilitating more efficient transactions at much lower costs.

However, these Layer 2 solutions are not without their limitations. They still depend on the underlying Layer 1 blockchain and there are often trade-offs between security, scalability, and decentralization with Layer 2 solutions. Most and perhaps all L2s are ‘blockchain-lite’; many L2s try to do the same as an L1 blockchain without the same security. To operate from the L1, they require transfer of currency (wrapped currency) which is very user-unfriendly and requires bridges.

Per L2Beat’s risk analysis, most Layer2’s come with risks. These include like the “the fact that “only a handful of whitelisted actors can submit”; “user withdrawals can be censored by the permissioned operators”; “there is no way to verify the system”; “Proof construction relies fully on data that is NOT published on chain”; and “Data depends on a Data Availability Committee with a threshold of 5/7”.

Bridgeless Minting

Alternative on-chain minting methods also promise avenues for improved scalability and efficiency. You may think this sounds like the job of a Layer 2, but solutions built on top of Layer 1s like Ethereum pay severe prices for security. Universal Layer 1s, unlike solo L1s like Avalanche, can exist untethered to a single network allowing for scalable interoperability between different ecosystems without bridges.

For example, Polkadot’s cross-chain protocol (XCMv3) allows blockchains to interact with each other seamlessly. L1s building with Polkadot can lean on an aspect of XCMv3 called ‘Universal Location’ which enables different consensus systems to refer to resources within each other.

Think of the way that the web uses URLs to refer to different websites and webpages: Universal Location does the same thing for blockchains, smart contracts, and tokens. This tech can be leveraged by L1s to develop bridgeless patterns by which every blockchain can offload part of their transactions.

Simple counting of on-chain transactions from the last 2 years shows that more than 20% of all transactions in Ethereum and Polygon can be offloaded right away. That’s not an insignificant amount.

Architecture such as these streamline token creation and management processes, drastically reducing the risk associated with cross-chain transactions and enhancing reliability overall. Imagine the ability to mint millions of assets on the blockchain of your choice, without paying native gas fees and remaining where the liquidity sits. That’s the power of bridgeless minting.

Unlocking Tokenization

The journey towards a fully tokenized world requires robust alternatives to public blockchains. Continued exploration and development of secure on-chain minting methods are crucial. By addressing the scalability and security challenges, we can unlock the full potential of tokenization, transforming industries such as gaming and finance and driving the next wave of digital innovation.

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