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    Tokenization | definition and applications

    What is tokenization?

    Tokenization involves replacing sensitive data with non-sensitive or anonymized elements, often referred to as “tokens”.

    What is the purpose of tokenization

    Tokenization is a security measure that allows you to transact using your sensitive information, without the information itself being revealed.

    For example, when you use a card payment terminal, you’re transacting using your card details. However, what enters the payment system is a tokenized version of those details. The token carries the essential data of your bank card to enable you to pay, but conceals the raw data so that nobody else can access your card.

    The tokens used to replace or represent data have no value on their own, and only become meaningful when they are securely associated with the data they represent.

    Tokenization offers the data security required by financial institutions, payment processing firms, and other private and public institutions handling sensitive details, such as medical records, bank account information, credit card information, Social Security numbers, and many more.

    Types of tokenization

    Vault tokenization

    In this form of tokenization, users keep a secure tokenization vault database where sensitive data and associated non-sensitive data are securely stored.

    Vaultless tokenization

    Instead of using a database, a more cryptographic device is used in vaultless tokenization, making it more secured and reliable than the vault approach. To convert sensitive data into non-sensitive data or generate tokens, secure cryptographic devices use standards-based algorithms.

    Blockchain based tokenization

    Blockchain tokenization is a relatively new concept through which ownership of real-world assets (property, artwork or music) can be represented via NFTs. Doing this enables the asset to be fractionalized, meaning a more liquid market and seamless trading via the infrastructure of blockchain.

    Tokenization in NLP

    The field of natural language processing uses tokenization as its very foundation. NLP splits text into smaller pieces, each of which is then tokenized to enable computers to understand natural language.

    NFT tokenization

    Non-fungible tokens do exactly what they say: create a tokenized version of a particular asset. Music, digital artwork collections and Web3 community memberships are all commonly represented as NFTs. Here, the unique token is owned via residing at the owner’s crypto wallet address. The token carries date relating to its provenance, and points to the metadata of the underlying artwork or asset, which is generally hosted online.

    Governance tokens

    Increasingly, Web3 communities and DeFi projects offer their members governance rights. This enables the community itself to take key decisions on the project, via on-chain voting. These voting capabilities are enabled by a protocol within the project’s native tokens, designed to interact with the smart contract of the project.

    Utility tokens

    Similarly, projects like metaverse platforms may offer specific utilities via their native tokens. For example, the Sandbox metaverse accepts payments for its in-game experiences via its native token.

    How tokenization works

    There are various ways that tokens can be created:

    • Using cryptographic function with a key (mathematically reversible).
    • Using a hash function (a nonreversible function).
    • Using a randomly generated function (or an index function)

    Let’s use an example. During credit card transactions, once you’ve entered your payment information into a Point-on-Sale (POS) system, the merchant’s payment gateway, generates a random token. That token replaces your account-specific data.

    Next, the tokenized data is encrypted and delivered to a payment processor. The merchant’s payment gateway stores the original sensitive payment information in a token vault—the only place where a token can be linked to the data it represents. Before being delivered for final verification, the payment processor encrypts the tokenized information once again. Once the tokenized encrypted data is delivered and verified, the transaction is confirmed to be successful.

    Tokenization v encryption

    Tokenization has recently emerged as a more cost-effective and secure alternative to encryption. Both are ways of securing sensitive data.

    When using tokens, the length and type of the original data remain unaltered. The original data is masked. However, in encryption, both the length and original data length are altered. Even if someone can access encrypted messages without the key, they will be unable to decrypt them. Tokenization does not use a key in this sense since a decryption key is not mathematically reversible. Thus, the approach represents secret data with undecryptable information.

    Tokenization is a key technology being employed by emerging cybersecurity startups. See eSecurity Planet’s run-down of 22 cybersecurity startups to watch.

    What are the benefits of tokenization?

    • Transparency is improved during transactions.
    • Assists firms in adhering to security standards and privacy legislation
    • Tokenization helps collectibles, microcap stocks, and other assets have more liquidity.
    • Is a cost-effective data security tool.
    • It covers not just credit card details but also passwords, files, and customer accounts.
    • Transactions are made faster and easier without sacrificing secure access to sensitive data.
    • Reduces the likelihood of hacking because there is rarely any meaningful data to steal.
    • Allows for recurring payments and other payment methods in a secure environment, making subscription-based operations easier to manage.
    • The possibility of a data breach is significantly reduced.

    Tokenization use cases

    The data security offered by tokenization means it is employed across many different industries. Here are a few current applications of tokenization:

    Data breach mitigation

    Any institution that needs to secure customers’ personal details runs the risk of being targeted by hackers. While tokenizing that data will not prevent this type of attack, it will mitigate the impact. Tokenizing sensitive data means even if a data breach occurs, an interloper won’t be able to read the information.

    Data regulation compliance

    Since tokenization substitutes raw data, applying it reduces the amount of information within a business that’s subject to data protection laws.

    E-commerce security

    With e-commerce increasing exponentially, ensuring secure transactions is a priority for digital platforms. By employing tokenization during the payment process, ecommerce sites can convert users’ payment details into digital tokens unique to that transaction. This makes it more difficult for hackers to intercept and use your raw payment data, since each token’s use is limited to its given transaction.