What is Tokenization and How Does it Work?

what is tokenization
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The advances in payment data security have been tremendous in the past few years. Leading the charge of this change is blockchain technology that is evidently critical to our security, and one part ot it is known as tokenization.

What’s pushed the value of tokenization has been the rise of serious data breaches. All of which are directly related to the uptick of CNP acquirements across our digital world. 

The ability to tokenized payment data is one of the solutions, but that is not even half of what is possible. In this article, we will cover everything you need to know about tokenization.

So whenever you’re ready to take your knowledge of the true game-changers of the digital world, keep reading and get ready for your new future.

What Is Tokenization?

In essence, tokenization is the process of taking an existing function or asset and representing it as a token, which develops and releases on the blockchain. However, tokenization can exist beyond distributed ledger technology, which shows lots of potential use in our near future. 

There are many types of tokenizable assets. They can be a real asset such as a bond or stock, a utility token to access Dapps, or a crypto-collectible.

The token value has use in a variety of ways as a real data substitute. If the real data is subject to acquisition (processing credit card payments that are set to renew), the token directs to a vault, and then the index is used to fetch the true value for the authorization.

For the end-user, this occurs seamlessly in the application or browser, in most cases, instantaneously. They are not aware of the data going through storage on the cloud in a different form.

The benefit of tokens is the fact there is no mathematical union with the true data that the tokens represent. If they are hacked or breached, they hold no meaning. No program or method can reset them to real values. 

However, consideration is subject to importance as to provide a token of some design useability. For instance, the final digits of a credit card number are secure on the token, so that this number (tokenized) is available for print on receipts for future reference of payments.

The printed numbers are redacted to asterisks, ended with the final digits. In this scenario, the merchant has the token, not a real card number. 

Types of Blockchain-Based Tokens

In general, there is a large variety of blockchain-based tokens. But they are usually prescribed to one of the two primary categories.

Fungible tokens are those that represent equal value assets. For instance, Stablecoins are considered fungible tokens. That’s because each coin is worth the same value as the next.

These tokens are useful for stabilizing fiat currency or the price of digital currencies. Assets such as several grams of silver or gold are applicable.

Non-fungible tokens are those that represent tokens that don’t have to have the same value. No matter if they are the same type. In this case, each token is unique and has its own characteristics.

For instance, imagine a painting. In essence, it’s the same type of asset as any other painting. However, in most cases, a painting by Leonardo Da Vinci will have greater intrinsic value than a painting by some students at an art school. And with non-fungible tokens, these unique parameters that make Da Vinci’s art his can become a token.

Differences Between Tokenization And Encryption

Encryption and tokenization are often thought to be alike. Mostly because they serve the same purpose. They both work to secure payment data, but they are not interchangeable. 

But what separates the two is the way they provide security to the asset. Most encryption makes use of algorithms to secure sensitive information before sending it over unsecured network structures.

The math behind encryption is very complex. Those who do get their hands on the algorithm can technically decode the information. As a matter of fact, they can reverse-engineer all information encrypted by the algorithm. 

If you have the algorithm, you have the solution to all of the problems that involve it. On the other hand, tokenization makes use of randomly generated substitution that does not correlate with the original information. This makes it impossible to hack the information. 

Only someone with token vault access can find a way to map the token to the original value. Many vendors are confused about which is more secure. But it’s not really a decision as both solutions support each other.

Hence, why best payment environments make use of encryption when sending data over unsecured networks. But also tokenization to substitute payment details with unique parameters. 

Other Differences

Encryption mathematically transmutes plain text into cipher using a key and algorithm. Whereas, tokenization randomly generates value for plain text and then stores the value mapping in the vault.

Encryption scales to the large volume of data with a small encryption key that helps decode the data. Whereas, tokenization is difficult to maintain and scale performance as the vault increases in size.

Encryption is ideal for unstructured data and structured fields. But tokenization is used only for structured data fields, such as SSN or payment cards.

Encryption is perfect for sensitive data exchange with third-parties who have access to the key. Tokenization is not great for that, because it requires true access to the vault mapping token values.

Encryption uses format-preserving schemes of lower security strength. But with tokenization, the format is subject to retention without decreasing security strength.

Encryption must allow the data to leave the organization as encrypted. But with tokenization, the data never leaves the organization, which satisfies compliance regulations.

The Process Of A Tokenized Transaction

decentralized tokens tokenization explained

When a customer provides their payment details, either online or with a POS terminal, each data value replaces with a randomly generated token. In almost all cases, the vendor’s gateway for payments is in charge of creating these tokens.

After this, the tokenized information is further encrypted before being delivered over other networks to the payment processor. The original payment information is subject to storage on the payment gateway’s vault for tokens. It’s the only partition that can be used to map this token back to the true payment data.

The vendor’s provider encrypts the data again before sending the details across to ACH or card networks for verification. If authorization is successful, confirmation of the transaction is sent across the ACH or card networks to all involved parties (payment gateway, processor, vendor, and client).

What Are the Benefits Of Tokenization?

Non-fungible and utility tokens that are used in Dapps bring great functionality to the world of blockchain. But, the tokenization of real assets represents the most important and substantial benefits of tokenization.

Tokenized assets can provide better transparency during transactions due to the immutable value of blockchain. But also faster processing and settlement, 24/7 availability accessibility. As well as improved liquids for collectibles, partnership shares, and microcap stocks.

In due time, trillions of asset dollars will likely be brought into the blockchain by the simple merit of tokenization. Very few methods of tokenization can provide expected security for enterprises. But that is soon to change.

Furthermore, tokenization can help remove the overall PCI scope. That’s because no sensitive details are being stored in the payment environment. With no payment information being locally stored, there’s nothing to steal.

Another benefit is that tokenization can help secure all information. In the US, the primary focus is on the payment world. But in other parts of the world, tokenization is required via privacy laws for:

  1. Addresses
  2. Passwords
  3. Employee files
  4. Patient records

If you operate internationally as many online vendors do, tokenizing all user data will make it easier to comply with the ever-changing privacy laws around the world. But that’s only some of the information that is subject to tokenization. As mentioned earlier, anything has the potential for encryption and tokenization.

Disadvantages Of Tokenization

Using payment processor tokenization specifically can lock you into that specific processor. To avoid this, you need to choose a tokenization service that your processor is neutrally supported by. But also will return your tokenized information if you need to migrate.

When choosing a tokenization service, you should always consider how easily data can transfer from one service to another in the future. 

Nevertheless, using tokenized data requires its retrieval from a remote point and detokenized. This introduces more transaction time for the processing which is negligible in most cases.

But if you’re operating a high-speed automated business, you might find that sub-millisecond responses from local vaults are much more valuable than data separation security provisioned by tokenization.

Use Cases for Tokenization

The most common use case is for protecting payment card information so that vendors can reduce their PCI DSS obligations. Encryption can also be used to do this. But because data is still locally stored, the vendor must ensure the entire infrastructure is fully compliant with PCI DSS.

Since 2011, PCI DSS has enforced a set of tokenization guidelines. This means tokenization is now a viable method for complying with the standards.

In other ways, tokens are used to secure personally identifiable information. Including phone numbers, SSN, emails, account numbers, and much more. The backend structures of many companies rely on such data as unique identifiers of clients. 

Since these identifiers are woven into their systems, it’s very hard to remove them. And these unique identifiers are also used to access order status, billing information, customer service, and much more. Tokenization helps protect this data without exposing it to attackers.

Advanced Use Cases

While encryption is often used to secure structured feels, it can also be used to protect unstructured data in the form of length plain text passages, such as entire documents.

Encryption is the preferred way to secure data exchanged with other parties. But also to validate identities because the other parties only need to have the encryption key. 

For instance, Secure Sockets Layer or SSL is the foundation for internet data exchange security. And it relies on encryption to create a bandwidth tunnel between the website and the end-user. Asymmetric encryption is an important segment of SSL certificates that are used to validate identity. 

Tokenization and encryption are both used regularly to protect stored data. Mostly on applications and cloud services.

Depending on the circumstances, an organization might use tokenization or encryption. Or a combination of both to protect different valuable information. But also to meet their compliance requirements.

For instance, McAfee leverages irreversible tokenization of user-identified information on-premises. But then it obfuscates enterprise data separately. As more and more data moves to the cloud, tokenization and encryption are becoming more and more important.

Most notably, if the government subpoenas data stored in the cloud, the provider can only turn over the tokenized or encrypted data. Meaning they will not provide any way to unlock the true data. 

The same is true for any cybercriminal who gets access to the data stored on the cloud service.

Our Service, Your Future

Now that you have discovered the value and importance of tokenization in our digitized world, you are probably thinking about how you can implement tokenization in your own business process. Well, at first glance, it might seem like a difficult task to accomplish. 

And it certainly can be, but if want to avoid the complications of this process, our company iMi Blockchain can help you. If you’re interested in token implementation as a means to leverage security and compliance in your organization, get in touch with us and we will happily accommodate your needs.

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FAQ about Tokenization

What does tokenization mean?

Tokenization means adding extra security to all kinds of data for safer transactions over a network (f.e. the internet). Random strings of characters (token) serving as a new reference to the original data to hide sensitive data.

What is tokenization of data?

Tokenization is the process of putting an extra layer of security to sensitive data. A random string of cryptographic code (token) is added. Tokens turning the original data into a reference so the value cannot be guessed nor hacked.

What is tokenization in NLP?

Tokenization in NLP is similar to crypto coding when it comes to technology. Phrases, sentences, or paragraphs are split into smaller units. Individual words or terms turn into tokens.

Types of tokenization?

There are many types of tokenization. The most important types are: 1) Utility Token enables blockchain-based businesses to raise capital for their project. 2) Security Token, for fundraising crypto-based projects. 3) Asset Token, to trade real physical goods or commodities. 4) Real Estate Token, to trade properties in the digital world.

How tokenization works?

An easy way to understand how tokenization works is if we look into credit card payments. While customers have a primary account number (PAN) their transactions could not be transferred safely. A randomly-generated number (token) replaces the PAN and this way all transactions are safe, without exposing any bank details.

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Marcel Isler

Marcel Isler

Marcel is a Business Economist and founder of iMi Blockchain. A Consultant and international Keynote Speaker. He studied at the University of Oxford. He helps enterprises to implement Blockchain applications. On our blog, he writes about distributed ledger technology, smart contracts, cryptocurrencies, industry news, and future trends.

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