What is Tokenization? Definition, Working, and Applications

Dacxi Chain
8 min readMar 29, 2023
Source: spiceworks
  • Tokenization is the process of hiding the contents of a dataset by replacing sensitive or private elements with a series of non-sensitive, randomly generated elements (called a token).
  • Tokenization is gaining popularity for data security purposes in business intelligence, fintech, and ecommerce sectors, among others.
  • Throughout the process, the link between the token and real values cannot be reverse-engineered. This article explains the meaning of tokenization and its uses.

What Is Tokenization?

Tokenization is defined as the process of hiding the contents of a dataset by replacing sensitive or private elements with a series of non-sensitive, randomly generated elements (called a token) such that the link between the token values and real values cannot be reverse-engineered.

Tokenization has flourished from the beginning of early financial systems, wherein coin tokens replaced real coins or banknotes. Since they function as money substitutes, subway tokens or casino tokens are instances of this. This is an example of tangible tokenization, but the purpose is identical to digital tokenization: to serve as a proxy for a more valued object.

The usage of digital tokenization dates back to the 1970s. It was utilized in the data archives of the time to isolate sensitive information from other recorded data.

Recently, tokenization has found applications in the credit and debit card industry to protect critical cardholder data and comply with industry norms. In 2001, TrustCommerce was attributed to developing tokenization to safeguard payment card data.

Tokenization substitutes confidential material with unique identifiers that maintain all critical information without jeopardizing security. It aims to reduce the data a company must keep on hand.

Consequently, it has become a popular method for small and medium-sized enterprises to increase the safety of card information and e-commerce transactions. In addition, it reduces the expense and difficulty of complying with industry best practices and government regulations.

Interestingly, the technology is not limited to financial data. Theoretically, one could apply tokenization technologies to all types of sensitive data, such as financial transactions, health records, criminal histories, vehicle driver details, loan documents, stock trading, and voter registration. Tokenization may improve any system a surrogate employs as a substitute for confidential material.

Types of tokenization

Tokens and tokenization can be of various types:

  • Vaultless tokenization: Vaultless tokenization employs protected cryptographic hardware with specified algorithms based on conversion standards to facilitate the exchange of sensitive information into non-sensitive assets in a secure way. One may store these tokens without a database. We will discuss this further in the following section.
  • Vault tokenization: This is the type of tokenization used for conventional payment processing, which requires organizations to keep a confidential database. This secure repository is known as a vault, whose purpose is to hold sensitive and non-sensitive information.
  • Tokenization in NLP: The field of natural language processing (NLP) comprises tokenization as one of its most fundamental operations. In this sense, tokenization splits a text down into smaller units called tokens so that bots can comprehend natural language properly.
  • Blockchain-based tokenization: This strategy distributes the ownership of a particular asset into several tokens. Non-fungible tokens (NFTs) that function as “shares” may be used for tokenization on a blockchain. However, tokenization could also encompass fungible tokens with an asset-specific value.
  • Platform tokenization: The tokenization of a blockchain enables decentralized application development. Also known as platform tokenization, this is a process in which the blockchain network offers transactional security and support as its foundation.
  • NFT tokenization: Blockchain NFTs are among the most prominent tokenizations nowadays. Non-fungible tokens contain digital information representing specialized and high-value assets.
  • Governance tokenization: This form of tokenization is designed for blockchain-based voting systems. Governance tokenization enables a more efficient decision-making process using decentralized protocols since all stakeholders can vote, debate, and participate equitably on-chain.
  • Utility tokenization: Using a particular protocol, utility tokens provide access to different services. There isn’t any direct investment token production using utility tokens, and their platform activity is beneficial to the economic growth of the system.

Reversible vs. irreversible tokenization

The tokenization process might be irreversible or reversible. Detokenization allows reversible tokens to be transformed to their original value. In terms of privacy, this is known as pseudonymization. These tokens could also be classified as cryptographic or non-cryptographic.

In cryptographic encryption, the cleartext data element(s) aren’t retained; it only preserves only the encryption key. This type of tokenization uses the NIST-standard FF1-mode AES algorithm.

Originally, non-cryptographic tokenization meant that tokens were generated by randomly creating a value and keeping the cleartext and associated token in a database, as was the practice with the initial TrustCommerce service.

Modern non-cryptographic tokenization emphasizes “stateless” or “vaultless” systems, using randomly generated data, safely concatenated to construct tokens. Unlike database-backed tokenization, these systems may function independently of one another and expand almost indefinitely since they need no synchronization beyond replicating the original data.

It is not possible to transfer irreversible tokens back to their initial value. In terms of privacy, this is known as anonymization. Thanks to a one-way function, these tokens are generated, enabling the usage of anonymized data bits or fragments for third-party analysis, operational data in reduced settings, etc.

How Does Tokenization Work?

Tokenization replaces sensitive information with non-sensitive equivalents. The replacement information is referred to as a token. This may utilize any of these processes:

  • With a key, a theoretically reversible cryptographic function.
  • A function that cannot be reversed, like a hash function.
  • An index function or a number produced at random.

Consequently, the token will become the exposed information, while the sensitive data that the token represents is securely held on a centralized server called the token vault. Only in the token vault can the original information be mapped back to its appropriate token.

In payment processing, tokenization requires replacing a credit or debit card or one’s account details with a token. Tokens, in themselves, have no use — and aren’t associated with any account or person.

The customer’s 16-digit main account number (PAN) is replaced with a randomly-generated, bespoke alphanumeric ID. This process eliminates any link between the transactions and the confidential material, reducing the risk of security breaches and making it ideal for credit card transactions. Tokenization of data preserves credit card and bank account details in a virtualized vault, allowing enterprises to transmit data securely via computer networks.

Some tokenization, however, is vaultless, as we mentioned before. Instead of keeping confidential data in a safe vault, vaultless tokens use an algorithm to store the information. The original sensitive data is not typically stored in a vault if the token is changeable or reversible. This method is rarely used due to its weaker security levels.

Understanding the working of tokenization with an example

When a retailer or merchant processes a customer’s credit card, the PAN is replaced with a token. 1111–2222–3333–4444 is substituted by alternatives such as Gb&t23d%kl0U.

The merchant may use the token ID to maintain client records; for example, Gb&t23:%kl0U is associated with Jane Doe. The token subsequently goes to the payment processor, who de-tokenizes the ID and verifies the payment. The notation for Gb&t23d%kl0U is 1111–2222–3333–4444.

The token is solely readable by the payment processor; it has no value to anybody else. Additionally, the token may only be used with that specific merchant.

In this case, the tokenization procedure will happen as follows:

  • Jane Doe enters her payment information at the point-of-sale (POS) terminal or digital checkout page.
  • The details, or data such as PAN, are replaced by a completely random token (or Gb&t23d%kl0U), which is often produced by the merchant’s payment gateway.
  • The tokenized data is subsequently transferred to a payment processor securely. The actual confidential payment information is kept in a token vault within the merchant’s payment gateway. This is the sole location to map a token and its value.
  • Before sending the information for final verification, the payment processor re-encrypts the tokenized data.

See More: What Is Cloud Encryption? Definition, Importance, Methods, and Best Practices

Tokenization vs. Encryption

Digital tokenization and encryption are two distinct data-security-related cryptographic techniques. The primary distinction between tokenization and encryption is that the former does not alter the extent or category of the protected data, while encryption modifies the length and type.

This makes encryption illegible without the key, even if the encrypted message is exposed. Tokenization does not employ a key in this manner; it cannot be mathematically reversed using a decryption key. Tokenization utilizes data that cannot be decrypted to symbolize or represent sensitive data. Encryption may be decrypted with a key.

Encryption has been the preferred data protection technique for decades, but tokenization has recently emerged as the most cost-effective and secure solution. However, encryption and tokenization can be used in tandem.

Before we explore how tokenization is used, here is an overview of the critical differences between tokenization and encryption:

1. The process of data masking

Through an encryption algorithm and a key, encryption mathematically converts plaintext into ciphertext. In contrast, tokenization creates token values randomly for plain text and maintains the mappings in a data repository. This database can also be a blockchain.

2. Ability to scale

Using a small encryption key to decode data, this technique can be used for massive data volumes. However, it is difficult to scale tokenization and safely maintain data quality and accuracy — as the database grows. For this reason, it is primarily used by large organizations and governments.

3. Type of data secured

Encryption is employed for unstructured and structured data, including entire files. Tokenization’s primary objective is safeguarding structured data fields, such as credit card information and Social Security numbers. That is why one can also use tokenized data for data analytics.

4. Third-party access

Encryption is excellent for communicating confidential information with other parties that possess the encryption key. It isn’t as secure, but more appropriate for transferring data. In contrast, tokenization makes information interchange harder since it requires full access to a token repository that maps token values.

5. Data format preservation

The vulnerability of format-preserving encryption systems is a tradeoff. With tokenization, however, the form may be preserved without compromising the level of security. This makes it a more no-compromise method of data security.

6. Location of data

When information is encrypted, the unencrypted source document will leave the organization. Tokenization is distinct because the original data is never transferred beyond the organization. This assists in satisfying specific regulatory criteria — particularly in industries like healthcare, financial services, etc.

7. Prerequisites

Tokenization works only via web services, and network connectivity is an essential prerequisite when tokenizing data. In contrast, encryption can be applied both locally (i.e., through a locally installed encryption tool) or as an online service. An internet connection is not a prerequisite for encryption.

Read the full article: https://www.spiceworks.com/it-security/data-security/articles/what-is-tokenization/

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