Typical uses of tokenization
In October 2020 we introduced the concept of tokenization, the “process of issuing a blockchain digital tradable token that represents ownership rights in a real asset,” creating a bridge between real-world assets and their trading, storage and transfer in a digital world [1].
The asset classes that have the most to gain from tokenization are those characterized by highly complex inefficient processes, high market capitalization, low speed and high costs (such as real estate, art, etc.). Nevertheless, that does not mean that other asset classes can’t take advantage of the technology. With that being said, let’s talk about tokenizing equity.
Tokenized equity refers to the creation and issuance of digital tokens which represent equity shares in a corporation or organization. The biggest difference between conventional shares and this type of token is the way of recording the transactions in a decentralized, digitized infrastructure.
Why tokenize stocks?
Substantial benefits can be reaped from blockchain technology, and more specifically from tokenization [1]. Although equity can be categorized as having the most efficient processes within the traditional financial ecosystem, it can still take advantage of tokenization and what it has to offer. Take the traditional method for raising capital for example. A long list of regulatory requirements like book maintenance, adherence to exchanges rules, constant disclosure of financial, accounting, tax, and other business information must be met.
Tokenization benefits can be categorized into two main types. The “general” and the “particular” ones. General benefits are derived from the blockchain itself, such as immutability and transparency, accessibility, efficiency, decentralization, etc. In the case of equity, several particular benefits can be found:
- Among almost every aspect of issuing equity, dividend repayment can be automated and distributed among holders in a much faster and cost-efficient way.
- Because of its inherent decentralized characteristic, blockchain issued tokens don’t have time limitations on trading, so there would be no more “normal trading hours” defined by traditional exchanges, but 24/7 trading instead. The consequences of this are still unclear, given that liquidity can vary depending on time zones, but it may provide a smoother price movement and lower volatility.
- Similarly, there is no geographical limitation. A higher democratization of access can be derived from assets traded seamlessly throughout the world, provided each actor conducts due KYC/AML processes. Additionally, a higher access will be derived from tokenized private companies (SME), previously restricted to qualified investors and private equity companies.
- Tokenized different classes (Participation % dividends rights certificates, registered shares, etc.)
- Improved efficiency
- Built in governance. Custom rules like free or restricted transferability, lock-up & vesting periods can be coded into the equity tokens.
- Remote interaction with shareholders can be established to send them corporate updates, organize votings and manage dividend transactions.
- Fewer intermediaries (like brokers, underwriting companies and others) result in lower fees for both the companies raising funds as well as for token (share) buyers.
- Similarly, lack of need on transfer, clearing & settlement (among others) processes.
- Liquidity. Born out of many of the previous points, deeper liquidity is a main benefit gained from tokenizing stocks. Having the capacity of tapping onto large secondary markets instead of finding private buyers, having unrestricted time and geographic access, and improved efficiency in the processes make an immense difference in the stock market.
A note on custody: Because tokenized stocks can so far be bought, sold and traded only on exchanges, you will not be able to withdraw to other exchanges or more secure, non-custodial wallets. This can be a problem if a hacker gets a hold of the exchange’s hot wallet tokens.
A note on trading: Trading tokenized stocks does not imply one can circumvent all the KYC procedures that today’s investors have to pass in traditional markets. All users who trade tokenized stocks must also pass through KYC and compliance. Until a certain level is attained (“KYC 2” in FTX, for example), you won’t be allowed to trade these assets. Similarly, you cannot trade tokenized stocks from any of the banned jurisdictions.
Regulation and current tokenized equity
Equity tokenization is not necessarily new, but it certainly is not mainstream yet. Only a few exchanges have a handful of tokenized stocks available for trading. Part of the reason could be that equity tokens should have the same treatment as its underlying stock (a security), and many countries still don’t have established regulation on digital asset securities [2][3].
We consider this small cog in the wheel as a step in the inevitable mass adoption of tokenization in the stock market. Even regarded as such by the US SEC Chairman, who believes it will be possible for all stocks to be tokenized in the future [4].
SCALABLE Tokenization
In SCALABLE you can find a partner that can tokenize basically anything in a short time frame, with industry leading technology, and a team to tailor to your needs and support you through every step of the way. If you’re particularly interested in tokenizing equity, get in touch with us today.
References
[1] “DeFi Apps: Asset Tokenization.” Resources, Scalable Solutions, 28 Oct. 2020, scalablesolutions.io/news/defi-apps-asset-tokenization/.
[2] “SIX’s Digital Stock Exchange Planning Tokenized Versions of Nestle and Novartis.” Ledger Insights, 12 Aug. 2019, www.ledgerinsights.com/six-digital-stock-exchange-tokenized-nestle-novartis/.
[3] Stoner, Joshua. “Tokenized Stocks from Apple, Tesla, and Amazon Now Available through Bittrex Global.” Securities.io, 8 Dec. 2020, www.securities.io/tokenized-stocks-from-apple-tesla-and-amazon-now-available-through-bittrex-global/.
[4] Riseshine, Judith. “SEC Chairman Predicts Blockchain Is the Future for All Stocks.” Market Realist, 5 Oct. 2020, marketrealist.com/p/sec-to-allow-tokenization-of-stocks/.
Sources
Roth, J., Schär, F., & Schöpfer, A. (2019). The Tokenization of assets: using blockchains for equity crowdfunding. Available at SSRN 3443382.
