Is it possible to buy and sell a work of art without moving it? Can we own pieces of property and collectibles that cannot be divided, and which lie in distant parts of the world?
Tokenized securities are digital representations of underlying assets. Like securities, they derive their value from the value of the asset they represent. However, unlike securities, they are not restricted to geographical regions and can allow you to own a fraction of a single piece of art or any other asset that cannot be broken up. These digital instruments are also cost effective for both the issuers and for the investors since they do not pass through trusted agents such as banks, clearing houses and brokers.
Conventional investments such as securities and bonds have a strong regulatory framework as well as intermediaries who ensure the protection of investors’ interests, transparency of trades and settlement, and efficiency. On the other hand, tokenized securities use a decentralized ledger that permanently records all transactions. Since they operate on blockchains, tokenized securities have improved liquidity, transparency, speed, affordability, and access for investors.
The blockchain technology behind tokenized securities
Blockchain is transforming the way we do several things and nowhere is this more evident than in the complex world of investments. Tokenized securities wrap conventional investments in a software protocol, and this makes them easy to access from everywhere. Transactions in tokenized securities are also transparent since they are visible on the decentralized digital ledger.
Tokenized securities vs. Security tokens
Tokenized securities are different from security tokens. Security tokens are programmable instruments that use smart contracts. Smart contracts are auto-executing protocols when certain preset conditions are met. For example, if the issuer of a security token wants to reward investors who have held the token for at least a year by paying dividends, that information can be ‘baked’ into the smart contract. So, every investor who has held the token for a year will be rewarded automatically.
Smart contract capabilities can have far reaching benefits. A lot of compliance and regulatory checks that are executed manually or ‘off-chain’ can be done via smart contracts, and this can reduce both the time and cost of execution. Tokenized securities do not have programmable features. However, they also have the benefit of reduced costs and transaction time due to the decentralized peer to peer network on which they operate.
Security Token Offering (STO)
Both tokenized securities and security tokens are issued through security token offerings or STOs. Security token offerings (STOs) are issued by companies looking to raise capital. Companies have several traditional routes to do this, such as an initial public offering (IPO) of shares in the company or through private placements which are available to accredited investors. Companies can also issue debt through bonds. All these options involve intermediaries such as investment banks and a lengthy process for due diligence, appropriate disclosures, and regulatory compliance.
Security token offerings are like IPOs and confer ownership rights and the right to share in future profits of a company. But they also allow companies to crowdsource funds on the blockchain with minimal regulatory requirements. STOs also allow companies to remain privately held, something that is not possible in an IPO. Unlike initial coin offerings (ICOs) which are issued to members of a blockchain community, and which are governed by the protocol followed by the community, STOs are regulated.
|Type of launch||STO||ICO||IPO|
|Type of funding||Public and Private||Private||Public|
As the regulatory framework emerges, forward thinking organizations such as the Intercontinental Exchange have started making provisions for transactions in cryptocurrencies, including security tokens and tokenized securities.
Use cases for Tokenized Securities
Even illiquid assets such as real estate or fine art can be represented through tokens that investors can then buy. Since tokens represent a part of the total value, investors can own fractions of the asset, and this results in improved liquidity. These tokens can also be traded in the secondary market after the initial offering.
Investors can participate in the price appreciation of underlying assets in proportion to the share of the total value they hold in the form of tokens. This increases the number of potential investors who can own a fraction of an asset. Since tokenized securities make it possible to raise capital through crowdfunding without taking a company public, this means that more investors can participate in private placements.
Tokens are issued in accordance with a blockchain protocol and since all transactions on a blockchain are immutable and tamper-resistant, tokens bring greater transparency to transactions. Currently the due diligence and regulatory checks that are done before an initial public offering of a company’s shares are time-consuming. Blockchain has the potential to speed this up due to its secure tamper-resistant protocols and decentralized networks that allow all transactions to be seen by everyone on the network.
The transparency of blockchains can also bring down the cost of issuing tokenized securities. With all transactions are verified by a network, a lot of systemic checks and regulatory processes can become irrelevant with tokenized securities. In the case of security tokens that are launched with smart contracts capabilities or automated protocols that are triggered when certain conditions are met, the fees of a transaction can come down dramatically due to the auto-execution of smart contracts.
The normal time taken to validate transactions, verify the identity of the sender and receiver and to transact is shortened since blockchains use a peer-to-peer network. So, the time saved in using tokenized securities can be significant.
Due to lower costs, greater transparency, and the ability to hold a small portion of an underlying asset, access to investments is improved. Thanks to tokenized securities, an expensive real estate asset or a collectible is not an investment option available just to high-net-worth individuals. Anyone can hold a part of the asset by buying a token that represents a fraction of the total value of the asset. Digital exchanges that list tokenized securities are open 24/7 and this also improves investors’ access to them across different time zones.
Access to investments can also grow exponentially since digital transactions are borderless and decentralized peer-to-peer networks stretch to different parts of the world. It is possible to invest in any corner of the world with tokenized securities.
Tokenized securities are already being used by several companies and blockchain communities and they democratize the investment playing field by generating liquidity for illiquid assets like real estate and collectibles, expanding access by digitizing the value of the underlying assets that anyone can own, and bringing transparency by using a decentralized peer-to-peer network. Tokenized securities also improve the affordability of investments through lower transaction costs. The increasing adoption of these instruments and other digital investment tools are being explored by the SEC and this is a positive indicator of the validity and future viability of tokenized securities.
Written by Vidya Ramakrishnan PhD
Vidya Ramakrishnan is a seasoned financial writer and focuses on cryptocurrencies and fintech. She covers emerging Web 3.0 technologies, blockchain and DeFi. She holds a PhD from Columbia University, NY.
This article is not investment advice, financial advice, or trading advice. Please conduct your own due diligence and research before making any investments. This article is covers one specific crypto mining example. It is not a comprehensive list or specific purchasing advice for any specific miner, company, manufacturer, or component. If you choose to invest in crypto, please conduct your own thorough research. Please understand the risks involved before investing in crypto.