Tokenizing Securities: A New Era in Investing


Tokenizing Securities: A New Era in Investing
Financial industries are embracing asset tokenization to transition away from the traditional databases
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Since its invention, blockchain use has expanded exponentially. Everyday people are applying blockchain technology to new and innovative uses. In recent years, start-ups, along with industry leading enterprises, have embraced blockchain technology including tokens and cryptocurrencies and have been looking for ways to integrate the blockchain into existing financial marketplaces. These efforts don’t seem to be slowing down anytime soon, with forecasts predicting that spending on blockchain solutions will increase to nearly 19 billion U.S. dollars by the year 2024.

The tokenization of assets has emerged as one of the most promising methods for hastening the financial industries’ transition from traditional databases to blockchain technology. According to BNY Mellon, “tokenization has the power to revolutionize the financial landscape ‒ intrinsically changing how investments are managed, used and monetized.”

Here at Bitwave, we are excited by the potential of tokenization of all kinds of assets.

The Tokenization Of Securities

When discussing financial securities, “the term ‘security’ refers to a fungible, negotiable financial instrument that holds some type of monetary value. A security can represent ownership in a corporation in the form of stock, a creditor relationship with a governmental body or a corporation represented by owning that entity's bond; or rights to ownership as represented by an option.”

The term tokenization describes the process of representing an asset as a digital token and recording that digital token on a distributed ledger (also referred to as a blockchain network). Accordingly, the tokenization of a security is simply the process of representing a security as a digital token and recording that digital token on a blockchain network. Once recorded on a blockchain network, the tokenized security can be traded in much the same way as other crypto assets.

Are tokenized securities the same as NFTs?

Before getting into the specifics of tokenized securities, it is important to recognize that tokenized securities are similar but not the same as non-fungible tokens (NFTs). “NFTs are by definition non-fungible, meaning that whatever a given token represents – be it a drawing of a monkey; or a video of a basketball player; or the first ever tweet – its associated digital form is unique, without equivalent anywhere in the universe. Even if, say, an artist mints 100 NFT prints of the exact same image, each of those prints will have a unique identity on the blockchain that distinguishes it from the other 99 copies.”

Tokenized securities, on the other hand, are often interchangeable. For example, if you buy a share of Mirrored Apple stock (mAPPL), that share can be swapped for a different share of Mirrored Apple stock without a problem. The two shares of stock are identical and, therefore, fungible.

Another distinction between tokenized securities and NFTs involves ownership rights of the underlying asset. In general, NFTs do not provide ownership rights to the underlying asset, while tokenized securities most often do provide ownership rights to the underlying asset. This is not always the case, though. Tokenized stocks and bonds, especially mirrored tokenized stocks and bonds, are an exception to the rule. These tokenized securities typically do not bestow ownership rights. However, mirrored stocks and bonds are fungible and are, therefore, still distinguishable from most NFTs.

The question of whether tokenized securities and NFTs are similar enough to be treated the same under the law is still up for debate. Some experts argue that tokenized securities and NFTs are distinct for many of the reasons stated above, while others suggest that, from a legal and regulatory perspective, NFTs are simply tokenized securities using a different name.

Examples Of Tokenized Securities

Tokenized securities are fungible, negotiable, and readily available. As a result, they are well-positioned for widespread adoption.

The three most popular types of tokenized securities are:

Stocks and Bonds

While tokenized stocks and bonds are similar to traditional stocks and bonds, there are some notable differences. It is important to understand that, unlike traditional stock and bondholders, tokenized stock and bondholders do not have an ownership stake in the underlying company or bond. Investors buy tokenized stocks and bonds in order to gain exposure to the underlying asset, but they do not actually own the asset. Technically speaking, tokenized stocks and bonds are derivatives that are backed by the actual stock or bond. In most cases, the price of each tokenized stock or tokenized bond is pegged to the value of the underlying asset.

There are also differences with regard to the purchase and digital storage of tokenized stocks and bonds. Traditional stocks and bonds are typically purchased via an investment brokerage account and stored on the investment firm’s database. Tokenized stocks and bonds, on the other hand, can be purchased on a cryptocurrency exchange and are stored on a blockchain.

Some of the most popular tokenized stocks and bonds mirror traditional exchange-traded funds (ETFs) and traditional company stocks. At the time of this writing, the top tokenized stocks by market capitalization are as follows:

  • SPDR S&P 500 (SPY)
  • MicroStrategy (MSTR)
  • Tesla (TSLA)
  • Facebook (FB)
  • Paypal (PYPL)
  • Swaperry (PERRY)
  • Alibaba (BABA)
  • Nvidia (NVDA)
  • Gamestop (GME)

Because tokenized stocks and bonds are so closely related to the underlying securities they mirror, regulatory bodies tend to make little distinction between the security itself and the tokenized version. Like traditional securities, tokenized securities are subject to regulation and must maintain compliance with securities laws. So, unlike cryptocurrencies which eluded regulation and enforcement for many years, tokenized securities have drawn government attention early in their lifespan. In the United States, tokenized stocks and bonds are governed by the Securities and Exchange Commission (SEC).

Real Estate

Like tokenized stocks and bonds, shares of tokenized real estate are digital securities bought and traded on the blockchain and accessed via a cryptocurrency exchange. However, real estate tokens provide ownership rights to physical property. Typically, each real estate token represents a fractional share of ownership in specific real property.

In recent years, real estate tokens have garnered significant interest from investors. In 2018, for example, a luxury condo development in Manhattan was tokenized and valued at over $30 million. In fact, name-brand companies have dabbled in real estate tokens as well. “One of the first successful commercial real estate STOs (security token offering) raised approximately US$18 million in 2018 through the issuance of Aspen Coins, where digital tokens represented fractional ownership of the luxury St. Regis Aspen Resort in Colorado, USA.” More recently, Alterra Worldwide has offered ownership interests in their T27 Tower via real estate tokens. T27 Tower is valued at $60 million and will be one of the most valuable properties in downtown San Jose, CA.

Real estate tokens can convey a wide range of ownership rights. The ownership rights are determined by the terms of the token itself. Although ownership rights can vary significantly from token to token, the following ownership rights are the most common among currently available real estate tokens:

  • Ownership of part of a real property
  • Ownership of the entire real property
  • An equity interest in an entity that controls real property
  • An interest in a debt secured by real property, or
  • A right to share in the profits generated by real property

From a regulatory perspective, real estate tokens are a bit more complicated than tokenized stocks and bonds. The increased complexity is due to the fact that real estate tokens can be structured in multiple ways. Because real estate tokens are attached to ownership interests in real property, the terms of the agreement between buyer and seller can be wide-ranging. Each real estate token can be distinct from the next.

As a result, real estate tokens must each be analyzed independently. The majority of real estate tokens are considered securities and are governed by the SEC. Others, however, qualify for an exemption and fall outside of the SEC’s purview. In addition, buyers and sellers of real estate tokens must be careful to conform to state and local laws regarding real property ownership. In most jurisdictions, for example, property owners must register their property with local authorities for tax purposes.

Benefits Of Tokenization Of Securities

The key benefits of tokenized securities are:

  • Increased liquidity
  • Improved efficiency in trading and settlement
  • Increased accessibility for smaller investors through fractional ownership

Increased Liquidity

Tokenized securities create increased liquidity because they help to open the securities market to more investors. While most of the attention is focused on tokenized stocks, bonds, and real estate, the tokenized fine art market might provide the most striking example of tokenization’s growth and accessibility potential.

In the past, only ultra-high-net-worth investors could bid on fine art pieces sold at auction. By selling fractional ownership shares in the form of digital tokens, the pool of potential investors in fine art has expanded significantly. For example, the ownership rights to Picasso’s masterpiece “Fillette au berét” were recently sold via digital tokens to more than 50 investors. Each digital token sold for 1,000 Swiss francs (about $1040 USD).

Improved efficiency in trading and settlement

Tokenized securities have several structural advantages that lead to improved efficiency in trading and settlement as compared to traditional securities. First, the tokenized securities markets (blockchain exchanges) are always open, while traditional securities markets typically close at night, on weekends, and over holidays. Second, tokenized securities trading is often faster and more efficient for average investors. For example, tokenized securities trades typically settle in a matter of minutes, while traditional securities trades commonly take multiple days to close. And finally, tokenized securities employ blockchain infrastructure which helps to improve the efficiency of many administrative processes such as profit sharing, voting rights distribution, buy-backs, etc.

Increased accessibility for smaller investors through fractional ownership

Tokenized securities provide greater accessibility for smaller investors through the use of fractional ownership shares. Historically, it was assumed that only wealthy individuals had the ability to invest. Those assumptions continue to affect the pricing of traditional investments to this day. As a result, many traditional securities are quite expensive and, therefore, out of reach for investors with limited resources. Tokenized securities provide greater pricing flexibility and have broken down some of the structural impediments to investing.

Challenges Of Tokenization Of Securities

As we have shown, tokenized securities have many potential benefits when compared to traditional securities. However, there are also some challenges that will need to be addressed before tokenized securities can achieve the widespread appeal of traditional securities. The most pressing challenges associated with tokenized securities are:

  • Regulatory Hurdles
  • Cybersecurity Concerns

Regulatory Hurdles

Like many blockchain-based assets, the regulatory environment surrounding tokenized securities is unsettled and suffering from a general lack of guidance. Currently, very few regulators possess expertise in tokenized assets, and as a result, there has been a reluctance to formulate a comprehensive set of regulations to govern them.

The lack of regulation in the tokenized securities space has a cascading effect that trickles down to even the most basic functions of investing. Without regulatory guidance, it is difficult to create and apply uniform accounting standards or best practices for tax preparation.

Cybersecurity Concerns

As with most blockchain-based assets, tokenized securities are vulnerable to cyber-attacks. All crypto asset investors should be familiar with the following cybersecurity threats before investing:

  • Phishing Attacks: Phishing attacks involve illegal actors posing as reputable businesses online in order to obtain personal information from unsuspecting users. The hackers then use this information to access accounts and withdraw funds.
  • Fraudulent Trading Platforms: Most crypto asset trading platforms are legitimate. However, some platforms are elaborate scams designed to steal money from new or unsophisticated investors.
  • Third-party Applications: Hackers can sometimes gather personal information from third-party applications that are not properly secured. The hackers can then use the information to access other user accounts and withdraw funds.
  • Malware: Malware is malicious code that hackers use to gain access to and control over another user's computer. In the context of crypto cyber attacks, malware can also be employed to gain access to personal information stored on a computer or to force a computer to mine crypto assets.
  • Private Key Security: Private keys are often used as an identifier or password of sorts to access crypto assets. Malicious actors seek these private keys in order to access crypto assets that do not belong to them. Because many users store their private keys online or on their computers, they are particularly vulnerable to cyber-attacks.
  • User Confusion / Human Error: As mentioned above, crypto asset investing can be confusing, especially for those who are new to it. On occasion, new crypto investors can mistakenly give away access to their assets and provide bad actors with an opportunity for theft.

Future Of Securities Tokenization

While there are some challenges facing the securities token market, most indications point toward wider adoption in the future. For the intrepid investor, the securities token market offers immense promise. In fact, securities tokens have the potential to revolutionize the way that securities are traded. Should they ultimately achieve their potential, securities tokens could impact or even displace traditional securities and accrue significant value in the process.

Bitwave Gives you a Simple View of your Tokenized Securities

As with any digital asset, Bitwave makes it easy to track your holdings across multiple wallets or custodial accounts. By connecting all of your digital asset sources to Bitwave, you get a simple, unified view. If you sell any of your tokenized securities, you can use Botwave to track the gains or losses and record journal entries for the transaction in your general ledger. Contact to see a demo.

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Disclaimer: The information provided in this blog post is for general informational purposes only and should not be construed as tax, accounting, or financial advice. The content is not intended to address the specific needs of any individual or organization, and readers are encouraged to consult with a qualified tax, accounting, or financial professional before making any decisions based on the information provided. The author and the publisher of this blog post disclaim any liability, loss, or risk incurred as a consequence, directly or indirectly, of the use or application of any of the contents herein.