The Tokenization Of Securities
A financial security is a fungible, negotiable financial instrument that holds monetary value. It can represent ownership in a corporation through stock, a creditor relationship with a government or corporation through bonds, or ownership rights through options.
Tokenization refers to converting an asset into a digital token and recording it on a distributed ledger (or blockchain network). Therefore, security tokenization is simply turning a security into a digital token on a blockchain. Once tokenized, these securities can be traded similarly to other crypto assets.
Are tokenized securities the same as NFTs?
Before discussing tokenized securities in detail, it's important to understand how they differ from non-fungible tokens (NFTs). "NFTs are by definition non-fungible, meaning that whatever a given token represents – be it a drawing of a monkey, a video of a basketball player, or the first ever tweet – its associated digital form is unique, without equivalent anywhere in the universe."
Tokenized securities, in contrast, are typically interchangeable. For instance, when someone buys a share of Mirrored Apple stock (mAPPL), that share can be freely exchanged for another share of Mirrored Apple stock since both shares are identical and fungible.
A second key distinction lies in ownership rights. While NFTs generally don't confer ownership rights to the underlying asset, tokenized securities usually do. However, there are exceptions—particularly with tokenized stocks and bonds, especially mirrored ones. These typically don't grant ownership rights. Nevertheless, they remain fungible, which still sets them apart from most NFTs.
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:
Tokenized Stocks
Tokenized Bonds
Tokenized Real Estate
Stocks and Bonds
Tokenized stocks and bonds share similarities with their traditional counterparts, but have key differences. The main distinction is that holders of tokenized stocks and bonds don't receive an ownership stake in the underlying company or bond. Instead, investors use these tokens to gain exposure to the underlying asset's performance without actually owning it. These tokens function as derivatives backed by the actual stock or bond, with their prices typically pegged to the value of the underlying asset.
Some of the most popular tokenized stocks and bonds mirror traditional exchange-traded funds (ETFs) and traditional company stocks as follows:
SPDR S&P 500 (SPY)
MicroStrategy (MSTR)
Tesla (TSLA)
Facebook (FB)
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.
Real Estate
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 a specific real property.
Real estate tokens can convey various ownership rights, which are defined by each token's specific terms. While these rights can differ considerably between tokens, several common types of ownership rights have emerged in the current market:
Fractional ownership of a real property
Complete ownership of a 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 more complex than tokenized stocks and bonds because they can be structured in multiple ways. Since these tokens represent ownership interests in real property, the terms between buyer and seller can vary significantly, making each token potentially unique.
Due to this variability, each real estate token requires individual analysis. While most are classified as securities under SEC governance, some qualify for exemptions. Additionally, buyers and sellers must comply with state and local real property laws. For instance, most jurisdictions require property owners to register 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 increase liquidity by opening the securities market to a broader range of investors. While tokenized stocks, bonds, and real estate receive most of the attention, the fine art market offers perhaps the most compelling example of tokenization's potential for growth and accessibility.
Traditionally, only ultra-high-net-worth investors could participate in fine art auctions. However, through fractional ownership via digital tokens, fine art investing has become accessible to many more people. For example, the ownership rights to Picasso's masterpiece "Fillette au berét" were divided among more than 50 investors through digital tokens, with each token priced at 1,000 Swiss francs (about USD 1040).
Improved efficiency in trading and settlement
Tokenized securities provide several key advantages in trading and settlement efficiency over traditional securities. Blockchain exchanges for these securities operate continuously—24 hours a day, 7 days a week—unlike traditional markets that close during nights, weekends, and holidays. The trading process itself is more streamlined, with settlements typically completing within minutes rather than the days required for traditional securities. Moreover, the underlying blockchain infrastructure improves the efficiency of administrative tasks such as profit sharing, voting rights distribution, and buy-backs.
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 could 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
Tokenized securities have many potential benefits when compared to traditional securities. However, some challenges 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 other blockchain-based assets, tokenized securities face an uncertain regulatory environment with limited guidance. Few regulators have developed expertise in these assets, leading to hesitation in creating comprehensive regulations.
This regulatory uncertainty creates ripple effects throughout the investment process. The lack of clear guidelines makes it challenging to establish consistent accounting standards and tax reporting practices.
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: Cybercriminals pose as legitimate businesses online to steal personal information from users, which they then use to access accounts and steal funds.
Fraudulent Trading Platforms: While most crypto trading platforms are legitimate, some are sophisticated scams designed to defraud inexperienced investors.
Third-party Applications: Hackers can exploit poorly secured third-party applications to gather personal information, enabling them to access user accounts and withdraw funds.
Malware: This malicious software allows hackers to gain control of a user's computer, potentially accessing personal information or hijacking the system for crypto mining.
Private Key Security: Private keys serve as crucial identifiers for accessing crypto assets. Since many users store these keys digitally—either online or on their computers—they become prime targets for cybercriminals.
User Confusion / Human Error: The complexity of crypto investing can lead to costly mistakes, particularly for newcomers. Users may inadvertently grant access to their assets, creating opportunities for theft.
Future Of Securities Tokenization
Despite the challenges in the securities token market, signs point to increasing adoption in the coming years. For forward-thinking investors, this market presents compelling opportunities. Security tokens could transform traditional securities trading. If they reach their full potential, these tokens may not only reshape but potentially replace traditional securities while generating substantial value. Meanwhile Allo leading the tokenization space with more than 2.2B USD worth of staked TVL it makes Allo one of the largest RWA platform. Join Allo in changing the way how assets are been traded and stored.
