Tokenized securities are a hot topic and the latest trend at the intersection of blockchain and traditional finance. Tokenizing classic financial instruments are expected to elevate the financial markets thanks to the benefits of the distributed ledger.
We already see multiple types of tokenized securities appearing, including STOs, stablecoins (digital assets backed by fiat currency), tokens backed by liquid and illiquid assets, and futures or ETFs based on crypto.
Such digital assets can be generalized into 2 categories: “crypto wrapped around legacy” and “legacy wrapped around crypto”.
“Crypto wrapped around legacy” hybrids are represented by asset tokens backed by underlying financial assets of various types. In this category of hybrids, the owner buys a digital asset designed to track the legacy asset’s price. Such hybrids are issued, traded and settled on a blockchain, but the underlying assets are held in the legacy financial system. The token may trade in fiat and in crypto.
Now, there are multiple scenarios on how exactly the token is linked to an underlying asset, and what may happen with such a token. Ideally, the token should be easily swapped with the asset, to bring the value and liquidity to the token.
- It’s not necessarily the case with stablecoins, as the recent news with Bitfinex & Tether shows. At the same time, the demand for the settlement tokens within the crypto space is sufficient enough to devour multiple stablecoins already.
- It may not bring liquidity either: real estate tokens have a certain value for the issue, but they have questionable value to the investor at the moment (and we have a few ideas as to why);
- Token offerings of startups (linked to company equity, bond or revenue stream) may provide the future markets for venture capital, but lack liquidity and have multiple trust issues (and we have a few ideas on how to improve that);
- While it is expected that tokenized gold is coming to the market this year, it seems, that the tracking token would be of more sense than the tokenized physical metal. First of all, that idea places such a startup in direct competition with banks, brokers and exchanges combined (e-gold saving accounts, gold bars, ETFs, futures, gold companies stocks etc). Second, many of these gold-backed tokens offer questionable legal paradigms and vault solutions.
- ETFs and indices traded in crypto and backed by liquid publicly tradable assets represent a clear and valid tokenization case, that may offer hedge and arbitrage opportunities. ETFs may experience issues with liquidity, but we expect that to be a matter of time.
- Finally, public equity and bond tokenization represent a great opportunity (if done properly) to have a digital asset that might be used for a hedge, arbitrage and ensure liquidity flowing between financial and crypto markets.
“Legacy wrapped around crypto” hybrids are represented by futures, swaps, bitcoin-settled ETFs and any other derivatives, based on a crypto asset, most frequently bitcoin at the moment. Such hybrids are issued, traded and settled in the legacy system, but the underlying digital assets (e.g., cryptocurrency) that back this category of the hybrid are held on a blockchain.
- Futures and ETFs on cryptocurrency are yet another valid and important instrument that helps to build the market and create liquidity in the upcoming generation of digital assets of various types;
- Index on cryptocurrency, even if traded OTC, is also an interesting entry point into the crypto space that is attractive to investors and can (comparatively easy) be created legally, in the form of a fund, structured product or even an option;
- Also, note that cryptocurrencies are yet undefined properly in legal terms. Many brokers and exchanges offer such instruments with no delivery, or with delayed delivery. Or it requires a custody with a digital wallet registered with regulators (one way or another).
So is it hard to create a tokenized security? While it’s becoming relatively easy to issue a token, the tricky and complex part rises from the regulatory and governance standpoint. A tokenized security offering may use an already existing regulation, and crypto security is going through a regulatory approval itself.
Unfortunately, the regulations in most jurisdictions are in development. Besides, security offering and trading of securities require filings and financial licenses, regardless of crypto regulation. It usually takes a lot of time to get those approvals, especially if a company is interested to work with retail as well as with accredited investors.
From a trading standpoint, blockchain technology may cut down costs and simplify processes for the market. Say, an investor is able to trade the token anywhere in the world while leaving underlying assets in the country of its origin and regulation. It allows an investor to receive a variety of services regardless of their country of residence. It means that a fintech service is able to cut down the costs of localization and regulation. And it also means that market infrastructure (exchanges, clearing, custody, to name a few) is faster, simpler and cheaper.
Overall, we think that we are witnessing a new market (or at least several new investment asset groups) being born, and as the history shows, it will go the same evolutionary way, as many markets before that.
Investors will be attracted if it has a safe and legit connection between old market infrastructure and new technology, offer a legitimate and liquid asset to trade, and ensure such an offering is an actual product fit. Give it time to develop, grow trading volume, let everyone grow their own appetite for risks - and then add other investment assets into the mix. Meaning, that it would make sense to introduce more complex assets such as commodities, marginal assets, STOs of startups, tokenized real estate only once the trading volume and liquidity is big enough - and step by step.
For example, financial exchanges list thousands of stocks, bonds, indices, precious metals, commodities and futures, and they also list IPOs, pink sheets, penny stocks, low-grade bonds, obscure notes, rare metals and illiquid commodities, and every instrument eventually finds its customer - it just was not built in one day. We can’t start the market with an exotic option, but we can certainly build towards such an offering in the future.
We believe that tokenized public stocks and indices, a few stablecoins, and futures and ETFs on crypto are the key assets that may gain traction, recognition and demand big enough to achieve escape velocity to travel into the future fintech markets.