The blockchain is one of the most important technological advancements in recent history. It is defined as a digital ledger where transactions made are recorded chronologically and publicly by a network. Blockchain enabled not only the creation and circulation of network tokens or digital currencies, but also of digital assets that represent a particular asset or utility. Tokens have three general functions: Payment Tokens, Utility Tokens, and Asset Tokens (or Security Tokens).
Tokenization of assets is the new big wave in 2019. You can look at the Security Tokens as a version of “programmable ownership”, the process of converting rights to an asset into a digital token on the blockchain. This means that most likely any financial asset with ownership can be tokenized, including stocks, gold, oil etc. Many of these assets are difficult to physically transfer or subdivide, so instead buyers and sellers trade paper that represents some or all of the asset. This process and the required complex legal agreements can be cumbersome, difficult to transfer and hard to track. The solution is switching to a digital system similar to Bitcoin but linked to an asset - asset tokenization.
Liquidity is one of the driving forces behind traditional asset tokenization. Tokenizing relatively illiquid assets and creating a market in which to trade these tokens can reduce the illiquidity discount by reducing frictions to trade. A share of stock that is traded on an exchange is of higher value than a share of stock in a private company because there are fewer frictions to trade the public stock. Less friction often means more market participants, more volume, smaller spreads, and less price impact. Such a difference in value is considered the “illiquidity discount,” or a “liquidity premium.” Financial economists’ rule of thumb is to measure it as 20–30%. This represents an impressive added value and shows great promise. Traditional assets may have to eventually tokenize in the future because they will lose the liquidity premium if they don’t.
Security Tokens bring multiple improvements to the financial industry by removing some of the multiple counter-parties and middlemen from investment transactions. This leads to:
- Lower fees since many fees associated with financial transactions are derived from middlemen fees. On top of that, smart contracts are believed to reduce the complexity, costs and paperwork with managing securities.
- Faster deal execution by removing middlemen from investment transactions. Additionally, immediate trade settlement on the secondary market for Security Tokens will become an attractive advantage for issuers and investors.
- Wider market exposure since asset owners market their deals to anyone anywhere with an internet connection (within regulatory limits).
- Penetrating borders by offering deals around the globe while the underlying assets stay put in the country of its origin and regulation.
Tokenization is putting a new wrapper around a familiar asset, leading to broadening the market and enhancing liquidity. As other blockchain-based assets, Security Tokens will transform capital markets, improving inefficiencies and access. The tokenized asset market is expected to be a $24trn business opportunity by 2027.
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