For hundreds of years, an investor's share of equity in a company was recorded using paper. Then, computers replaced these hand-written records with digital ones. Yet, in many ways, the market is still set in the past, using traditional systems with digitization laid over the top.
However, now, a new advancement is gaining traction. Forward-thinking companies can create tokenized versions of company stock that are recorded on blockchains. In this article, I'll take you through exactly what tokenized stocks are, the benefits of them, and why every investor should understand their importance in the shifting finance world.
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What Are Tokenized Stocks?
A tokenized stock represents a share of company ownership recorded on the blockchain. This is done using non-fungible tokens (NFTs). It allows investors to combine the benefits of stock trading with the advantages of blockchain technology.
Tokenized stocks work similarly to traditional stocks. For example, if Tesla stock were tokenized on the blockchain, its asset value would rise and fall in the same way as its traditional counterpart. Tokenization is just another method for representing and verifying asset ownership, and it still possesses the value of the underlying asset or company.
How Tokenization Works
Normally, when you buy a share of a listed company using an online stockbroker, your shares would be credited to your trading account.
Tokenized stocks work in a similar way, except instead of just being a number on a digital platform, the shares are coded as digital tokens. This gives them the ability to sit directly in your self-custody wallet, so you don't even need to trust a third party to store your asset.
Tokenization also means you can own part of a stock, an advantage, particularly when it comes to those which are exceptionally popular and expensive. Additionally, with the stocks represented as blockchain tokens, ownership and trading can be done using the efficiency, accessibility, speed, and transparency of blockchain technology.
Pros and Cons of Tokenized Stocks
Advantages
1. Fractional ownership
Stocks can be owned in parts, particularly for high-cost stocks that would be tough for some investors to own completely. Multiple people could take fractional ownership of a stock.
3. 24/7 trading
Tokenized stocks can be traded 24/7. Just like with cryptocurrency trading the market is never closed.
5. Lower costs
While traditional stocks may still cost $10 or more to trade, blockchains can settle for less than one cent.
6. Faster settlement
The highest performing blockchains can process and settle transactions in seconds. It's near-instant trading; the assets literally change ownership in real time.
Disadvantages
1. Regulatory uncertainty
Governments are struggling to keep up with innovation in the blockchain sector. Its decentralized, borderless nature, along with new asset classes, means that regulations are constantly evolving.
2. Security concerns
Blockchain technology is secure, but smart contracts could be vulnerable to hacks. Any errors could lead to lost assets.
3. Counterparty risk
It adds an extra layer of risk when relying on the stability of the asset token issuer. Many traders might use a custodian to hold their assets, reintroducing third-party trust issues.
4. Market liquidity challenges
Currently, there is lower trading volume for tokenized stock. So, it might be hard for you to trade in and out of positions quickly.
5. Tax implications
There's still unclear tax treatment, and many financial firms might not be equipped to deal with tokenized stocks when it comes to reporting.
Use Cases and Examples of Tokenized Stocks
DeFi Platforms
DeFi platforms like Synthetix and Mirror Protocol provide synthetic stock exposures. Although these might not be official ownerships of stock, they essentially provide a derivative method to gain exposure and stock ownership.
Tokenized ETFs
Tokenized Exchange Traded Funds (ETFs) can be represented as blockchain tokens to make trading easier and more accessible across the world. This can give investors access to new markets internationally.
Private Company Equity
Private company equity can also be represented as a tokenized asset. This could open up a new world for smaller companies or private companies to be more liquid and tradable in real time.
Bottom Line
Tokenized stocks are the next step in the evolution of equity trading. They allow small investors to trade fractional amounts of stocks with anyone, anywhere in the world. Plus, the technology could solve some of the inherent inefficiencies in traditional markets, helping to reduce costs, settlement times, and fees.
The only downsides are the constant regulatory uncertainty that challenges all blockchain finance integrations, along with new security concerns and counterparty risk.
