In the tech jargon – and even more fintech or regtech – there is a word that is increasingly used, so called a buzzword: Tokenization. What is it about? What are the concrete applications around this phenomenon? We asked Ivor Colson, Head of Marketing at Tokeny, to enlighten us on this new trend.
What are tokenized securities?
Tokenized securities follow the exact same rules and regulations that govern traditional securities, but they are distributed digitally, in the form of a “token” registered on a blockchain infrastructure.Therefore, a tokenized security can be any typical security, such as equity, bond, or an investment fund. Tokenized securities can also represent a securitized fraction of a real asset (e.g. a piece of art).
How do tokenized securities work?
Tokenized securities are issued on a blockchain infrastructure. Typically, a blockchain works as a distributed ledger that is accessible for all to use. Blockchains enabled for businesses, such as the Ethereum blockchain, verify transactions through a consensus protocol. Nodes in the network, or in other words computers, are used to validate these transactions and store the data in blocks. Each block is encrypted and if the information is modified by a particular party, the ‘hash’ that uniquely identifies each block notifies the participants in the ecosystem.
One key feature of certain blockchains is the usage of ‘smart contracts’, which are essentially rules that are programmed into the tokens. For example, if a tokenized security requires for an investor to be from the United States, and that the individual needs to be a registered Accredited Investor, this rule can be programmed into the token to ensure only participants that fit this profile are able to own that specific token.
“This technology will bring the new tools required to enhance operational efficiency, and develop many roles that exist today.”
What’s the point of tokenized securities?
Tokenized securities have the potential to completely transform the way capital markets operate. This technology will bring the new tools required to enhance operational efficiency, and develop many roles that exist today. The use of blockchain technology in financial services will lead to an array of benefits for both the sell-side and the buy-side:
Liquidity: Certain financial securities are currently difficult to trade and are highly illiquid. For example, privately issued securities can only be traded on secondary markets after an extensive amount of work has been carried out by middlemen following difficult to navigate regulations. By streamlining and automating these processes and by using a common distributed infrastructure, companies can remove the burdensome hurdles that previously restricted the liquidity of their securities.
Automation: Service functions that are carried out by middlemen can be automated through a blockchain. For example, in the instance of reconciliation, in current processes every holding needs to perform position reconciliations with the previous ones. This leads to a time-consuming operational process. This processes can be simplified and automated via smart contracts, and by using a singular source of data in the blockchain, all parties can act off the same data source.
Speed: Automation increases the speed of current security processes as many of these services can be automated through the use of smart contracts. As a result, transactions are generally settled in an hour, and often take minutes to effectuate. Looking at the settlement of traditional securities, this process often takes one or two days.
Cost Efficient: Currently, middle men charge significant fees for their services. These players pile up their fees, which are baked into the share price and paid for by the end investor. By using blockchain technology and smart contracts, issuers can cut out many of the typical, low-value added, expensive, intermediaries that are needed for offerings.
Transparent: Blockchain technology offers full end-to-end transparency, allowing different parties to eliminate the asymmetry of information that is present during traditional security transfers. Using the blockchain as a central source of truth, the same data is shared by every player in the value chain.