The Tokenization of Everything

What the rise future of Securities Token Offerings mean for everyday investors

 

Security transactions traditionally operated on a T+5 cycle via brokerage firms, meaning the purchase and sales of securities requires ‘trade date plus five days’ to settle. Unfortunately, it still takes T+2 to settle security transactions today, even following the reduction of settlement periods almost a decade ago. 

 

Despite the explosive growth of new technologies, the stock settlement process has barely evolved until recently. Stock exchanges, such as the Australian Stock Exchange and the Hong Kong Stock Exchange, are now working to rectify transaction inefficiencies by testing blockchain-based settlement systems. 

 

Blockchain technology made its debut in 2008 and has certainly come into its own, reshaping industries from finance to supply chain to manufacturing. The technology is a game-changing innovation within the context of decentralized value exchange and distribution, where potential applications are virtually limitless, leading to a frenzy of Initial Coin Offerings (ICOs) last year. 

 

ICOs have been in decline since the second half of 2018, as savvy investors realized that ICO tokens generally lack real backing or are not needed in most use cases, making it an opportune time for Securities Token Offerings (STOs) to step into the spotlight. This new financial instrument is combining ICOs’ one-of-a-kind and highly efficient trading and settlement process with asset-backed tokens.

 

To get a clear picture of STOs, it’s necessary first to understand the tokenization of assets and how it’s realized through blockchain technology. Asset tokenization is the process of converting asset rights into a digital token on a blockchain. The token represents a portion of the underlying asset’s value and can be traded freely on Over-the-Counter or exchange markets.

 

Blockchain ensures the ownership information of your token is immutable, so no other person or authority can modify its records once it has been documented in the system. Tokenized assets are shaping the future of finance, as they bring a horde of benefits to the current business landscape, including enabling flexibility and liquidity for previously illiquid assets, automating the execution process, and lowering transaction costs.

 

As appealing as STOs seem, there are still some roadblocks that must be addressed. There’s a need for regulatory clarity on whether token holders have legal ownership of the assets and whether the law protects investors. To transform real and physical assets into digitized assets, centralization–to a certain extent–will be required.

 

Considering the state of the capital market and the regulatory measures that are in place, STOs are the most promising financial instruments to disrupt current securities transactions, with the potential to construct a brand new asset class. Not only can they streamline the way assets are bought and sold, they can also democratize the process by removing the intermediary.  

 

From purchasing artwork to properties, STOs offer a defined structure for fractional ownership and give individuals the opportunity to access markets with high barriers to entry. Ultimately, the meaning of ownership will be completely redefined. 

 

Non-fungible and unique assets, like the Mona Lisa, can be tokenized and distributed in fractions. The tokens are one-of-a-kind to retain authenticity, and each ‘share’ of the artwork can be bought and sold freely by accredited investors or even the general public. For a novice who wants to invest in the art world, STOs make it possible to do so with a modest amount of capital. 

 

Likewise, real estate is another opportunity for new investors. Tokenized assets enable properties around the world to be securitized and financed globally. Imagine the ability to purchase multiple properties in different parts of the world to rent out with greater liquidity, and doing so without any intermediaries. 

 

STOs are more practical for regulators to approach, as Know Your Customer (KYC) and anti-money-laundering (AML) checks can be incorporated into security token contracts. While many countries are slow to acknowledge the indisputable rise of STOs, the regulatory frameworks that are currently in place will gradually shed light on the benefits of embracing this system. 

 

Malta has always been ahead of the curve regarding token regulations, and the recently ratified Virtual Financial Asset Act is a case in point. The Act is a preliminary regulatory framework for blockchain, cryptocurrency, and distributed ledger technology, and serves to prepare for the rising prevalence of digital securities.

 

The Singaporean government has also displayed a friendly attitude toward STOs, as stated by the Monetary Authority of Singapore (MAS). However, under the Securities and Futures Act and the Financial Advisors Act, the issuance of digital tokens deemed to be capital market products must still be regulated, depending on the tokens’ structure and attributes. 

 

It is worth noting that digital securities are referred to as “shares” in MAS’s ‘A Guide to Digital Token Offerings’ because the organization is essentially giving the green light to attract international asset owners to conduct STOs in the country. Singapore is setting the bar for regulatory openness, and it’s likely that regional and global governing bodies will follow suit in the coming years. 

 

In the U.S., the Securities and Exchange Commission similarly allows companies to conduct STOs by applying for an exemption through Regulation D 506(c), Regulation Crowdfunding (Reg CF), or Regulation A+. 

 

China’s stance towards STOs is in stark contrast to the countries mentioned above. The Central Bank Deputy Governor has explicitly stated that STOs are considered illegal financial activities due to their adverse impact on the country’s economic and social stability.

 

The future of STOs in Hong Kong remains uncertain. However, it is likely that Hong Kong will apply its existing ordinance of traditional securities to digital securities. After all, digital securities are essentially private assets, only with the Registry of Members stored on the blockchain. 

 

In the face of regulatory awareness around STOs, it’s easy to envisage normalization akin to the how the Jumpstart Our Business Startup Act liberalized crowdfunding activities in the U.S. Along these lines, businesses can raise capital quickly without the need to go through a time-consuming and complex fundraising process, accelerating the rate of innovation in all industries. 

 

About the Author

Drey is the Chief Product Officer of Liquefy, an end-to-end digital securities platform. He is also the Partner and Head of Research of BlackHorse Ventures, an investment arm focusing on digital security infrastructure. He is a speaker on blockchain at various events and an instructor on a blockchain course certified by the Ministry of Human Resources and Social Security of the People’s Republic of China.

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