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What is tokenized equity? How tokenized stock works and examples
What is tokenized equity?
Tokenized equity is a digital token or “money” that represents the shares of a company or organization.
With the growing adoption of blockchain, businesses are finding it convenient to use digitized crypto versions of capital. Tokenized shares are emerging as a means of raising capital where a company issues shares in the form of digital assets such as cryptocurrencies or tokens.
Key points
- Tokenized capital is the creation of units of equity ownership represented by digital tokens or “coins.”
- Equity tokenization became popular with the advent of decentralized blockchain systems, which allowed for the simple and convenient creation, issuance, and transfer of digital tokens.
- Tokenized capital has been used in the form of initial coin offerings (ICOs) for blockchain-based projects, although its legal and regulatory status as a traded security remains uncertain.
Understanding tokenized equity
Tokenized equity is like any standard stock purchased in a listed company, except that such shares are cryptographic tokens.
To draw a parallel with stock ownership, let’s say you purchased shares of a listed company during its initial public offering on the stock exchange. These actions would then be credited to yours Demat account: an electronic account that holds financial securities, such as stocks and bonds, in digital format for online trading and investing. Tokenized stocks work the same way, except those stocks are in digital crypto coins or tokens. Instead of logging into your Demat account, you will be credited to your blockchain-hosted account.
Traditional methods of raising capital present some operational obstacles. They include rules on regular accounting and bookkeeping, compliance with strict stock exchange rules, the reluctance of banks and other financial institutions to extend credit, and entrepreneurs’ challenges in convincing private investors to buy parts of a company.
In contrast, tokenizing corporate ownership of stock on a blockchain offers flexibility in fundraising. The low-cost method allows an accessible way of valuing the company based on the direct participation of interested investors. The valuation depends primarily on market forces rather than on a group of sponsors or angel investors.
Despite their potential, the viability of tokenized shares remains uncertain. Regulatory hurdles, digital asset thefts, hacking attempts, and the anonymity of cryptocurrency transactions raise investor protection concerns.
Tokenized equity in practice
Many new startups and businesses raise funds through ICOs that award token shares to investors. For example, US-based biotechnology company Quadrant Biosciences Inc. tokenized all of its capital as Quadrant Token and offered 17% of its diluted capital via a token sale. It successfully raised over $13 million at $1.25 per share. The Quadrant token, which resides on its native blockchain, represents traditional equity.
The underlying blockchain infrastructure also supports all necessary activities applicable to tokenized shares. For example, the blockchain system handles popular corporate actions such as dividends, mergers, acquisitions, shareholder voting, and subsequent stock offers.
tZERO, Polymath, Securitize Markets and Templum are blockchain-based platforms offering regulatory-compliant tokenized asset offerings and their secondary trading.
New Directions in Tokenization: BlackRock’s USD Digital Institutional Liquidity Fund
In 2024, BlackRock, the world’s largest asset manager, launched its first tokenized investment fund called BlackRock USD Institutional Digital Liquidity Fund (BUIDL) on the market Ethereum blockchain. While the capital is not tokenized as such, BUIDL seeks to maintain a stable value of $1 USD per token and will pay out daily accrued dividends as new tokens every month. The fund itself invests in cash, U.S. Treasury bills, and repurchase agreements.
The fund trades on the blockchain, offering benefits such as expanded access to investors, instant settlement, and seamless transfers between platforms. Securitize acts as a transfer agent and tokenization platform.
How does tokenized capital differ from traditional equity ownership?
While tokenized equity represents ownership rights like traditional stocks, there are some key differences. Tokenized shares are issued, bought and sold on blockchain platforms, while traditional shares are traded on centralized platforms stock exchanges. This means that tokenized capital is held in digital wallets, while traditional stocks are usually held in brokerage accounts. The regulatory landscape for tokenized stocks is still evolving, while traditional stocks are subject to established securities regulations.
Can anyone create a stock token?
In theory, anyone can create an equity token, but there are laws and regulations that must be followed. Those issuing equity tokens must follow applicable securities regulations, such as registration requirements and disclosure obligations. The company or asset to be tokenized must also have a legal structure that allows this tokenization, like a company. Creating and issuing equity tokens requires specialized technical knowledge and resources, including blockchain development and smart contract programming.
What are the risks of holding tokenized stocks?
Like any investment, tokenized capital carries some risks, including a decline in the value of the company’s equity. The value of tokenized capital may be subject to significant price fluctuations, particularly in the early stages of adoption. More specifically regarding tokenization, laws and regulations are still evolving, which creates uncertainty and potential compliance risks. As a digital asset, tokenized capital may be vulnerable to hacking, theft, or other security breaches. If you lose yours private keys to access your digital wallet, you will also lose your stock tokens forever.
How are dividends and voting rights managed with tokenized capital?
The specific terms and conditions of dividends and voting rights for tokenized shares depend on the issuer but will be executed according to smart contracts. These are blockchain-based scripts that automatically execute pre-set terms between counterparties. Dividend payments can be scheduled into a smart contract, allowing automatic distribution to token holders based on their ownership percentage. Voting rights can also be incorporated, allowing token holders to participate in governance decisions through blockchain-based voting mechanisms.
The bottom line
Tokenized equity represents ownership rights in a company or business that uses digital tokens on a blockchain network. In other words, it converts traditional capital, such as shares of a company, into cryptocurrencies that can be bought, sold and traded on a blockchain platform. This allows for decentralized, peer-to-peer trading rather than relying on centralized exchanges or private placement markets. Tokenization also divides capital into smaller, more affordable units, allowing for fractional ownership and potentially increasing liquidity. Capital terms and conditions, such as voting rights and dividend distributions, can be programmed into smart contracts, automating the enforcement of these rules.
However, laws and regulations for tokenized capital are still evolving, and challenges related to compliance, security and investor protection have yet to be fully addressed.