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Every stock, bond, currency, and commodity will be tokenized.
This has been my core thesis in crypto for years. We moved one step closer yesterday with the announcement of an Estonian digital trading platform that plans to offer tokenized stocks starting next week. The company, DX Exchange, is building on top of the Ethereum blockchain and has received regulatory approval in the European Union to commence operations in a compliant way.
Here is what you need to know:
The product will initially offer digital tokens backed by shares of ten companies listed on Nasdaq. Each digital token is backed one-to-one by a single share of one company and the traditional stocks are purchased by DX Exchange’s partner MPS MarketPlace Securities Ltd.
The digital tokens will allow investors to gain exposure to Tesla, Apple, Google, Facebook, Amazon, and others. The digital token holders will also be entitled to all cash dividends, similar to an investor who invests directly into the stock.
DX Exchange is licensed by Estonia’s Financial Intelligence Unit and MPS MarketPlace is licensed in Cyprus. Interestingly, the SEC has not commented publicly about this product, but most lawyers seem to believe the US regulator will have a hard time laying claim to any oversight for non-US businesses.
The successful launch of tokenized stocks will be a major win for investors. It increases access to public equities for individuals globally by removing many of the barriers of setting up US-based bank and brokerage accounts, while also allowing stocks to trade 24/7/365. Additionally, investors will be allowed to purchase fractional shares of each stock, which was previously not possible.
Since each digital token is backed one-to-one by a traditional stock, it will be important to see if the tokens trade at a premium, a discount, or flat to the price of the underlying stock. This could create positive or negative investment opportunities depending on where the market initially shakes out. Price differences are likely to be affected by liquidity as well — we know these particular stocks have deep liquidity in traditional markets, but don’t yet know what liquidity looks like for a tokenized version.
DX Exchange is using Nasdaq’s Financial Information exchange (FIX) protocol which should lend credibility and peace of mind to both investors and regulators. The token-specific work is being built on Ethereum, an open-source, public blockchain best known for its smart contract functionality.
This is the first time a company will offer tokenized shares of public companies in a fully regulatory compliant environment. While exciting, there are many unanswered questions in the tokenized security industry:
How will US regulators react to this product? How effective will the exchange and broker-dealer be in ensuring compliance in the necessary jurisdictions? Can the publicly traded companies do anything to stop this? Will there be different rules for US investors compared to non-US investors?
How much investor demand is present for tokenized shares of publicly traded companies? Will there be liquidity issues? Are there problems with accepting fiat currencies and cryptocurrencies for investments?
How do investment platforms like Robinhood, eToro, TD Ameritrade, eTrade, Coinbase, Gemini and others react? Does this create urgency for them to include tokenized securities on their platforms? Do they watch and learn from DX Exchange before deciding on a strategy?
We won’t know answers to these questions until the product is live and it may take months for the company to iron out any initial issues. On top of the market and regulatory questions though, there is a technology question that is hotly debated throughout crypto.
What network will the eventual winners be built on?
The majority of teams in the tokenized securities industry are currently building on Ethereum based on a belief that the smart contract platform has superior functionality. While they are probably right today, there are plenty of people who believe Ethereum has significant scalability issues ahead too.
The most compelling situation from my perspective is to build tokenized assets, and the related infrastructure necessary to create markets, on top of the Bitcoin network. This would allow teams to benefit from the most secure blockchain, while also incorporating the functionality of other networks. (Check out Liquid and Ravencoin for early examples). Remember, it is quite easy for experienced developers to essentially “copy and paste” functionality from one network to another in open source software.
Time will tell which blockchain ends up as the default for this new use case though. While we wait, I’m also paying attention to the difference between the current form of tokenized securities (digital token backed by traditional stock shares) and “digitally-native tokenized securities.” The latter is not well-understood, but has the greatest potential in my opinion.
A digitally-native tokenized security is a digital token that is the actual share of equity in a company from the day of incorporation. This removes the need for a traditional equity share to back the token, while also increasing the programmability of the equity. In a world where these digitally-native equity tokens become popular, companies would be able to more efficiently manage their cap tables, create new categories of value for investors (ex: claim on cash flow that is automatically dispersed onchain), and access global capital markets much earlier than normal.
No one knows exactly what the future holds, but there are many teams working hard to create the future they envision. This competition among teams, networks, and jurisdictions is healthy — it should lead to a faster pace of innovation.
The disruption of money is the dominant use case for blockchain technology, but the disruption of stocks, bonds, and commodities is not far behind.
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