Tokenized stocks are digital assets that mimic the price action of publicly traded stocks. These tokens allow cryptocurrency traders to gain exposure to the price action of stocks without leaving the crypto ecosystem.
What Is a Tokenized Stock?
There are key differences when it comes to cryptocurrency vs. stocks. Tokenized stocks occupy the middle ground.
A tokenized stock is basically the same thing as a share of equity in a publicly traded company, like stocks traded on the Nasdaq or S&P 500. The difference is tokenized stocks come in the form of digital tokens.
When an investor buys a traditional stock on an exchange or during an initial public offering (IPO), their shares typically arrive in an investor’s brokerage account. The process for tokenized stocks is the same but with one key difference: because these shares are based on a blockchain, they can be bought and traded on a cryptocurrency exchange.
There’s usually a custodian and an investment institution involved in the process of creating a tokenized stock. The institution buys the underlying stock and deposits it with the custodian. Based on the shares that the custodian holds in reserve, tokens are issued on a blockchain. The price of each token is pegged to the value of the shares.
The tokens can then be listed on a cryptocurrency exchange where they can be bought and traded like any other cryptocurrency. Those who hold a stock token gain exposure to the underlying stock pretty much as if they owned it, including dividend payouts where applicable. However, they don’t actually own shares. They own a derivative that is backed by actual shares.
How Does Tokenized Stock Trading Work?
Tokenized stock trading isn’t the same as trading actual stocks. The tokens are cryptocurrencies and can only be traded as such.
Trading tokenized stocks involves many of the same steps required for trading cryptocurrency in general.
1. Find an exchange that trades the tokenized stock you’re interested in. This could be a centralized exchange or a decentralized exchange.
2. Create an account on the selected exchange. This usually involves submitting some basic personal info and verifying your identity.
3. Fund your account. This can usually be done with a variety of cryptocurrencies or fiat currencies. (note: be sure to use a currency paired with your token of choice. For example, if the token only trades against BTC, you will need to deposit Bitcoin).
4. Buy the stock token of your choice. Make sure the stock fits your risk tolerance.
Why Are Companies Tokenizing Equity?
The chief reason that many companies are tokenizing equity is the same reason that they issue shares of stock: To raise capital. There can be some distinct advantages to raising additional capital by issuing digital tokens, rather than going through the traditional method of either going public (IPO) or issuing additional shares.
With the goal of tokenized equity being to raise capital, and digital equity tokens taking on the role of stocks in some cases, it opens some cans of worms. For instance, while the federal government has been somewhat slow to determine how or if it wants to handle Bitcoin regulation and other cryptocurrencies, tokenized equity is essentially forcing the Securities and Exchange Commission’s hand.
The tokens issued by companies in lieu of stocks have the same characteristics and functions, and thus, are securities. That means they’re subject to registration and filing requirements. That’s brought on security token offerings (STOs), which are more or less the same as initial coin offerings (ICOs), but with the added caveat that the company issuing the tokens acknowledges that the token represents equity and is therefore a security.
Examples of Tokenized Stocks
Many tokenized stocks will be familiar to most investors. They include stock tokens of companies like Twitter, Tesla, Apple, and Alibaba, as well as some exchange-traded funds (ETFs).
Here are the top ten tokenized stocks by market cap according to CoinMarketCap data as of December 2021 (the top tokens change frequently since they trade on very little volume). Nine of the top 10 are “Mirrored” tokens that were minted on the Mirror Protocol and can be traded on one or more decentralized exchanges.
1. Mirrored Apple (mAAPL)
A tokenized stock of the Apple computer company, mAAPL has traded as low as $142 and as high as $171 over the last three months.
2. Mirrored iShares Gold Trust (mIAU)
The Mirrored iShares Gold Trust is a tokenized stock of the iShares Gold Trust ETF. The price has held steady between $17 and $18 for much of the past three months. From 11/30 – 12/3, however, there was a flash crash that saw the price of mIAU trade as low as $15.38 for a time.
3. Mirrored Tesla (mTSLA)
Mirrored Tesla (mTSLA) is a tokenized stock of Tesla, the electric car company. The token has traded as low as $748 and as high as $1,210 over the last three months.
4. Mirrored iShares Silver Trust (mSLV)
The Mirrored iShares Silver Trust (mSLV) is a tokenized stock of the iShares Silver Trust ETF. The token has traded as low as $20.83 and as high as $24.40 over the past three months.
5. Mirrored Netflix (mNFLX)
Mirrored Netflix is a tokenized stock of Netflix, the online streaming entertainment company. The token has traded as low as $590 and as high as $700 over the last three months.
6. Mirrored United States Oil Fund (mUSD)
Mirrored United States Oil Fund (mUSD) is a tokenized stock of the United States Oil Fund ETF. It has traded between $50 and $60 over the last three months.
7. Mirrored Alibaba (mBABA)
Mirrored Alibaba is a tokenized stock of Alibaba, the Chinese wholesale company. It has traded as low as $117 and as high as $183 over the last three months.
8. Mirrored Google (mGOOGL)
Mirrored Google is a tokenized stock of Google, the tech giant. The token has traded as low as $2,713 and as high as $3,073 over the last three months.
9. Mirrored Twitter (mTWTR)
Mirrored Twitter (mTWTR) is a tokenized stock of Twitter, the social media company. The token has traded down to $41.23 and up to $67.77 over the last three months.
Not all tokenized stocks are backed by real shares at a 1:1 ratio. Some of these tokens, particularly those based on DeFi platforms like Synthetix or Mirror, only track the prices of the stocks themselves. They accomplish this by using Chainlink or Band Protocol, which feed real-time price data into the blockchain from elsewhere.
Pros of Trading Tokenized Stocks
Tokenized stocks provide some advantages over trading regular shares of equity with a licensed brokerage, including:
• Greater liquidity. Because a broader segment of the population can access tokenized stocks compared to traditional shares, these tokens can have greater liquidity than their counterparts that are traded thinly on major brokerages.
• Faster transaction and clearance time. Depending on the network and exchange, token transactions might settle in a matter of minutes. Compare this to traditional stock transactions, which may take a number of business days to clear.
• Fractional shares are easy to obtain. While fractional stocks are only available from specialized firms (like SoFi, for example), fractions of any tokenized stock are readily available wherever it is traded.
• Low fees. Some crypto exchanges don’t charge fees for the trading of tokenized stocks.
• 24/7 trading. Tokenized stocks can be traded any time of day, any day of the week. The cryptocurrency markets never close. However, in an attempt to make sure that stock tokens trade in tandem with their equity counterparts, trading of some of these tokens is restricted to the regular hours that traditional stock exchanges are open (which typically 9:30 AM to 4 PM Eastern time Monday-Friday in the U.S.).
Cons of Trading Tokenized Stocks
Tokenized stocks also come with some drawbacks. These include:
• Token holders are not technically shareholders. They don’t own any equity in the underlying company, and therefore they don’t have the right to participate in the Annual General Meeting (AGM) of the company behind their tokenized stock, nor are they granted voting rights in the decision-making process of the company.
• Tokenized stocks come with additional risks. There are several additional intermediaries involved, including the custodial firm that holds shares and the crypto exchange that holds the tokens.
• Additional know-your-customer (KYC) requirements. Extra KYC requirements from the custodian or exchange can create a hassle for investors.
Holding a tokenized stock is a way to gain exposure to the price of a stock. Other than possibly receiving dividend payouts, token holders are not considered to be shareholders within a company in the same way as those who hold traditional equities are.
|
Tokenized Equity: Advantages and Drawbacks |
|
|---|---|
| Advantages | Drawbacks |
| Accessibility for investors | Availability still not widespread |
| More efficient markets | Lack of clarity around regulation |
| More market liquidity | Investors may lack voting rights |
Who Can Trade Tokenized Stocks?
In theory, anyone can trade tokenized stocks. That’s the beauty of cryptocurrency in general — there are no barriers to entry in the market besides an internet-connected device and some funds to get started with.
Tokenized stocks might be ideal for investors who want but don’t have access to traditional financial markets. For example, someone without a bank account can’t register with a stock brokerage, but they could potentially trade tokenized stocks.
To do so, a potential stock token investor might buy Bitcoin with cash at a Bitcoin ATM, send it to their own wallet, and deposit it at an exchange that trades tokenized stocks. As long as they are able to verify their identity to pass KYC requirements, they’d be unlikely to encounter any problems with this process.
Tokenized Stock Regulations
The Securities and Exchange Commission (SEC) makes it clear that a tokenized stock is subject to the same regulations as regular stocks.
The SEC asserts that all tokenized securities need to be registered. Tokenized stocks that do not register their issuances will be regarded as illegal. In the past, the agency has taken legal action against both the Paragon and AirFox tokens for failing to comply.
In addition, all exchanges that trade tokenized securities are required to register with the SEC as national securities exchanges or request an exemption. The Commission has previously taken action against EtherDelta for failing to comply with this requirement.
What it comes down to is this: while crypto regulation in general may still have some legal gray areas surrounding it, this is not the case for tokenized stocks. According to the SEC, these tokens are to be regulated just as if they were regular stocks. And the exchanges providing trading services for these tokens can be subject to the same regulations as traditional broker dealers.
The Takeaway
The tokenization of stocks is a fairly new phenomenon in crypto and comes on the back of a wave of DeFi innovation over the last few years.
Keep in mind that some decentralized exchanges don’t actually trade tokenized stocks. Instead, they trade something called “synthetic assets” or “synths.” These are tokens designed to mirror the performance of other assets. But they’re not directly pegged to actual shares in the way that tokenized stocks are.
Another important fact is that these tokens can be highly concentrated into a few wallets. Mirrored Alibaba (mBABA), for example, has 100% of its supply held by the top 10 holders, according to CoinMarketCap data. Many other tokenized stocks have 90% of their supply controlled by the top 10 or top 50 wallets.
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