Tokenisation: The rationale for tokenising equities

Talk of tokenisation within the financial industry has been popular as of late, with initial focus centring on tokenising traditional securities, such as equities and bonds. But there is now talk of extending tokenisation to encompass physical assets, covering property or even artwork. This series of articles touches upon the benefits of tokenising securities, including improved efficiencies in raising capital and trading equities, the democratisation of asset ownership, as well as the creation of a brand new asset class that has not previously been possible. 

This is the first in a series of three articles on tokenisation. The second article will ask whether fractionalisation can democratise asset ownership; while the third will be looking at a new asset class - the Royalty Token.

Why tokenise assets?

The tokenisation of assets refers to a digital representation of a tradable asset, stored on a blockchain. These digital representations are often referred to as security tokens. But why tokenise assets? What benefits can the process bring to the industry? In this article we consider the rationale behind tokenising equity. Needless to say, many of these benefits are applicable to all security types.

How does ownership work?

The token represents the security which remains in custody and gives the token’s holder beneficial ownership of that security. When the security token is sold (and paid for), the token is transferred to the new owner, the transaction is recorded on the blockchain and the register updated with the details of the new beneficial owner of the underlying security. Further, a double layer of security is provided as the token holder has to match the owner on record of the security in order to facilitate a trade. This may also create certain tax advantages, whereby the security remains in place but the ultimate beneficial owner changes, therefore it may not be subject to a transfer tax.

The problems associated with the current methods of listing equities 

As many businesses can attest to, the process of listing an equity on exchange can be extremely costly, requiring the involvement of several counterparties. Typically, firms need to appoint lawyers, a corporate adviser, an underwriter, a bank and maybe a broker. While the fee for actually listing on an exchange is normally relatively low, the fees for the intermediaries can be prohibitive; unless the listing is of a significant size, hence the reason most stock exchanges only tend to deal with large companies.

Private companies that aren’t listed on an exchange can face a number of challenges when trying to transfer shares and sell them to other counterparties. If a problem develops in a business, or between shareholders, then all too often it has an adverse effect on the company as it’s very difficult for equity holders to liquidate or raise capital to buy out other shareholders.

Tokenising Equities: Easing the path

Tokenisation alone does not solve these issues, but it can make the process of both buying and selling equities easier. Tokenising and listing an equity on a regulated security token exchange can significantly reduce the overall cost of listing by reducing the need for intermediaries and automating many of the processes involved in a listing. While existing venues are finding it difficult to convert their existing technology, new entrants in this space are not reliant on legacy technology. In some situations, it is currently far more efficient to trade and settle tokens than traditional forms of securities. Blockchain provides an immutable record, ensuring that there is finality in, and auditability of, the transaction.

It is now possible to create a full end-to-end solution to help guide companies through the process of listing on a regulated exchange. Tokenisation is not unique in its ability to help in this process, but it does offer the potential to simplify matters. Blockchain technology provides the ability to track the security and ownership rights, and trades are settled almost instantaneously, 24/7. This makes tokenisation a sound option for equity listings on a regulated exchange, not to mention the opportunity to reduce costs and find additional investors who support this evolution in equities trading.

A solution for private companies

Tokenisation also presents a solution for private companies that may otherwise find it difficult to trade shares and attract additional shareholders. For instance, in the UK it is possible to place the shares of a private company into a nominee company. Those shares can then be tokenised, and the ultimate beneficial owner can trade those tokens in a private market and find new investors more easily. It’s also more straightforward for the rights to be transferred through a token than through a direct transfer of the actual shares. It is possible to do this through crowdfunding, and a secondary market can be established to facilitate post issuance trading. 

Once a company has tokenised its equity, it is possible to pass shares to other people in a more cost effective manner, for example, the rewarding of employees with shares. Further, if there was a case of a disagreement with one of the partners in the business, it might be possible to use the community to buy that person out of their shareholding, or the owners might have an opportunity to cash in on some of their shares. This can be facilitated through the use of a bulletin board, essentially a marketplace for shares. A regulated entity might be required to facilitate the trade, but this could still provide a more accessible secondary market than is currently available to retail investors.

Tokenisation makes the market more accessible

Although tokenisation alone does not make a market, it makes the market more accessible through the reduction of cost, the automation of processes and the provision of frictionless trading underpinned by a secure and immutable record of transactions. As a result, while a token cannot create a buyer, it can increase the possibility of finding a buyer by making the process of trading the equity more straightforward.