The key benefits of tokenizing assets / securities
In the beginning of the evolution of digital assets the expected marketing effect was often one of the drivers for a tokenization. However, this effect has recently decreased. Fundamentally, the main benefits of tokenization are directly linked to the advantages of distributed ledger technology (DLT). This is why efficiency gains, higher liquidity and more transparency are probably among the most recited benefits of tokenization of assets and securities. While all these three factors make sense from a high-level perspective, it is important to take a closer look on what exactly they mean.
1. Efficency gains
The transfer of assets via a DLT solution is being done by smart contracts (see more in part 3). One can think of this as an automation of actions. While in traditional financial markets lengthy processes of settlement and clearing were necessary this process will be carried out automatically by the smart contract underlying the respective security tokens. Often this is also being referred to as atomic settlement (i.e. the delivery of the token versus the payment happens at the same exact time and is conditional to one another).
Many tokenization platforms and respective technology providers offer on top of the basic issuance and transfer of assets in a tokenized, digital way (therefore digital assets) also some digitally enabled functions for corporate actions or reporting requirements (e.g. digital voting). This automation and digitalisation of processes can absolutely result in efficiency gains, which can also enable a broader use of additional functionalities (e.g. issuance of employee shares). Depending on the costs to build or fees to use tokenization for oneself or your clients these efficiency gains can also result in monetary gains. This however has to be looked upon on a case-to-case basis.
2. Higher liquidity
Tokenizing assets and therefore digitalizing them shall make them more accessible to a broader range of investors and finally lead to higher liquidity of the underlying. Especially the outlook of establishing some kind of secondary markets is fuelling this assumption. In the short term these options are limited. Just by enabling historically illiquid assets to be traded in an easier way does not necessarily result in a liquid market as we know it from blue chips (for example equity tokens of SMEs will hardly ever be traded on such a regular basis as stocks of the SMI).
Nevertheless, this might not be necessary. There are plenty of private placements that could benefit from even a slightly higher liquidity. And who knows, maybe over time, when more and more assets will be tokenized, new products will evolve, new investors will enter the markets and lower transaction fees could very well allow more active trading in general. Time will show.
3. More transparency
The legal rights and duties of a token can be embedded onto the smart contract. Thus, the security token itself has at least the function to enable an immutable record of ownership. Other features (for example the right to call for an extraordinary general assembly) could be included in the code of the smart contract [on-chain] as well or it could be facilitated outside of the smart contract [off-chain].
This differentiation between information/logic that is being kept on the blockchain – on-chain – and information/logic that is being kept in a separate database – off-chain – is crucial for blockchain applications.
In the case of security tokens, normally, any kind of personal data about investors and issuers are being kept off-chain. The reason for this is the need for conformity with privacy laws such as GDPR. Information that is integrated into a smart contract and therefore part of a blockchain would be publicly available (in case it is a public blockchain — more to that in part three of this series) and as a blockchain is immutable it could not properly comply with GDPR requirements.
Still, a tokenization (on a public blockchain) would i) allow issuers to reconcile its investor instantly and on a continuous basis and ii) grant investors an immutable proof of their right of ownership. This intermediary-free transparency should affirm trust into tokenized assets, which again is in line with the basic concept of every DLT application.
The challenge going forward
To sum up, all of the above explained benefits can really come into play; some of them have already partly materialized. However, to really leverage on them, the whole ecosystem of tokenization must grow. In this process, more importantly than just the bare scale is the conformity of the various approaches and tokenization solutions. Hence, it is a question of interoperability. Therefore the last part of the series will go into detail about what interoperability exactly means and how it could be achieved.