In our previous course on private markets, we explored the advantages and potential for investors. However, most investors were unable to participate in these private markets because accessibility was limited to only accredited or high-net worth individuals.
That all changed with the birth of tokenization. Similar to trading on the stock market or purchasing crypto assets today, tokenization and security tokens improves accessibility for investors to invest, trade, and participate in private markets.
While the biggest advantage of this technology is that it gives reach to makes investments that were previously unreachable, tokenization and security tokens are technologies that go beyond merely private markets, and have the potential to transform and improve the entire financial system. In the future, we envisage that everyone will use it as a means to manage their assets more efficiently. This technology has the potential to revolutionize the private markets in the same way that public markets were transformed through dematerialized shares, infrastructure upgrades and other improvements in technology, which have largely been non-existent in the private markets..
The primary focus of this course will be to explore the concept of tokenization and security tokens, their relationship with each other, the benefits they offer, and their practical applications. Although we will mainly explore these technologies in the context of private markets, it is important to note that the advantages they offer can also be applied to public markets.
What is tokenization?
Tokenization is a process of converting an asset into digital tokens on a blockchain network. These tokens represent fractional ownership of the underlying asset, which can be anything from real estate, artwork, or even stocks. Tokenization is essentially slicing up an asset into small, easily tradable pieces and comes with many more benefits which we will explore further.
For example, imagine a real estate property worth $250,000. Instead of selling the entire property to a single buyer, the owner can tokenize the property by dividing it into 10,000 tokens, each representing a 0.1% ownership interest in the property. Each token can then be sold to different investors who can each own a fractional ownership interest in the property. This means that each investor seeking to invest in the property could have participated in the investment with as little as $25, instead of a much larger commitment size of $250,000.
What are security tokens?
Security tokens are digital representations of ownership or investment in an asset which has been tokenized. They are called "security" tokens because they are subject to securities regulations and laws, just like traditional financial instruments. Security tokens offer many of the benefits of tokenization, such as increased liquidity and reduced transaction costs, while also providing greater investor protection through regulatory certainty and oversight. These digital securities can be traded on licensed digital securities exchanges, allowing investors to buy, sell, and trade their holdings in real-time.
In the real estate property example above, the 10,000 tokens, each representing 0.1% ownership interest in the property, would constitute security tokens.
The relationship between tokenization and security tokens
As explained above, the relationship between tokenization and security tokens is that security tokens are a type of digital asset that can be created through the process of tokenization, with each security token representing a fractional ownership interest of a tokenized asset. When we say tokenization of assets, we are simply referring to the process of issuing a blockchain token that digitally represents ownership or investment rights in an asset.
What can be tokenized?
Virtually anything can be tokenized, from tangible to intangible assets, from fungible to non-fungible assets. Tokenization can represent any asset that has value and can be made divisible and transferable through the use of blockchain technology. Anything that has value, once tokenized becomes a “digital asset”. Some current examples of assets that have been tokenized are stocks, bonds, commodities, derivatives, funds, startups, real estate, collectible cars, artwork (physical or digital), precious stones, fine wines and whiskeys, even carbon credits and NFTs. And you can even tokenize cash deposits, which once tokenized, become stablecoins. As the technology continues to evolve, it is possible that additional types of assets will become available for tokenization.
What are the benefits of tokenization and security tokens?
- Increased liquidity: Tokenization allows issuers to make their assets more liquid by fractionalizing ownership and enabling easier trading of the security tokens representing these fractions.
- Reduced transaction costs: Digitizing the process of buying, selling, and transferring ownership reduces transaction costs and makes these processes more efficient.
- Enhanced market efficiency: Blockchain technology can reduce inefficiencies and friction which exist in the private markets for traditional assets.
- Innovative and customizable investment structures: Another key benefit is the ability to create entirely new investment products or financial instruments. Similar to the creation of REITs or ETFs in the public markets, tokenization will enable new financial products to be programmed using smart contracts and blockchain technology (e.g. e-Variable Capital Companies or e-VCCs).
- Improved record-keeping and administrative processes: Blockchain technology can automate record-keeping processes and eliminate the need for intermediaries to manage asset ownership and transactions, which can help issuers streamline their operations.
- Expansion of collateral options: As opposed to traditionally indivisible assets, holders can use their security tokens as collateral in more diverse ways, transforming a one dimensional asset (where you just invest and hold) into a multi-dimensional financial asset (where you can lend, borrow and stake).
- Broader investment opportunities: Fractionalization , provides investors with access to new investment opportunities by lowering minimum investment amounts. This makes it easier for investors to invest in assets that might have been too expensive or illiquid to purchase in full.
- Increased market accessibility: Tokenization enables investors to access new markets or assets that were previously only available to a limited number of high-net-worth investors.
- Reduced settlement times: Blockchain technology allows for real-time transactions, which can reduce settlement times and reduce the counterparty risk that can occur when transactions take longer to settle.
- Transparency and clear ownership records: Blockchain technology provides an immutable record of ownership and transaction history, which can increase transparency and reduce the possibility of fraudulent ownership claims.
What is the future of tokenization and security tokens?
The future of tokenization and security tokens looks incredibly promising, with the industry already experiencing significant growth and more businesses successfully adopting this transformative technology. We expect continued expansion as more businesses and investors recognize the advantages of this new infrastructure. As the market continues to mature, we anticipate more innovation and a wider adoption of tokenization across various industries that have not yet been exposed to this technology.
How will investors be able to benefit from this industry growth?
Investors can benefit from this growth by gaining access to a wider range of investment opportunities as more companies adopt the technology. These opportunities include investing in assets such as startups and other private market opportunities such as those we went over in our first course “What are private markets”.
However, there is one last piece missing of the puzzle to make your private investing journey start, which is IX Swap’s liquidity solution. In the following part of the course, we will discuss IX Swap and how it will make tokenization and security tokens fully functional for issuers and investors. We will explore the product offerings of IX Swap such as the IXS Launchpad for investing in startups and the security token exchange for trading security tokens. By utilizing IX Swap, investors can benefit from the growth of this industry and gain access to a range of exciting investment opportunities that were previously inaccessible.