What Is Tokenized Equity?
Tokenized equity is a digital token or "coin" that represents shares in a corporation or organization.
With the growing adoption of blockchain, businesses find it convenient to use digitized crypto-versions of equity. Tokenized shares are emerging as a means for raising capital in whicha business issues shares in the form of digital assets such ascrypto coins or tokens.
Key Takeaways
- Tokenized equity is the creation of equity ownership units represented by digital tokens or "coins."
- Equity tokenization became popular with the dawn of decentralized blockchain systems, which allowed for the easy and affordable creation, issuance, and transfer of digital tokens.
- Tokenized equity has been used in the form of initial coin offerings (ICOs) for blockchain-based projects, although its legal and regulatory status as a traded security remains uncertain.
Understanding Tokenized Equity
Tokenized equity is like any standard share purchased in a listed company, except those shares are crypto tokens.
To draw a parallel with equity share ownership, say you bought shares of a listed company during its initial public offering on the stock exchange. These shares would then be credited to your Demat account—an electronic account that holds financial securities, such as stocks and bonds, in digital form for online trading and investment. Tokenized equity shares work the same way, except those shares are in digital crypto coins or tokens. Instead of going into your Demat account, you arecredited to your blockchain-hosted account.
Traditional methods of raising capital have a few operational hurdles. They include regulations about regular bookkeeping and account maintenance, adherence to stock exchanges' strict rules, bank and other financial institutions' reluctance to issue credit, and business owners' challenges in convincing private investors to buy parts of a business.
In contrast, tokenizing business ownership of equity shares on a blockchain offers flexibility in fundraising. Thelow-cost method allows for an accessible way to value the business depending on the direct participation of the interested investors. The valuationmainly depends on market forces rather than a group of sponsors or angel investors.
Despite their potential, the viability of tokenized shares remains uncertain. Regulatory hurdles, digital asset thefts, hacking attempts, and the anonymity of cryptocurrency dealings raise concerns about investor protection.
Tokenized Equity in Practice
Many new startups and businesses raise funds through ICOs that allot token shares to investors. For instance, U.S.-based biotechnology company Quadrant Biosciences Inc. tokenized all its equity as Quadrant Token and offered 17% of its diluted equity via a token sale. It successfully raised over $13 million at $1.25 per share. The Quadrant token, which resides on its native blockchain, represents traditional equity.
The underlying blockchain infrastructure also supports all necessary activities applicable to tokenized equity shares. For example, the blockchain system handles popular corporate actions like dividends, mergers, acquisitions, shareholder voting,g and follow-on equity sale offers.
tZERO, Polymath, Securitize Markets, and Templum are blockchain-based platforms offering regulatory-compliant tokenized asset offerings and their secondary trading.
New Directions in Tokenization: BlackRock's USD Institutional Digital Liquidity Fund
In 2024, BlackRock, the world's largest asset manager, launched its first tokenized investment fund called the BlackRock USD Institutional Digital Liquidity Fund (BUIDL) on the Ethereum blockchain. While not tokenized equity as such, BUIDL seeks to maintain a stable value of USD $1 per token and will pay daily accrued dividends as new tokens each month. The fund itself invests in cash, U.S. Treasury bills, and repurchase agreements.
The fund trades on the blockchain, offering benefits such as expanded investor access, instantaneous settlement, and seamless transfers across platforms. Securitize acts as the transfer agent and tokenization platform.
How Does Tokenized Equity Differ from Traditional Stock Ownership?
Though tokenized equity represents ownership rights like traditional stocks, some key differences exist. Tokenized equity is issued, bought, and sold on blockchain platforms, while traditional stocks are traded on centralized stock exchanges. This means tokenized equity is held in digital wallets, while traditional stocks are usually held in brokerage accounts. The regulatory landscape for tokenized equity is still evolving, while traditional stocks are subject to well-established securities regulations.
Can Anyone Create an Equity Token?
In theory, anyone can create an equity token, but there are laws and regulations that must be followed. Those issuing equity tokens must follow applicable securities regulations, such as registration requirements and disclosure obligations. The company or asset being tokenized must also have a legal structure that allows for tokenization, such as a corporation. Creating and issuing equity tokens requires specialized technical knowledge and resources, including blockchain development and smart contract programming.
What Are the Risks of Holding Tokenized Equity?
Like any investment, tokenized equity carries certain risks, including the decline in the value of the company's equity. The value of tokenized equity may be subject to significant price fluctuations, particularly in the early stages of adoption. More specifically to tokenization, laws and regulations are still evolving, which creates uncertainty and potential compliance risks. As a digital asset, tokenized equity may be vulnerable to hacking, theft, or other security breaches. If you lose your private keys to access your digital wallet, you will also lose your equity tokens forever.
How Are Dividends and Voting Rights Handled with Tokenized Equity?
The specific terms and conditions of dividends and voting rights for tokenized equity depend on the issuer but will be executed based on smart contracts. These are blockchain-based scripts that automatically execute preset terms among counterparties. Dividend payments can be programmed into a smart contract, allowing for the automatic distribution to token holders based on their ownership percentage. Voting rights can also be incorporated, too, enabling token holders to participate in governance decisions through blockchain-based voting mechanisms.
The Bottom Line
Tokenized equity represents ownership rights in a company or enterprise using digital tokens on a blockchain network. In other words, it converts traditional equity, such as shares in a company, into crypto that can be bought, sold, and traded on a blockchain platform. This allows for decentralized, peer-to-peer exchanges rather than relying on centralized stock exchanges or private placement markets. Tokenization also divides equity into smaller, more affordable units, enabling fractional ownership and potentially increasing liquidity. The terms and conditions of the equity, such as voting rights and dividend distributions, can be programmed into smart contracts, automating the enforcement of these rules.
However, the laws and regulations for tokenized equity are still evolving, and challenges related to compliance, security, and investor protection still need to be fully addressed.
