The New Crossover Star:  An Introduction to Stock-Backed Tokens

View Demo Get Started
The-new-crossover-star-algotrader

As digital assets become more embedded into the financial system, the boundaries between traditional and digital assets are becoming increasingly blurred. Asset tokenization is one such example, where stock tokens serve as a good illustration of this trend.  

In late April, the crypto exchange Binance became the latest to announce it would start offering stock tokens. It follows in the footsteps of other early movers in this space, including Bittrex and FTX. However, due to differing regulations governing the sale of securities, combined with underdeveloped regulation concerning the sale of tokens, there are few common standards for defining tokenized stocks. An exception to the rule is Switzerland, however, which is taking steps to put in place a comprehensive regulatory infrastructure for offering and trading tokenized stocks and securities.  

Currently, there are four main types of stock tokens that broadly fall into two categories – those representing ownership of the underlying and those that simply offer exposure to the underlying without ownership rights.  

Stock-backed Tokens 

Starting with those representing ownership of the underlying, stock-backed tokens represent a share in a company and as the first type of stock tokens it is perhaps the most commonly available – offered by large exchanges such as Bittrex, FTX, and now Binance.  

In this scenario, the token buyer receives all the same rights as a shareholder, including the right to dividend payments, to attend annual general meetings, and to vote on certain company affairs.  

All three exchanges mentioned, which offer this type of stock token, currently partner with a third party called CM Equity, based in Germany. CM Equity is a licensed and regulated brokerage and trading firm that handles the sales and purchases of shares underlying tokenized stocks traded by their partners.  

Stock-backed tokens are generally available for large, listed companies, including Google, Apple, and Tesla. They may be tradeable with fiat currencies; however, some exchanges limit the trading of stock tokens to stablecoins.  

Stock-backed tokens are suitable for any trader or investor who wants to trade tokens that mimic actual stock trading. The main advantage of tokenized stocks over actual stocks is that they can be traded 24/7.  

Private Equity Tokens 

Private equity tokens are very similar to stock-backed tokens in that they also convey ownership rights of the underlying to holders. However, the key difference is that they are tokenized stocks in companies that are not yet public.  

Robinhood was the first firm to offer its own stock tokens as a private equity offering to accredited investors. In 2018, the company partnered with the security token platform Swarm Fund to issue the Robinhood Equity Token. More recently, private equity firm BridgeTower Capital launched a private security token offering as the company established its Swiss entity.  

Swiss bank Sygnum has stated its intention to use private equity tokens to open up new sources of investment for small companies. Electric car manufacturer BAK Motors is using the Sygnum platform to raise funds via tokenized equity.  

Private equity tokens are ideal for investors looking for exposure to early or mid-stage start-ups before they become listed on any public exchange. The advantage of private equity tokens over a traditional equity investment is that they can be potentially traded on secondary markets, which creates more liquidity. In addition, private equity tokens can also enable fractional ownership, which can help investors to establish a more diversified portfolio.  

CFD Tokens 

CFD tokens in turn fall into the second category of tokenized stocks that do not offer shareholder rights. They work in a similar way to a traditional contract for difference (CFD), allowing the holder to speculate on the price movement of any given stock without taking custody of the underlying.  

CFD tokens tend to be offered by smaller crypto-native exchanges. Unfortunately, identifying which versions of tokenized stocks are CFD tokens can be a time-consuming task that requires detailed examination of the small print.  

For short-term traders, however, there are no significant differences between trading tokenized stocks backed by the underlying or trading tokenized CFDs. Conversely, longer-term investors who are interested in earning dividends should ensure that their tokenized stocks are backed by the real thing.  

DeFi Synthetic Stock Tokens 

DeFi synthetic stock tokens are one of the newest and most innovative ways of bringing stock tokens to the market. The first thing to note is that they do not offer any ownership of the underlying. Instead, they are simply a tokenized representation of a stock that mirrors the price. From that perspective, they are comparable to CFD tokens, but the key difference is that they are created and traded using decentralized protocols rather than on centralized exchanges.  

Currently, only a small number of DeFi protocols offer synthetic stock tokens. For example, Synthetix requires a user to lock the protocol’s native SNX token as collateral to mint synthetic tokenized US dollars, sUSD. These can then be traded against other synthetic assets, including stocks and indices, on the Synthetix decentralized exchange. Mirror Protocol, which is focused on synthetic stock tokens, is another example.  

While DeFi synthetic stock tokens are a very novel concept, they currently come with significant risk, particularly where the trader is required to deposit a volatile native token. Furthermore, some DeFi protocols have been prone to hacks and smart contract bugs in recent years. However, as the sector matures, some of these risks may recede so this is certainly a trend to watch for the future.  

Further Market Opportunities to Come 

The advent of tokenized stocks is an exciting development for financial institutions. This is particularly true in countries such as Switzerland, where the government has shown itself to be welcoming to digital assets and associated innovations with regulations such as the 2020 Blockchain Act. Several Swiss banks, including SEBA, Sygnum Bank, and Crypto Broker AG, now hold FINMA-issued licenses that allow them to create and list tokenized securities.  

Up until recently, the missing piece of the puzzle was secondary market trading infrastructure. However, this is about to change. From August, the second part of the Blockchain Act will come into force, introducing financial market infrastructure upgrades to facilitate the trading of tokenized securities. Thereafter, Switzerland will have a fully regulated digital securities sector, paving the way for other countries around the globe to follow suit.  

AlgoTrader Logo

Stay informed about AlgoTrader