What are tokenized stocks?
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Updated: August 16, 2023
As technology advances, so do the number of investment options available. While many people are familiar with the concepts of blockchain and cryptocurrency, a less common digital asset on the market is tokenized stocks, which track the performance of an underlying asset.
In this article, we discuss what tokenized stocks are, how you can trade them, and a few things to consider before you do.
What are tokenized stocks as an equity?
A tokenized stock is a digital asset traded on exchanges using blockchain technology. The term tokenized stock describes two slightly different types of investments.
First, some companies issue tokenized stocks as a form of equity to help raise capital. Similar to an initial public offering (IPO), companies issue an ICO — initial coin offering. These tokens allow companies to adapt to the market and raise capital using the latest technology available. For example, in 2018 the company Quadrant Biosciences converted all of its common stock into Quadrant Tokens, a form of tokenized equity.
But more commonly, they are a type of derivative that tracks the performance of an underlying stock. For example, if you buy tokenized stocks for Tesla, you don't actually buy ownership in Tesla. Instead, you buy a derivative that is collateralized by a share of Tesla stock and tracks its performance.
These tokenized stocks are traded on cryptocurrency and blockchain platforms such as FTX, Binance and Bittrex.
How do you trade tokenized stocks?
To trade tokenized stocks, you first sign up for one of the exchanges. Each exchange has a slightly different process. But each has a section of their website where you can buy these kinds of a stock like you would buy any other digital asset they offer.
Remember that when you buy tokenized stocks, you aren't actually buying a share of ownership in the company. Instead, you're buying a derivative with an underlying stock. In some ways, the process resembles traditional stock trading. If the underlying stock pays dividends, you receive dividends. When the value of the underlying security increases, so does the value of your tokenized stock.
Regardless of what exchange you buy your tokenized stock on, it's likely to be custodied by a partner such as Digital Assets AG or CM-Equity. These are the companies that tokenize the stocks. In many cases, you may be able to redeem your tokenized stock for the actual underlying stock.
The hours you can trade tokenized stocks differ depending on the exchange. Some exchanges, including FTX and Bittrex, trade 24/7. Binance, on the other hand, allows trades only during the trading hours of major stock exchanges.
What stocks are available?
Only some stocks are tokenized. So you can't buy tokenized stocks to track the performance of every stock on the market. Companies that are typically tokenized include popular technology firms such as Tesla, Facebook, Apple, and Google. Which stocks are available in token form also depends on which exchange you use to purchase them.
Is it regulated?
The regulatory status of tokenized stocks still isn't entirely clear. In 2018, the U.S. Securities and Exchange Commission (SEC) stated that many of the coins and tokens offered through ICOs meet the definition of a security and would therefore be regulated as such.
Digital assets that are considered securities fall under the purview of the SEC. Not only must the securities be registered, but the platform offering these securities must be registered with the SEC as a national securities exchange.
That being said, exchanges that trade tokenized stocks argue that since they aren't stocks, but derivatives, they shouldn't be subject to the same regulations as if trading an actual security.
Because of the unclear regulatory status of tokenized equity, there's an increased risk of scams and fraudulent activity, possibly without recourse for the victims. The SEC advises that investors remain cautious and steer clear of anything that guarantees a return or sounds too good to be true.
Who can trade tokenized stocks?
Anyone eligible to trade on a blockchain or cryptocurrency exchange can also trade the tokenized stocks they offer. Keep in mind that some exchanges are available to individuals in only certain countries.
How do futures on tokenized stocks work?
Futures are derivatives contracts where two parties agree to trade a particular underlying asset at a certain time in the future and at a predetermined price. Just like you can purchase futures with stocks as the underlying assets, you can also enter into futures contracts with tokenized stocks as the underlying assets.
The concept of a futures contract for a tokenized stock is an interesting concept, since both futures and tokenized stocks are derivatives (assets whose value is derived from an underlying asset). In other words, it's a derivative where the underlying asset is also a derivative.
Pros and cons of tokenized stocks
Pros
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Fractional shares are available: Exchanges sell fractional shares of tokenized stock, meaning rather than purchasing an entire share of stock, you buy just a percentage of one. For example, you could purchase a fractional tokenized stock with an underlying asset that is half of a share.
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Tokenized stocks may be more liquid: Because you can buy fractional shares of tokenized stocks, they may be more liquid. People who can't afford to buy an entire share of Amazon (at over $3,000) can still buy a fractional tokenized stock.
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Trading is available 24/7: Some exchanges (such as Binance) trade tokenized stocks only during the trading hours of major exchanges. But others offer trading around the clock.
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Foreign investors have increased access to stocks: It can be difficult for foreign investors to access popular stocks such as Tesla, Apple and Amazon. The ability to purchase a tokenized stock makes stock ownership more accessible and affordable.
Cons
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You aren't actually buying ownership in the underlying company: When you purchase a tokenized stock, you aren't buying ownership in that company. Instead, you're buying a derivative that tracks the performance of a particular stock. You don't have any of the rights of being a shareholder, such as voting rights.
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The regulation is unclear: It's still not entirely clear how tokenized stocks and the exchanges that sell them are regulated. In fact, there seems to be some disagreement between the exchanges and the regulating agencies themselves.
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There may be a lack of understanding: Investors who are new to tokenized stocks may not entirely understand what they're getting themselves into. This could lead to individuals losing money.
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Tokenized stocks may have more risk: A tokenized stock is designed to track the performance of an underlying security. But they are a relatively new concept with little track record or regulation. As a result, there's no guarantee they will track well.
Example of tokenized equity
Let's say you want to buy one of the most popular tokenized stocks on the market: Tesla. Tesla's tokenized stock can be purchased on a variety of digital exchanges.
On May 18, Tesla closed at $577.87. To purchase a single tokenized share of Tesla would cost the same amount of money. Or you could choose to purchase a fractional share. For example, a half share would cost $288.94. For a quarter share, you'd pay $144.47.
But when you buy a tokenized stock for Tesla, you don't actually have any ownership in the company. Instead, you've purchased a derivative whose value is derived from its underlying asset, Tesla shares.
But despite not technically being a shareholder in Tesla, you still get the benefit of the company's good performance. If the company's stock price increases, so does the value of your tokenized stock.
Bottom line
Tokenized stocks are a relatively new investment opportunity. They present an interesting opportunity for investors. There's a lot to consider before investing in them. This includes the lack of regulatory certainty and the fact that buying a tokenized stock doesn't actually earn you a share of ownership in the company. However, for those looking for a chance to invest using the latest technologies, tokenized stocks may be worth considering.
Erin Gobler is a freelance personal finance based in Madison, Wisconsin. After seven years working in state politics, she left to pursue writing full-time. Now she writes about financial topics including mortgages and investing.
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