Tokens on the blockchain can be classified into different token categories. The most popular ones are utility tokens, NFTs, and security tokens. What Is a Security Token? Blockchain security tokens represent tokenized version of regulated financial instruments. They are usually sold via a Security Token Offering (STO).
Tokenization of assets is gaining in popularity. Especially after the scandals that we witnessed recently in crypto markets (I.e. Celsius Networ, FTX, Luna…). BlackRock CEO Larry Fink said in a recent interview that “the next generation for markets, the next generation for securities, will be tokenization of securities.”
Traditional processes in capital markets are highly inefficient. Blockchain technology solves pain points that issuers and financial institutions face in regards to transfer, settlement and custody of assets.
In this article, we will attempt to answer some of the most frequently asked questions, namely: what is a security token in cryptocurrency? How do security tokens improve inefficient processes? Why are security tokens so revolutionary? What is needed to drive further adoption of security tokens and DLT?
Security tokens revolutionize capital markets in 4 major aspects
Security tokens are a form of digital asset that represent ownership of a real-world asset, such as equity in a company or a debt instrument. These tokens can be traded on blockchain-based platforms, which can improve the efficiency and transparency of capital markets. For example, because security tokens are digital and can be easily transferred and tracked on the blockchain, they can make it easier for investors to buy and sell assets, and can help to reduce the need for intermediaries such as stock exchanges and brokerages. This can make the process of raising capital and investing in assets more accessible and efficient. Additionally, because security tokens are immutable and transparent, they can help to improve the accuracy and reliability of information in capital markets, which can help to reduce fraud and improve overall market integrity.
1. Enable greater liquidity, transparency and efficiency
- Greater transferability for illiquid, intangible, and soft assets
- Increased efficiency and cost-effectiveness
- Increased transparency through the use of DLT
These can be considered the most recognized benefits of tokenized securities today. When assets can be traded in a friction-less ecosystem without intermediaries, this will naturally increase their liquidity. A security token is blockchain-native, its trading can be executed automatically with predetermined conditions thanks to the smart contracts feature. Consequently, the need for middlemen decreases admin processes and leads to a cost-effective faster deal execution.
Transparency is another important aspect: the owner’s information, rights, legal agreements can be embedded directly into the digital asset in an immutable way, this increases the level of security and trust.
2. Enable cross-border transferability
- Significantly more efficient cross-border transfer of assets
DLT was designed to be friction-less, trust-less, and border-less by default. Cross-border financial transactions are traditionally heavily regulated, it has always been expensive, and inefficient. Smart contracts can be programmed to be self-compliant in respect of relevant jurisdictions, transactions would then be executed automatically only when certain conditions and requirements are met.
For instance, this can be utilized for delivery of payments, automatic issuance of contracts, restricted ownership rights and so on. This spreads the cost of execution, which traditionally requires qualified third parties across the market to ensure compliance. Security tokens are compliant through the smart contracts that are built-in.
3. Enable more efficient payment
- Seamless transferability of fractional ownership
- Instant Delivery vs Payment settlement, reducing counterparty risk
They enable more efficient division and transferability of assets. Tokenized assets can be sliced down into tens of millions of fractions which would not be limited by fiat currency. Profit sharing is at the core of security tokens, therefore, automatic and real-time updates on transactions are in high demand, this is easily achieved with DLT.
Moreover, the payment settlement process as it currently is, has significant inefficiencies that raises the risk for the parties involved. It can happen that one of the parties in a transaction defaults during the settlement period, which leads to non-delivery of the asset. Using blockchain, you can tokenize fiat currencies like euro and create a digital version of it that runs on DLT (i.e. stablecoins or Central Bank Digital Currency).
When two assets issued on the same ledger are exchanged, a so-called atomic swap mechanism occurs, it is a simultaneous instant transfer of the assets to the designated owner’s account. In blockchain terms, the security token and stable coin are instantly exchanged between wallets.
4. Enable built-in compliance and security
- Greater compliance with regulations
- Traceability, security, and accountability, are drastically improved through automation
- Enhanced corporate governance
Events such as fundraising, due diligence, and share transfers, rely mainly on third parties in terms of consultation and actual execution. Tokenized assets address this inefficiency with predefined criteria coded in smart contracts. Automated features make sure all parties have fulfilled their contractual requirements before releasing funds. Traditionally, this part of the process would be manually expedited by an escrow or settlement agent, therefore increasing friction, inefficiencies, and risks.
Security tokens leave an immutable trace on everything that happens, it naturally provides better traceability, transparency and accountability. It makes fraudulent intentions harder. The register is updated simultaneously across all network participants, the ledger acts as the single source of information which enables accurate live reporting of the asset’s performance.
The benefits of security tokens bring disruptive added value to capital markets’ transactions.
How to drive further adoption of security tokens?
Regulations recently introduced facilitate the implementation of blockchain-based solutions
Recent years have been very important for the blockchain industry. Many governments acted on their interest in the utilization of blockchain tech products. Germany introduced a comprehensive set of regulations and draft legislation for electronic securities, the EU launched the Markets in Crypto-assets (MiCA), making it easier for institutions to implement blockchain based solutions in their processes. The eWpG offers great flexibility for leveraging different types of security tokens, while the DLT pilot regime is soon to be implemented.
Public authorities and financial institutions are realizing the benefits of crypto-assets and the efficiency gains offered to ensure financial inclusion. Overall, more players are entering the ecosystem, while more products are being developed taking advantage of blockchain. We’re definitely still at the start of widespread adoption of DLT across the financial and non-financial sector.
While regulation is important to drive adoption, other factors are important (i.e. reliable tech vendors) for facilitating it on a widespread level.
Financial institutions require highly reliable blockchain tech vendors
With further adoption of blockchain technology, highly regulated entities like banks have strict compliance requirements they must adhere to. Tech vendors that provide their services to institutions such as banks, undergo extensive and complex due diligence before being accepted as a white lable provider. Therefore, to drive further adoption, blockchain SaaS companies like Bitbond need to have extensive experience in developing compliant tech products.
Bitbond delivers the bond of trust between banks and blockchain technology
Token Tool is Bitbond’s tokenization platform that spares all kinds of organizations and individuals looking to tokenize assets from dealing with cumbersome technical processes. Creating tokens and selling them via token offerings, is as easy as just a few clicks. The Web3 functionality of Token Tool makes it easily integrated within any existing infrastructure, as well as with key service providers in the ecosystem (i.e. digital asset custody solution).
In 2019, Bitbond issued the first security token in German, it was a tokenized bond (BB1) issued on the Stellar protocol. It was groundbreaking as it was the first of its kind to be issued under German Law with a securities prospectus approved by the German Financial Authority (BaFin).
Thanks to Bitbond’s compliant technology dedicated to the issuance, custody and settlements of security tokens, Bitbond was able to autonomously handle the issuance process across all its value chain without having to rely on intermediaries such as Central Securities Depository.
Bitbond is currently catering blockchain solutions to several institutions such as the DAX30 company Vonovia; Standard Chartered Bank; and Bankhaus von der Heydt. Bitbond’s mission is to empower banks and corporations with customized, easily integrated, blockchain white-label tech products designated to the tokenization, and settlement of assets.
Recent developments in regulations for the blockchain ecosystem are increasing the demand for compliant blockchain tech products. The industry is headed towards maturity and a new age for our global financial system is nearing. Blockchain-based security tokens and other crypto-assets enable a much more cost-effective, time saving means to handle and transact assets across financial markets.
Highly regulated institutions require experienced tech vendors that they can easily onboard, understanding traditional legacy technology is also very important in order to ensure the seamless implementation of blockchain solutions on existing core banking technology. If you’re interested in learning how issuing security tokens and tokenization can improve your business, please make sure to contact us or send us an email on [email protected]. Follow us for more content on blockchain and tokenization, we are happy to answer any questions you may have.