Tokens as messengers. What are the prospects for investors regarding new assets?

Attracting investments through traditional financial instruments is becoming increasingly challenging. Tokenization can solve this problem. What are the advantages?

The global financial instruments market mainly consists of stocks, bonds, and derivatives: In 2016, the nominal value of stocks was $67 trillion, and the value of debt instruments was $99 trillion. It is difficult to assess the capital value of derivatives. According to the Bank for International Settlements, the nominal value of all contracts is $542.4 trillion, while the real value is $12.7 trillion.

For many companies, the ability to raise funds in the market through the sale of traditional financial instruments is limited or impossible. The main obstacles include market regulation, lack of funding sources, a large number of intermediaries, and high costs of structuring financial instruments; preparation for an IPO can take from one to three years, and the results in terms of the volume and value of funds raised are highly questionable.

In Russia, in the conditions of global sanctions, the opportunities for companies, especially startups and small and medium-sized businesses, to find cheap and long-term financing are extremely limited. Therefore, there is an objective need for the development and implementation of new mechanisms for attracting funds to the market through the issuance of new types of assets.

Investors dealing with traditional financial instruments face many difficulties in trading them. For example, to trade many quoted instruments, they need to have the status of a qualified investor and interact with intermediaries such as brokers and exchanges. Relatively low liquidity of financial instruments, limited functionality of trading infrastructure for financial instruments, low transaction settlement speed, and lack of transparency are also factors that deter trading.

Formalization of transactions with such financial instruments generally requires a large amount of unnecessary paperwork, such as registering the transfer of ownership rights to shares. These factors significantly hinder borrowers’ and investors’ access to capital markets and, as a result, reduce the volume of transactions in the capital market.

Why is tokenization necessary?

Tokenization is the process of transforming the issuance and trading of assets into the digital space. Tokens issued for specific types of assets represent a new type of asset existing in the digital space. Any type of asset, whether illiquid or liquid, including stocks, bonds, metals, intellectual property, and real estate, can be tokenized. It is important to ensure that the token is “tied” to a real asset during tokenization. Otherwise, the token’s value will be zero.

Tokenizing illiquid assets can have the same economic effect as securitization. In other words, illiquid assets can be converted into liquid ones, which can then be financed in the market.

Tokenization aims to realize the possibility of partially selling an object, such as real estate, while retaining ownership rights to the asset for the owner wishing to finance it. Tokenization also increases the liquidity of the asset, allowing investors to acquire a portion of the asset.

There are compelling reasons for tokenizing liquid assets, i.e., publicly traded securities. For example, tokens can be issued for Apple stocks. Buyers of these tokens receive the same economic benefits as if they had purchased Apple stocks on the NASDAQ market. At the same time, unlike buying stocks on a traditional stock exchange, investing in tokens does not require access to organized trading, entering into a brokerage agreement, or (in some cases) being recognized as a qualified investor.

The issuance and trading of tokens occur on the blockchain through the execution of a series of smart contracts. This ensures complete transaction transparency, cryptographic protection, accelerated settlements, the ability to trade large sums, and high liquidity of such assets.

Regulatory Methods

Tokenization requires new legal regulation that designates tokens as a new class of assets and ensures all the aforementioned benefits. Currently, in most jurisdictions, regulatory bodies prefer to apply existing legislation on traditional financial instruments to this asset class. Under this approach, a license will be required for the issuance and trading of tokenized assets. Considering tokenized assets as securities entails certain risks as well as uncertainties and additional tax implications.

As a result of the global economic crisis of 2008, global regulation of trading in financial instruments was tightened (Dodd-Frank, EMIR, MiFID I and II). Although the aim of these measures was to ensure transparency in capital markets, the functioning of these markets was significantly disrupted.

It is evident that tokenizing classical types of assets as a new financing method has several important advantages that contribute to the efficient development and functioning of capital markets. However, the scalability of the tokenized market and its potential to increase trading volume and market liquidity depend not only on the implementation of innovative solutions in the field of digital technologies but also on the development of regulatory frameworks.