Trading in Tokenized Securities (and What is a Tokenized Security)

Tokenized Security

The tokenization of assets and resources facilitates faster, cost-effective, and increasing in functionality configurations. Another vital factor that has made tokenized securities a suitable alternative to the conventional trading/purchasing methods of stocks and shares is the outstanding level of liquidity that can be secured through tokenization of securities. What is more? Customer investment is guaranteed through the newly introduced rules and regulations. This initiative has turned the tokenized securities into a resourceful and secure method for exchanging and trading of assets.

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The idea of tokenization is in no way new. In fact, the concept of tokenized securities has been around for several years. Although, tokenized security has received more attention lately due the evolution of the crypto market. An additional driving factor for the increased demand for tokenized securities was the enormous number of ICO projects that came out to be a complete deception. Evidently, a lot more than half of the ICO projects were not credible at all.

Tokenization enables consumers to quickly and easily link their payment card with digital payment services , managing and keeping their data secure when paying in physical stores or on the Internet. In addition, this service allows more entities to operate in the payment ecosystem, from financial entities to technology partners, all through a single tokenization platform provided by a prestigious financial entity such as Visa.

In this way, new digital products can be developed or existing ones can be improved to meet the growing demand of consumers who ask for greater comfort and safety. The expansion of the service will enable many new ways to pay adapted to the new online payment experiences, which are more innovative, comfortable and can be integrated into applications and all kinds of connected devices.

Security experts argue that payment tokenization is “the best solution currently available to significantly increase security around payment card data without having to change anything for the cardholder.” This service makes it possible to store data confidential on a device when “devaluing” it, so that it is useless if it falls into the wrong hands.

In this way, this solution helps us to keep the card data secure, regardless of the way in which we make the payment, replacing a series of numbers, that is, a token, with the actual account information. In this way, whenever a token is stored, the data of the linked card will be safe. When consumers make a payment using a ‘tokenized’ payment service, a token is sent to the payment process, instead of cardholder account details.

Multiple tokens can also be created for the same card. Tokenization also enables financial institutions to flexibly control and manage the environments in which a particular token can be used, helping them to offer new cardholders ways to pay with your favorite card.

For example, a token configured only for a payment service in a certain application / mobile cannot be stolen and used elsewhere to make a purchase on the Internet. For consumers it also has an added convenience benefit, as if a device is lost or stolen, the token can be quickly and easily deactivated by the cardholder or their bank, without the need to cancel the Visa card associated with the token.

Similarly, if a card is lost or stolen, the consumer can continue to use their tokenized phone to make payments while waiting for the replacement card to arrive. As Visa Europe continues to expand its services, issuers, merchants and acquirers can take advantage of tokenization to manage and keep digital payments secure in all its forms.

Previously, the term “tokenization” meant a technology that enables electronic payments to provide a high degree of security through data encryption. With its help between the seller and the buyer it eliminates the need to transfer personal data and details. All information is replaced by a unique encryption code: token.

Now, conversations about the benefits of tangible asset tokenization are becoming more frequent, allowing them to be transferred to a transparent blockchain system, while retaining their characteristics.

In addition, the transition to digital form increases the speed and security of operations, as well as making them as simple and convenient as possible, and eliminates the need to cooperate with intermediaries. Traders trading on the stock market tokenizatsii assets will get rid of paperwork, which is the main difficulty in trading, will provide an easier way to sell and buy assets, and thus eliminate the need to hire management companies of assets. All this should significantly increase liquidity of assets.

What is asset tokenization?

Asset tokenization is the process of transferring rights from a financial asset to a digital token. Therefore, physical assets can be transferred to the digital system on the blockchain, where they will be registered and sold. Said system will be more confidential and secure, since all the operations in it are carried out in encrypted form and are entered in Blockchain information blocks , which cannot be falsified or modified.

How does tokenization work?

The basic principle of tokenization is to replace real assets or data with unique encrypted digital currency codes. In this case, the token itself does not contain personal data – information, but only logically related to real data.

Therefore, tokenization of bank cards eliminates the need to transfer card data to intermediaries or the seller during settlement transactions on it. Card details and the owner’s name are replaced with an alphanumeric combination inherent in a particular token. Tokens are created using mathematical formulas or are a randomly generated alphanumeric code. For intruders, they do not carry useful information, so they provide the data with the highest degree of security.

A security is a fungible (mutually interchangeable) financial instrument with a certain monetary value. Basically, the securities can be classified into stocks (such as Apple) or debts (such as a US Treasury bond).

It is important to note that security tokens should not be confused with utility tokens – which have received a lot of attention recently due to potential non-compliance with US Securities and Exchange Commission (SEC) laws. Security tokens are compliant and legally represent the property of an asset.

According to the SEC, tokens are divided into two main categories: Utility token and Security token.

What is a Utility token?

Since most ICOs (or STOs) represent investment opportunities in the company itself, most tokens are considered to be securities. However, if the token does not meet the criteria for the Howey test, it is classified as a utility token. These tokens simply provide users with a product and / or service.

Utility tokens can:

  • Give licensees the right to use the network, service or application
  • Give holders the right to perform other actions such as voting
  • Since the maximum token availability is capped, the value of tokens may increase due to the supply-demand equation.

What is a Security token?

A token that passes the Howey test is considered a security token . This generally derives their value from an exchangeable external asset. Since tokens are considered securities, they are subject to federal laws and regulations. If the ICO does not comply with the regulations, it could be subject to very high penalties.

The Howey test includes three criteria to determine if the token is of the security token type :

  • An investment of money or goods
  • In a “normal” business
  • With an expectation of profits derived from business management

Security tokens are simply titles with an electronic envelope. The advantage of this electronic envelope lies in the fact that it facilitates the negotiation of tokens in accordance with the regulations in force.

The security tokens are defined as any value of representation based on blockchain and subject to regulation under the laws securities. This includes tokens representing traditional assets such as stocks, debts, derivatives and real estate, as well as pre-launch utility tokens which are considered to be securities by the SEC.

Why trade in tokenized securities?

Unlike the paper property, the digital property can be programmed. Think of dividend payments, vesting periods, distributions, shareholder votes, etc. These are tasks that teams of accountants, bankers and lawyers are often enforcing and which instead will be automated with code in the token itself. Securities becomes a computer program ( smart contract ) that can interact with its shareholders and other organizations without intermediaries, which considerably reduces governance and issuance costs.

Take the example of private and public capital: issuing capital becomes as simple as clicking a button on the Internet. As security tokens mature, the software will allow securities to perform functions as simple as paying dividends, to more complex securities such as convertible debt or even credit default swaps; where the terms of the contract are hard-coded in the token itself and run automatically. Regulators will also be able to impose laws or standards in the token code themselves, which will allow securities regulation to become proactive, thereby eliminating the need for intermediaries to enforce these regulations.

For instance, If I am a qualified investor in the United States, I can purchase an offer of Reg D securities but I am not authorized to trade them within 12 months of purchase. The new token system, especially the protocol, knows who I am (my wallet is verified by a KYC ( know your customer ), what tokens I have (its properties such as regulatory exemption status, jurisdiction and date of issue, etc. are entered in the token), and all the people I try to deal with (their portfolio is checked by KYC).

If I attempted to trade my Reg D security within 12 months or with an unaccredited investor, the protocol would instantly identify the non-compliance criteria for the transaction and that transaction would be rejected. The token would be returned to my wallet, along with information on why the transaction was declined.

Tokenized public shares will be tradable 24 hours a day and settled instantly.The major stock markets around the world generally close on weekends and holidays. The settlement of assets often takes place between the usual hours of office workers. By definition, a blockchain has no downtime and, therefore, trading and settlement is possible 24 hours a day, 7 days a week.

Take the example of the Australian stock exchange: the ASX settles in 2 working days. Two working days after the exchange are necessary before the asset is settled and the owner change is made. Blockchains, on the other hand, regulate ownership from one entity to another almost instantly. Currently, the average settlement time for Ethereum is currently 15 seconds. You can easily check online to confirm if an asset has successfully moved from one entity to another in real time. Other blockchains, like EOS, offer up to 50 times more transaction capacity per second than Visa’s global payment network.

In 2017, ICOs experienced unprecedented growth, resulting in the creation of new asset classes, challenging the structure of financial markets. ICO’s values ​​provide an important source of innovation, which includes more effective channels in a wider circle of investors. However, with the continued advancement of technology in the blockchain industry, the framework that regulates these ICOs cannot successfully contain the surplus in the blockchain market. Cases of fraud and scandal have been widely reported, creating uncertainty among stakeholders and issuers.

Advantages of security tokens

  • Blockchain transparency

In the United States, progress is being made to allow the launch of securities on public networks such as Ethereum, thereby allowing public blockchains to serve as shared infrastructure for a global financial network.

With regard to public equity, the information required by regulators such as major shareholders will be automatically disclosed to the public in real time, thereby eliminating the need for a single “static” disclosure in annual reports and further enhancing transparency for shareholders.

In fact, as more and more services migrate to distributed blockchains, public reporting will evolve from static disclosure in PDF documents to real-time web disclosure that will completely revolutionize financial transparency – Force public companies to become more accountable while regulators and investors can be more proactive in how they interact with financial reporting.

  • Eliminate trusted intermediaries

The ownership of tokenized securities is entirely managed by the blockchain. Security owners will no longer need to trust third-party intermediaries to keep their assets. Instead, they are allowed to hold the assets themselves online, with portfolios to which only they have access. Assets have some security against theft because the token itself is programmed so that it can only be transferred between specific people or entities.

Only digital wallets linked to an identity are authorized to have security tokens . Once an identity has been linked to a portfolio, it can theoretically invest in any type of transferable security for which it fulfills the required conditions. This will allow securities to be exchanged directly between eligible wallet addresses on the open market.

The need to store and secure tokens is actually a potential disadvantage for those who prefer to trust third parties for the conservation of their assets. However, it can be argued that people will gradually remove expensive custodians and thereby reduce costs. In any event, the financial asset custodian services will change from “required” to “optional”.

Take the example of investment funds: the “units” (or, in this case, the “tokens”) of the fund are issued and managed transparently on a blockchain. This contrasts with the traditional approach of asking each KYC investment fund to verify each investor during the request and to manually manage the ownership of the fund’s shares in a centralized database (subcontracted companies such as registers of units providing these services to investment funds may be disrupted).

Dividends or distributions from the investment fund are completely transparent and go directly from the fund to the final investor (no intermediary is necessary to facilitate payment). Dividends and distributions can be paid with a stablecoin such as TrueUSD in the same digital investor wallet, simplifying payments for funds and investors.

  • Speed

The number of ICOs has decreased considerably, making it necessary to move from ICO to STO [also known as tokenized securities]. Tokenized securities are better regulated than ICOs, and are backed by various underlying assets. These tokenized securities tend to produce more natural results or benefits for their holders. Tokenized securities are also said to provide investors with a higher degree of collateral and stability.

Due to the creation of a more attractive investment platform with greater technological progress, 2019 is also a year of structural improvement in the blockchain industry. By 2020, the structure of the blockchain industry is expected to be better integrated.

More and more investors and merchants are expected to join the growing number of participants in the blockchain industry. It is speculated that there will be more service providers and exchanges licensed to bring a stronger industry, the industry will develop regulations and security measures, all thanks to the provision of tokenized securities.

  • Makes accounting easier

Business tokenization will save significantly on payment processing and make accounting easier. In particular, modern encryption algorithms that protect payments require the introduction of PCI DSS protocols in applications and platforms. Tokenization also enables you to store and manage data, operating with just one token, without compromising company and customer data.

Of course, the main advantages of tokenization remain the decentralization, transparency and security of the characteristic blockchain transactions.

Other unique advantages of trading in tokenized assets.

  • Market open 24/7
  • Fractional ownership
  • Quick Settlement
  • Reduction of direct costs
  • Increase in liquidity and market depth
  • Automated compliance
  • Asset interoperability

Tokenization is encountering cross-border regulatory, tax and property rights issues, but many countries are adapting their legal frameworks towards these digital market models and it is only a matter of time before asset tokenization on blockchain becomes the norm for all kinds of assets.

The financial market is full of various assets. Many of them are difficult to transmit physically, so only property rights are transferred to them. This is a rather complicated technological process that requires accounting and monitoring. Simplifying it and moving to a new level in the economy will allow asset asset creation.

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