A tokenized security is simply any security, such as as a corporate stock, a government bond, proof of ownership in real estate, wrapped up into an electronic form.
This wrapper allows the underlying security to be divided, if you do not have a million dollars to buy a whole building. It also allows a local pizza shop to issue shares without doing the IPO, that costs a fortune to do.
You may immediately start thinking of tokens recently issued by various ICOs, where lots of people lost lots of money. Those were called utility tokens.
However, a security token differs from utility tokens in two principal ways:
1) There is always an underlying asset behind the security tokens, none other then a promise of future use behind the utility tokens
2) Security tokens are programmed to comply with all laws and regulations in the jurisdiction of the issuer, including KYC/AML.
The latter makes security tokens different from cryptocurrencies. In the latter, anyone who knows your private key can use your bitcoin. You can’t steal a security token because a token is not the security itself, it is an electronic representation of a security.
No one can transfer a token to their wallet unless their wallet is whitelisted, in which case they would have gone through KYC/AML so you would be aware of any attempts before any unauthorised actions took place.
Security tokens is a new financial instrument, however use cases are there in abundance. Buildings and land are being tokenized. It allows you to buy ‘a piece’ of a building. This security token will typically entitle you to receive a part of the rental income and a part of the sale amount once the building is sold.
Expensive classic paintings were recently tokenized and sold to several thousand investors, who through the same issuance platform voted to accept a higher bid several months later. The proceeds were distributed to investors through the same platform.
Tokenization of corporate stock allows small investors to purchase a fraction of an expensive share or to purchase a stock not available through institutional brokers in their countries. In fact, it allows to buy stock directly, without paying commissions to brokers.
Investment in government bonds in some markets have very high entry levels, one cannot purchase government bonds for less them a five figure amount in US dollars. Tokenization of bonds opens up this market to people who have regular salaries.
The main use area of security tokens is crowdfunding. A startup or an existing business with need for capital and plans for expansion issues security tokens, aka electronic shares. Investors who purchase these tokens become co-owners of the business, pretty much like owners of reguæar shares, with rights to dividends, voting rights and right to sell the tokens on secondary exchanges.
There are issuance platforms to issue tokens, compliance experts who make sure tokens comply with regulations, custodians who keep them, trading platforms and secondary exchanges. I will review them in a separate post.