> Blog > Tokenized Stocks and How They Work

Published September 29, 2022

Reading time 4min

Share

As technology grows, so does our ability to invest in companies driving technological innovation. With more options available to us, there’s increasing flexibility as to how we can approach investments in both traditional and crypto markets.  

Some may want to be direct holders of the assets they purchase, whereas others may not to better suit their personal needs. So, how do you invest in a company without directly purchasing its stock?  It’s possible with tokenized stocks, which have been growing rapidly in recent years.  

Tokenized stocks introduce a new, more versatile way to invest in companies. But how exactly do they work and what are their benefits and drawbacks?  

In this article, we’ll take a closer look at tokenized stocks to help you understand the best way to invest in them.

What is a Tokenized Stock?

For centuries, companies have offered shares of stock to investors that represent partial ownership in exchange for capital. While it has been effective, the crypto revolution is bringing new tools to the trade, so to speak. 

A tokenized stock is similar to a traditional share of a company traded on global markets. However, instead of receiving a share from a brokerage, investors get tokenized stocks added to their crypto wallets through a crypto exchange.   

How do Tokenized Stocks Work?

visual graphic of how tokenization works

Tokenized stocks utilize the process of tokenization to harness their unique characteristics. Tokenization is the process of compiling information about any sort of asset and storing it on a blockchain in the form of a token. Anything can be tokenized – from art to insurance documents, companies, and more. 

Think of a tokenized stock like any other share of a company, except that the shares are represented by crypto tokens. Put simply, it’s a cryptocurrency of a company rather than a decentralized platform. 

You can access tokenized stocks much in the same way that you’d access any cryptocurrency. They are offered by several crypto exchanges, such as FTX and Bittrex.

Why Tokenize Equity?

The more money a company can raise, the more it can do. Tokenized equity can potentially offer  companies another avenue for raising additional capital without diluting the current share price. They open the door to more potential investors on exchanges who want to buy fractional shares of stocks. Fractional shares make investing in larger companies possible for investors just getting started or with little money to work with. 

Tokenized stocks are considered a security by the Securities and Exchange Commission (SEC), and as such they must follow certain regulations. That being said, tokenized stocks do not have nearly as many hurdles and red tape to overcome as traditional publicly traded shares. 

FTX is one of the leading crypto exchanges that’s starting to roll out tokenized stocks on its platform. This was done to push the company further towards realizing its vision to become an all-encompassing hub for financial services. Whether you want to use cryptocurrency products or invest in the traditional financial realm, FTX is stepping closer to bringing all aspects of modern finance to the user in one seamless platform

Tokenized stocks are not just appearing on centralized exchanges, however. Decentralized marketplaces like Synthetix are also bringing tokenized equity, commodities, and more to the decentralized finance (DeFi) ecosystem. Synthetix offers derivatives of stocks which track the prices of underlying real world assets using decentralized oracle pricing mechanisms. 

 Benefits of Tokenized Stocks

Tokenized stocks offer a whole new way to trade shares. In contrast with traditional methods which can only trade on weekdays for a few hours a day, these electronic funds can be accessed 24/7. Transactions settle in seconds, as opposed to shares, which can take days to finalize. 

As mentioned, fractional tokenized stocks offer more opportunities for companies and investors alike. A fractional share is simply ownership of part of a share. While normally low-income investors cannot trade high price stocks, with fractional tokenized stocks, smaller traders have more opportunities to invest. And with more investors available and able to purchase fractionally, tokenized stock liquidity is higher than in traditional shares. 

Along with the additional flexibility that they can offer to companies for fundraising, tokenized stocks offer several attractive incentives for companies looking to get involved with the blockchain space. 

However, despite their perks, tokenized stocks have a few downsides to consider as well. 

 Drawbacks of Tokenized Stocks

The first issue is the number of tokenized stocks available. While there are about 2,500 stocks trading on the New York Stock Exchange, there are less than 100 tokenized stocks that can be traded. So, although tokenized stocks promote greater accessibility, the smaller number of them being traded currently leaves that accessibility more of an ideal than a reality today. 

Since there are less tokenized stocks currently available, they offer relatively low trading liquidity. Trading tokenized stocks thus incurs higher fees, and the market making infrastructure is not as well established as compared to traditional markets. These aspects add a bit more friction to tokenized stock trading, however, advancements are being made every year to further bolster the infrastructure for seamless tokenized stock trading,  

Depending on the exchange, investors who buy tokenized stocks may miss out on perks that shareholders obtain. This is because tokenized stockholders technically do not own equity in a company, they own tokens distributed by an exchange. Some exchanges like FTX provide investors with dividend payouts, but other exchanges don’t. 

Another drawback is that tokenized stocks are stuck in the exchange in which they were created, meaning that Tesla tokens on Bittrex, for example, cannot be freely moved to another exchange in the same way that cryptocurrencies can.  

Additionally, tokenized stocks offer less regulation and investor protections compared to traditional markets. Traditional markets have more regulations in place to support investors with well established transferral procedures of ownership of shares. Tokenized stocks, on the other hand, are not as flexible – they must reside on the platform they are purchased on.

Not all exchanges are created equal. While some exchanges back their tokenized stocks with actual collateral, other exchanges back theirs with algorithms or even nothing at all. Lack of collateral backing can be risky; if the price begins to slip and investors sell off, it can have a cascade effect and wipe out your earnings. 

graphic representation of benefits and drawbacks of tokenized stocks

The Takeaway on Tokenized Stocks

There is no doubt that tokenized stocks are an intriguing way to invest in a company. Keep in mind that as a security, tokenized stocks are under the same regulations as traditional shares by the SEC, so approach them like traditional companies rather than cryptocurrencies.  

The FTT DAO likes FTX because of its diverse product offerings, including tokenized stocks, as well as their commitment to effective altruism.   

With every trade taken on the FTX exchange, a percentage of the trading fee is contributed to investments in humanitarian-focused projects as part of the exchange’s effective altruism initiative. 

To get involved, join the FTT DAO, a like-minded community of FTX fans seeking to promote effective altruism across the globe. 

Tags

Share

Tags

Join our Community

Join the Discord Server