Investors have been greeted with a flurry of news since the beginning of the year about tokenized stocks, with splashy new offerings for overseas customers from the likes of Coinbase, Robinhood and Binance, and more recently, offerings for eligible U.S. investors from Securitize and Dinari.
Meanwhile, the NYSE, Nasdaq and the London Stock Exchange are all developing technology and infrastructure to allow tokenized stocks to trade on their platforms, and the Depository Trust & Clearing Corporation—the organization at the heart of U.S. securities clearing and settlement—just launched a service allowing major financial institutions to convert conventional securities into blockchain-based tokens.
Perhaps most significantly, the SEC announced in September a five-year program to allow qualified US trading venues to experiment with trading tokenized equities.
The promise is to allow equity assets to move fully to the blockchain, where they can be traded in fractional amounts 24/7, settle almost instantly and eventually become a part of automated transactions creating entirely new financial products, representing the vaunted “composability” element of blockchain assets.
As a sign of growth, Binance reported that its tokenized offering, BStocks, had already reached a total market capitalization of $3 billion by the end of September, while Citi projects that 3% of the US public stock market will be tokenized by 2030.
But will tokenized stocks ever actually become a dominant way to trade equities? One big challenge is that two of the most touted benefits of tokenized stocks — the ability to trade fractional shares at any time of the day — are already largely available to US retail investors, who account for the vast majority of trading in domestic stocks.
“US investors already have efficient access to tokens’ underlying shares,” said Reid Noch, vice president of US Equity Market Structure at TD Securities. He noted that trading platforms like Schwab already offer 24/5 trading for many popular stocks and ETFs, while US exchanges themselves are expected to move to 23/5 access this December. Meanwhile, Robinhood recently announced that it would be offering 24/7 trading of select stocks and ETFs some time next year.
Also, despite the SEC’s encouraging stance towards tokenization, there are still significant logistical and regulatory hurdles to overcome — notably, how important rights such as receiving dividends and participating in shareholder votes can be passed on to investors. Most of the major tokenized equity offerings so far — Binance’s BStocks, Coinbase’s Tokenized Stocks, Kraken’s XStocks and Robinhood’s Stock Tokens — offer “wrapped” products that don’t currently convey those rights, while the SEC’s innovation exemption requires that eligible products offer such rights, as well as that public companies be able to object to their shares being offered in tokenized form by others.
These wrapped products are “where we’re seeing most of the adoption now,” said Tanay Ved, a senior research analyst at Talos, a digital-asset trading technology firm. But given the SEC’s moves, Ved expects the market to move in the direction of actual shares being represented onchain with the attendant shareholder rights.
In addition, while instant settlement of trades might appeal to retail investors who can access funds quickly, this change would likely not be supported by institutional traders, who benefit from the netting of transactions under the existing T+1 system in which trades settle one day after transactions are executed. This delay reduces the cash needed to settle trades, and requiring every transaction to settle immediately could force firms to prefund their trades, tying up substantial amounts of capital.
Lastly, there are also concerns about equities’ liquidity fragmenting across multiple tokenized pools, leading to inconsistent pricing and other inefficiencies. “If each platform creates a separate pool with costly or uncertain conversion, investors may face wider spreads and additional risks,” said Will Cong, a finance professor at the Cornell SC Johnson College of Business who has studied the mechanics and implications of stock tokenization. “A market being open around the clock does not mean it is liquid around the clock.”
Given all these potential issues, even the most optimistic estimates call for only around 20% of stock trading activity to migrate towards being blockchain-based, about the same percentage of spot cryptocurrency trading itself that occurs onchain.
Wild Cards
There’s a chance that more stock trading could move onchain, however, as both retail and institutional investors start to take advantage of some of the unique features of assets traded on a blockchain.
“I’m not of the view that literally everything has to trade onchain,” said Alex Thorn, head of research at Galaxy Digital, the large digital assets and infrastructure firm. “But I think equity investors are going to find what crypto investors have found, which is that in some circumstances … the programmability that DeFi can bring is objectively a net new feature set that doesn’t exist in the equity market.”
In terms of what those new feature sets might be, Thorn said it could be “creating liquidity on an automated market maker (AMM)”—which manage the pools where tokenized equities can trade — “or taking liquidity from an AMM and trading or borrowing and lending your coins in a cool, permissionless, 24-7 way.” He also notes that the certainty of execution and settlement of trades on a blockchain can substantially reduce counterparty risk and lead to efficiencies.
Galaxy itself is a public company that has issued tokenized shares of its GLXY stock, and Thorn notes that the company has successfully used the structure for its own treasury operations to borrow, lend and trade its shares.
There could also be advantages for retail investors to having all of one’s financial assets residing and moving seamlessly on the blockchain, which is one of the major goals of the larger trading platforms such as Coinbase, Binance and Robinhood.
Even TD Securities’ Noch, who’s generally pessimistic about the potential for tokenized stocks to take off, acknowledges that the development of such “super apps” could play a role in driving more usage of these products. “The idea is to keep everything on that single platform, and that’s something you could see much more of in the future,” Noch said.
What’s clear for now, however, is that tokenized stocks will have to prove themselves before U.S. equity investors jump en masse onto that train.
“The strongest sign of success will be investors using stock tokens because they offer better execution, lower total costs or more useful access — not simply because the stock has been turned into a token,” Cong said.
Written by Nelson Wang
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