Tokenized Trading Finally Comes

At my old blog, I used to go back and forth from his blog to my blog about the rise of crypto. William wrote a book a long time ago, The Business Blockchain, and he continues to be a thought leader in the space.

We kicked around a lot of topics. Crypto was very new then, and so we were imagining all the things it might do. For example, what if air miles or credit card miles were tokenized and a market was created? I could sell Delta miles and buy United miles. I could sell Amex and buy Visa. Trust me, because of supply, demand, and other constraints, it would not be a dollar-for-dollar market.

We truly were on the cutting edge of discussion, and our blog traffic back then showed it.

I had hypothesized what tokenizing stock securities would look like, along with some of the ensuing trade. Is it different from what it is today? Yes, it is, but the end product will not look that different.

I also invested in OpenFinance.io. They were the very first firm to go through the entire SEC process and get permission to trade security tokens. It was a very, very thorough process. Your doctor doesn’t get that thorough when you get a physical.

We made it to the finish line only to have the SEC pull the rug and tell us we couldn’t trade security tokens. They were not doing stock, but tokenizing REITs, which is a royal pain in the you know what if you have traded them. I had an old pit trading friend who traded REITs and tax delinquencies. He had an actual rubber stamp with an ink pad for his signature. It was paperwork trail after paperwork trail. OpenFinance tokenizing it would have brought a lot of efficiency to the market that truly needed it.

Today in the WSJ, tokenized trading was announced by the NYSE. NASDAQ has a similar effort underway. This should help you understand the basic premise of what tokenization means.

There are three primary types of tokenized stocks:

Natively issued tokens—Native tokenization involves companies issuing their own shares directly on-chain, without using an intermediary or wrapper. The blockchain becomes the primary source of truth for ownership records, with tokenized shares representing original equity rather than mirrored or wrapped versions.

Wrapped tokens—Wrapped tokens are issued on-chain and backed by publicly traded shares held with a licensed and regulated custodian or broker-dealer. Each token mirrors the price of the underlying stock.

Synthetic tokens—Synthetic tokens are on-chain derivatives that use oracle data to track the prices of real-world assets such as stocks without holding or being backed by the actual asset. These tokens enable on-chain exposure and 24/7 trading.

When we went from trading during designated hours to trading 24/7, there was a marked change in the marketplace. The game and control of the game changed. The way the edge was defined changed. The big money funds were able to put someone on a desk all night and push the market. In the old days, the market would close, and no one could do a thing until the open on the next trading day. It gave people time to rethink, rejigger, get some financing, and attack each other the next day. It also gave time for news to drift into the market, be digested, and not have anyone act on it.

Tokenizing stocks might, or might not, give the same rights as an actual shareholder has to the token. Currently, in the NASDAQ model, it is replicating an ADR model, so if you own a token, you have the same voting and dividend rights as you would with stock. In some ideas that are being talked about, the token is programmable, and only some rights are retained. That introduces a different sort of risk to the token.

My guess is that all regulated stock exchanges you are familiar with will have tokens that have a 1:1 replication of the underlying stock.

Startup crypto exchanges might have variants of it. For example, a tokenized stock might automatically reinvest the dividend by crediting holders with more tokens, since the tokens themselves don’t carry rights to traditional dividend payouts.

What will it do? Here is a broader discussion. Each segment of a token can have its own peculiarities and risks. A natively issued token won’t be exactly like a synthetic token, even though they represent the same underlying stock.

First, it will eliminate some friction in trading. Even though stocks are liquid, there is still friction. Transfer of ownership and things like that take time. Tokenized stock smooths a lot of that friction. Any elimination of friction brings more capital efficiency to the market.

Second, for short positions, it will be a lot easier to find and allocate, or borrow, stock. No more phantom stuff, especially if it is a native token. Tokenization also enables the shorting of international stocks that may be prohibited from shorting today. You might find yourself in a trade where a synthetic token, because of the properties coded into the token, leads the market lower and outpaces the native token.

Clearing and settlement change. Today, clearing is +1 day. Tokenization brings speed and efficiency, and also allows for easier netting of positions, freeing up margin money for big players.

Global and democratized access. In the US, we take for granted that we can access the US market. It’s not that way in other countries. With tokenization, their citizens could buy a tokenized stock or buy a tokenized index and realize the same return even if they can’t access the underlying security.

Tokenization makes owning fractional shares a lot easier. Today, if you want to sell out an entire position, you are often left with shards of that position in your account. Tokenization makes it simple to sell or buy it all. Being able to buy a piece of a share is great for smaller retail investors. Suppose I don’t have the money to buy Berkshire Hathaway. I can buy a fraction and enjoy the same risk exposure and potential upside benefits.

Tokenization will change the way trading’s edge is distributed. Currently, it goes to the big guys like Citadel. In a tokenized market, they might not be able to dominate in the way they do today. We might see more trading done on exchange versus in dark pools off exchange. It remains to be seen if that comes true but some people out there are thinking it might change the playing field a bit.

The opposite might also be true. Tokenization might draw volume away from traditional exchanges into tokenized exchanges since many people in some countries want access to the US market but cannot currently get it.

There will be more arbitrage opportunities since there will be traditional security exchanges and tokenized security exchanges trading basically a similar underlying instrument. Arbitrage will exploit price discrepancies and make the entire market more efficient. We used to do this between CME and LIFFE with Eurodollars.

Because of the tokenization, it should bring more retail investors to the table because they will have greater and easier access. As international markets get tokenized, US investors will have easier access to foreign markets. It will be far easier to build an international portfolio.

Tokenization will see AML/KYC programmed into the token, taking away a lot of friction in the market. This is especially true for some asset classes that are deliberately walled off from some investor classes.

The ability to lend out, or stake, tokens will be easier than shares.

Cap tables of companies can update automatically with tokenization. That creates more certainty and less waste of time and effort on behalf of companies when it comes to shareholder meetings/votes and things like that.

Total trade costs should go down. There should be fewer intermediaries in transactions, and fewer hands on the transfer and processing of stocks. As a small retail investor, you don’t see those costs because they are eaten up by the big institutions on the opposite side of your trade. But the costs remain. Lowering the costs should mean more liquid markets, tighter markets, and faster markets.

There are risks to tokenization, which I haven’t covered at all here. But the opportunity costs of the benefits probably outweigh the risks.

The summary is that we will get more efficient, liquid markets with more democratized access. We will see more innovation by companies and exchanges with regard to the way they sell, process, and categorize equity investments.

I might also add, this is a huge win for investors that wouldn’t have been possible if Gary Gensler or some other Democrat were in charge of the SEC. It was brought to you by Trump and his head of the SEC.