Tokenised Financial Products Are New Reality

As reported in the media, the US Securities and Exchange Commission (SEC) has taken a landmark decision by paving the way for the establishment of trading venues that will offer tokenised stocks in the United States under two five-year innovation exemptions. This move will enable companies to prepare for the launch of tokenised stock trading platforms. However, the SEC’s decision does not constitute unconditional approval, as certain safeguards and restrictions apply. One key condition is that, before permitting third-party trading of tokenised stocks, a trading venue must give the company whose shares are to be tokenised 30 days’ notice. If the company objects, the venue will not be allowed to proceed with offering those tokenised stocks for trading.

The SEC’s decision will grant temporary exemptions to authorised trading venues and market makers from certain stock trading rules that previously restricted the trading of digital tokens representing shares in listed companies. Tokenised stocks are traded on blockchain networks, which are digital ledger systems also used in cryptocurrency transactions. However, access to such products has so far been limited, with some offerings available only to overseas investors. The SEC’s decision could establish a new framework under which tokenised shares confer the same rights on their holders as conventional shares.

Tokenised stocks are digital tokens representing shares in publicly listed companies. Although the concept may appear relatively new, similar products already exist in the market. These include tokenised derivatives that track share prices but do not confer ownership rights. Once tokenised stocks are traded on blockchain platforms under the proposed framework, the tokens will represent actual share ownership and entitle holders to the associated rights, including dividend payments and voting on shareholder matters.

The official launch of tokenised stock trading could offer several advantages. First, blockchain technology can facilitate round-the-clock trading, allowing investors to buy and sell tokenised stocks 24 hours a day, seven days a week, unlike conventional stock markets, which operate during designated trading hours. Secondly, tokenised stocks could improve international investors’ access to the US market, enabling people across the world to invest in and trade US-listed shares. Supporters believe this development could open the world’s deepest and most liquid capital markets to a broader global investor base.

Proponents also argue that blockchain-based trading could speed up transaction processing by reducing the need for intermediaries. This could lower transaction costs and potentially improve returns for investors. Furthermore, some believe that tokenisation of financial instruments and other assets could help markets operate more efficiently and maintain liquidity during periods of stress. According to media reports, some banking executives have suggested that tokenised money market funds could provide instantly transferable collateral to support trades during periods of market turbulence.

Several companies have already been exploring blockchain-based financial products. Robinhood, Coinbase, Kraken and Gemini, among others, have offered blockchain-based versions of US stocks and exchange-traded funds (ETFs) to investors outside the United States. Asset managers, including BlackRock, and JPMorgan Chase’s asset management division have also launched tokenised money market funds, although these products have largely been targeted at institutional and high-net-worth investors. The SEC’s decision could pave the way for broader access to tokenised stock trading, potentially extending it to retail investors.

Despite these potential benefits, the rapid tokenisation of capital market instruments has attracted criticism. Opponents argue that trading outside conventional market hours, particularly during periods of low trading volume, could expose tokenised stocks to price manipulation and excessive volatility. Cybersecurity risks are another major concern. Some corporate executives have also objected to the proposed changes, arguing that tokenisation could allow traders to circumvent US regulations, undermine companies’ ability to raise capital and create uncertainty over whether investors would enjoy the same shareholder rights as conventional shareholders. In response, proponents contend that companies cannot necessarily control the financial products developed around their shares once those shares become publicly traded instruments.

Stock markets are particularly vulnerable to manipulation, which is why stringent compliance requirements and extensive surveillance mechanisms are in place to protect market integrity. Self-regulatory organisations, including stock exchanges, monitor trading activity and enforce market rules, while the SEC provides broader regulatory oversight. These mechanisms help detect and deter fraudulent and manipulative practices in conventional stock markets.

However, blockchain-based trading platforms may not have surveillance and preventive mechanisms equivalent to those operating in traditional exchanges. This raises concerns about the possibility of an uneven regulatory environment. While conventional stock trading is subject to established compliance requirements and surveillance during regular market hours, tokenised stocks could be traded around the clock on platforms with different levels of regulatory oversight. Unless appropriate safeguards are established, this disparity could expose investors to additional risks and undermine confidence in the fairness of the capital market.

Nevertheless, demand for the tokenisation of capital market instruments is growing, and traditional stock exchanges are working to embrace this emerging trend. According to media reports, Nasdaq and the New York Stock Exchange, two of the largest stock exchanges in the United States, have been actively exploring tokenised stock trading. Many Wall Street firms are also keen to participate in this transformation.

The shift towards tokenisation is therefore gathering momentum. Although regulatory, technological and investor protection challenges remain, tokenised stocks could eventually become an integral part of the global financial system. If supported by robust regulation, effective surveillance and adequate safeguards for shareholder rights, blockchain-based stock trading could reshape how securities are issued, traded and settled, ushering in a new era for the capital market.

The writer is a certified anti-money laundering specialist and banker based in Toronto, Canada. He can be reached at [email protected]