How can Stock Exchanges prepare for the tokenization of financial markets?
Financial markets and securities trading are on the brink of major disruption in the form of tokenization: the issuance of digital tokens that represent real, tradable assets. This new “token economy” is made possible by rapidly maturing blockchain technology at the core of these digital assets. The result is greatly reduced friction involved in creating, buying and selling securities, transforming the financial ecosystem and hence the business of stock exchanges.
“Stock Exchanges are trying to wrap their head around how this all works,” says Jai Waterman, CTO and Chief Enterprise Architect of Blockstation, an innovative turnkey solution platform provider for listing, trading, clearing and settlement of digital assets based in Toronto, Canada. “Will this attract new issuers, who are the right partners, who has the right technology, and do we have the green light from the regulators? These are some of the questions facing the industry right now.”
Tokenization is already under way
Blockstation is a front-runner to make tokenization a reality for stock exchanges, broker-dealers and traders around the world. The company recently completed phase one of its trailblazing partnership with the Jamaican Stock Exchange (JSE) to establish the world’s first end-to-end trading ecosystem for digital assets in a fully regulated environment.
As it moves forward, the JSE pilot will demonstrate an industry blueprint for tokenization, reducing the cost and risk for stock exchanges that join the token economy.
“Traditional global markets trade over $60 trillion USD per year,” says Waterman. “I believe we’ll see even higher volume than that with tokens because they can support traditional assets as well as utility tokens, national currencies and complex hybrids. In the next 5 years alone, we’ll see anywhere from $10 to $20 trillion traded annually by security tokens.”
Securities take blockchain technology a step beyond the cryptocurrencies and utility coins used in recent years. Security tokens can represent any asset traded on a regulated exchange, including ownership shares, dividend rights, and cash. They also bring unprecedented liquidity to traditionally illiquid assets, like fine art, real estate, and publishing rights permitting them to be listed and traded easily on primary & secondary markets of the issuer’s choice.
“We’re at the stage right now where we can have an exchange up and running on Blockstation’s platform in seven days. Five for training the exchange staff and their broker network, two to go live, and it’s done. The technology to do it quickly and easily — with all the regulatory requirements — is there.” — Jai Waterman
Tokens can also be faster and cheaper to issue and trade than traditional IPOs and stocks, with smart contracts automating aspects of the transaction and eliminating the need for many intermediaries that add time and cost today.
“With security tokens, smart contracts can automate and bring transparency to every part of the transaction,” states Waterman. “If shares are supposed to be escrowed, then smart contracts ensure they stay locked until the contract conditions are met. Same for insider trading. On the blockchain, everybody can see if an insider just moved a block of their shares into the market in real time. Why should the regular retail investor be disadvantaged while insiders get the unfair or illegal advantage?”
That transparency and accountability extends to voting rights as well, as security tokens can include an immutable record of the holder’s identity, rights and responsibilities. Today, that information is challenging to track and verify through layers of broker records.
These characteristics provide confidence in the providence and value of digital tokens and the assets they represent, creating a more transparent and trustworthy market than exists today.
The path to tokenization for financial institutions
The token economy signifies a tremendous shift from centralized trust agents to individuals, as cryptology replaces third-party intermediaries with blockchain participants who collectively certify the integrity of the shared ledger. In managing this shift, financial institutions must determine how they are going to adapt to and facilitate the token economy.
The key to mass adoption, according to Waterman, is education and institutional-grade holistic solutions. “A lot of blockchain companies have built a piece of the puzzle, such as creating a smart contract platform or know-your-customer (KYC) application — but that’s not enough. The stock exchanges can’t just go ahead and accept any token to list on its exchange. They have a list of regulatory requirements to satisfy. For instance, what happens when people lose the private key to access their tokens? You can’t just say they don’t own those tokens anymore — you need to be able to burn and re-issue them. You need to be able to do everything you do today in the existing market, only better.”
The way forward is to partner with end-to-end solutions that understand this technology as well as satisfy regulatory requirements for consumer protection. “We’re at the stage right now where we can have a stock exchange up and running on Blockstation in seven days,” adds Waterman. “Five for training the exchange staff and their broker network, two to go live, and it’s done. There’s a misconception that it’s hard and will take years to build, but the technology to do it quickly and easily — assuming there are no objections from regulators. That’s what our pilot with the JSE is out to prove, and so far, it’s been a success.”
Institutions that engage with this technology, plan for the future, and adapt to the realities will thrive in the emerging token economy. For stock exchanges, providing new capital formation opportunities and a steady stream of new global listing and trading revenues is their lifeblood. The coming of tokenization will offer many new opportunities for forward looking stock exchanges to provide leadership and prosper.