digital dollars in action
Digital Securities & Global Stablecoins: The Evolution of Capital Markets
What Are Digital Securities?
Digital securities (or security tokens) are digitized investment contracts that provide an investor with a contractual claim on an underlying asset. These assets range from traditional securities (such as stocks and bonds) to real estate and commodities, all traded using blockchain technology.
Through the process of tokenization, investment assets can be issued and traded as digital security tokens on a distributed ledger.
So far, regulators have been complimentary of blockchain technology and its implications for securities:
“Blockchain technology has incredible promise for securities and other industries.”
— US Securities Exchange Commission (SEC) Chairman, Jay Clayton
The two most common types of digital securities are tokenized equity and tokenized debt. Tokenized equity, also known as equity tokens, represents a claim on a company’s assets and earnings. Tokenized debt, also referred to as debt or bond tokens, is an investment in a debt instrument.
Digital securities are a digital representation of a financial contract on a distributed ledger, such as a public blockchain, represented as a token with the additional benefit that this security token is governed by a set of smart contracts and those smart contracts enforce the programmability of the features of the security.
— Carlos Domingo, Founder & CEO of Securitize
As digital securities are investment contracts, they are regulated under the securities laws of the issuer’s country, providing a layer of consumer protection for investors.
Digital Securities vs. Traditional Securities
While digital securities aim to replicate the investment vehicles of traditional securities, there are several clear differences between the two.
A company that wants to raise funds could issue 25% of its share capital as digital security in the form of an equity token (hence security token) sold to investors and financial institutions. The company’s shares would be tokenized so that one token would represent one share. The value of each tokenized share would be determined at issuance and linked to the current valuation of the business.
During the security token offering (STO), investors could purchase the equity token using a stablecoin, such as USD Coin (USDC). Once the token sale is complete, investors receive their security tokens and are now shareholders. The digital security can then be traded in the secondary market just like traditional securities such as stocks.
Digital Securities: Investment Assets for the Digital Age
Digital securities are the natural progression of the digitization of financial markets and innovation from the blockchain-powered tokenization of underlying assets. While the digital securities market is still in its infancy, a number of tokenized securities have already been issued and traded.
The First Digital Securities
The first-ever digital security issued in compliance with securities law was launched by the financial institution Blockchain Capital in April 2017 to raise $10 million for a $50 million tokenized venture capital fund. The BCAP token sale only lasted a few hours as demand for the equity token, and the first tokenized investment into a venture capital fund, was higher than expected.
Following Blockchain Capital’s equity token, numerous crypto startups followed suit to raise funds using the new, regulated investment vehicle. Security token trading marketplaces, such as OpenFinance and tZero, emerged to meet the growing demand for digital securities trading. New types of security tokens were issued, such as tokenized real estate and blockchain bonds.
Today, the digital securities ecosystem is composed of a variety of tokenization service providers, secondary markets, and a growing array of tokenized investment vehicles.
Securitize: Digital Securities in Action
Securitize, a pioneer in digital securities, worked with Lottery.com to enable payouts to its shareholders across the globe.
Investors who took part in the Lottery.com security token offering were eligible for royalty payments, and the company needed a way to process payouts while complying with local government regulations.
Using the Securitize Payout App, investors could choose between fiat currency or digital currency payments, and fill out the required tax forms online with the click of a button. A large portion of investors chose crypto payouts, with more than half opting for payment in USD Coin (USDC).
The Future of Digital Securities
In the future, we can expect effectively any financial security to be turned into a security token to operate using blockchain technology. Through tokenization and the deployment of smart contracts, even the most complex financial products can be digitized into security tokens and traded over the Internet.
For issuers, that means a reduction in cost to go to market and a broader investor base. For investors, it means the democratization of a wide range of asset classes, as anyone with an Internet connection will be able to purchase tokens that represent a legal claim on a company or digital asset.
Tokenization: How to Turn Anything of Value Into a Digital Security
Tokenization is the process of digitizing a physical asset or a security and turning them into tradable, liquid digital securities in the form of a digital security token that “lives” on a blockchain.
The tokenization of assets can create new digital securities that unlock the ability to access, invest in, and trade the underlying physical asset.
— Jeremy Allaire, CEO at Circle
The ability to tokenize assets and securities opens up new opportunities for businesses to raise capital and for investors to gain exposure to a wide range of asset classes.
For example, a real estate development company could raise capital by tokenizing 50% of a property and selling the tokenized shares to investors across the globe. The real estate developer would gain access to fresh capital, while investors would receive a fractional share in a real estate property — a traditionally illiquid asset class with high barriers to entry. Investors could also earn rental income from the property that is programmatically paid out in digital dollar stablecoins like USDC.
Benefits of Tokenization
The tokenization of physical assets and traditional securities opens up new opportunities for businesses and investors.
The main advantages of tokenization include:
- New avenues to access capital
- Access to a new pool of investors
- Enable fractional ownership
- Access to illiquid asset classes
For issuers, the primary benefit of tokenization is a new, affordable avenue to raise capital. Companies no longer need to issue bonds via a syndicate of banks, or list their shares on a public stock market. Instead, businesses can tokenize share capital or issue a tokenized bond directly to investors in the form of digital security tokens.
Due to the open, borderless nature of distributed ledgers, digital securities can be sold to and traded by investors across the globe. Anyone with an internet connection and the right investor accreditation can take part in a digital securities offering (DSO). As a result, issuers gain access to a new pool of investors while the financial markets are democratized in favor of the investor.
For investors, tokenization also offers fractional ownership, which is not always a possibility in the traditional financial markets. For example, a young investor who has just graduated from college could purchase a tokenized share in a real estate property to benefit from the growth in the real estate market, without having to purchase a property.
Tokenization also provides in-roads to illiquid asset classes typically reserved for institutional investors or high net-worth individuals. Examples of illiquid asset classes ripe for tokenization include art, antiques, fine wine, real estate, venture capital, and vintage cars.
Securitize: A Market Leader in Tokenized Digital Securities
Securitize has built a platform that enables companies to tokenize existing securities and to create new, digital securities that operate on a distributed ledger.
Securitize uses blockchain technology as a way to digitize a security in a way that includes all the programmability of the security, like features and rights, while enforcing compliance rules of the security with smart contracts on the distributed ledger. With blockchain technology all beneficial ownership can then be tracked.
— Carlos Domingo, Founder & CEO at Securitize
Additionally, the San Francisco-based digital securities services specialist handles investor onboarding and setting up features for a security, and can act as a transfer agent to process security payouts, corporate communications, and governance on behalf of the issuer.
A Tokenized Future
While it is difficult to determine exactly when the wave of tokenization and digital securities will hit traditional financial markets, it is only a matter of time.
In the future, we can expect investment portfolios with digital securities that include:
- Tokenized shares in real estate properties in New York
- Gold-backed security tokens as a hedge against inflation
- Bonds from small and medium-sized businesses
- Fractional shares in a Picasso painting or other art-based assets
- And more...
A great example of tokenization would be this company that is taking incredibly popular cartoon characters in Asia and creating a tokenized digital security for the future royalty streams of that animated character.
— Jeremy Allaire, Circle CEO
Settlement would occur on-chain and within seconds, alleviating the need for clearing and settlement intermediaries, and allowing the global investor community to take part in these investment vehicles.
The Role of Stablecoins in the Digital Securities Market
As the digital securities market grows into an innovative new asset class, there is one missing piece to the puzzle: stablecoins.
Digital securities require a blockchain-native pricing and settlement currency that enables smart contract-powered payments (for dividends and coupons, for example) and on-chain settlement.
A digital dollar stablecoin, such as USD Coin (USDC), is ideally positioned to fulfill that role because of its features:
- Price stability
- Secure, low-cost settlement
- Technical specifications
Digital securities need to be priced in a currency that provides price stability. For digital securities issued in the United States, a digital dollar stablecoin like USD Coin — redeemable 1:1 for US dollars held in a regulated financial institution — would be the logical solution.
Stablecoins also provide an unprecedented level of asset accessibility. Anyone with an internet connection regardless of where they are located in the world can store, send, and receive stablecoins. For the digital securities market, that means issuers can tap into a global investor base through on-chain settlement of dividends and coupon payments.
Secure, Low-Cost Settlement
Global stablecoins can also act as a secure, low-cost settlement mechanism, as all on-chain transactions can be followed in real-time, can never be reversed, and only cost a fraction of existing alternatives like wires and ACH payments.
Finally, stablecoins possess the technical specifications to process smart-contract-powered payment flows. Dividend or coupon payments that are automated via smart contracts, for example, require an on-chain digital currency to process transactions. That’s where digital dollar stablecoins come in; price-stable, on-chain money is a requirement for digital securities to replicate existing investment vehicles and unlock their full potential.
Digital securities and stablecoins are two sides of the same coin. You have this cash on blockchains that can be used to move and settle value, and you have a [digitized] financial contract. That contract is the security.
— Jeremy Allaire, Circle CEO
The integration of digital dollar stablecoins into the digital securities market has already begun and is poised to accelerate as this new asset class continues to grow.
USD Coin: The Base Currency for Digital Securities
USD Coin (USDC) is arguably the best positioned stablecoin to act as the base currency for dollar-denominated digital securities.
USDC is a fully reserved digital dollar stablecoin issued by regulated financial institutions. Each USDC is redeemable 1:1 for the US dollar, and all US dollar reserves for USDC are subject to monthly attestation reporting from leading auditing firm, Grant Thornton LLP. USDC comes with the highest level of trust and transparency.
USDC is open, global, transparent, liquid, and regulated, which makes the market-leading digital dollar stablecoin highly suitable as a pricing and settlement currency for digital securities.
Additionally, Circle offers a full suite of solutions for supporting USDC, enabling companies that are developing digital securities or marketplaces to seamlessly manage their flows and payment flows. For example, using the Circle Payments product, issuers can accept card, wire, or ACH transactions that automatically settle in USDC while Circle's Digital Dollars Accounts product can be used to integrate digital dollar wallets into a tokenized securities trading marketplace.
Digital securities require a trusted pricing currency and settlement vehicle to succeed. USDC is poised to play those roles in the upcoming tokenization of the capital markets.