Contents

  • Introduction

  • What is a financial token?

  • Why use financial tokens?

    • Transparency

    • Quick payment

    • Availability

    • Divisibility

  • Financial or utility tokens, what is the difference?

  • What makes a token a financial security?

  • Tokens financiers et finance programmable

  • To conclude


Introduction

A financial security is a financial instrument that holds value and can be exchanged. According to this definition, many of the instruments we know today, stocks, bonds, options can be considered securities.

In a legal context, the definition is much narrower and varies from jurisdiction to jurisdiction. If an instrument qualifies as a financial security under the criteria of a given country, it is subject to intensive regulatory review.

In this article, we will discuss how blockchain technology is poised to streamline long-standing financial markets with financial tokens.


What is a financial token?

A financial token is a token issued on a blockchain, which represents a stake in a company or an external asset. They can be issued by entities such as corporations or governments and serve the same purpose as their traditional counterparts (i.e. stocks, bonds, etc.).


Why use financial tokens?

To take advantage of an example, let's say a company wants to distribute shares to investors in the form of tokens. These tokens can be designed to come with all the benefits one would expect from stocks, including voting rights and dividends.

The advantages of this approach are numerous. As with cryptocurrencies and other forms of tokens, financial tokens benefit from the properties of the blockchain on which they are issued. These properties include transparency, fast settlement, no downtime, and divisibility.

Transparency

On a distributed ledger, the identity of participants is hidden, but everything else can be controlled. Everyone is free to consult the smart contracts which manage the tokens or which allow their issuance and the balances of the owners to be monitored.

Quick payment

Transfer and settlement have long been considered a bottleneck when it comes to asset transfer. While transactions can be completed almost instantly, reallocating ownership often takes time. On a blockchain, the process is automated and can be completed in minutes.

Availability

Existing financial markets are somewhat limited in their operating time. They are open for fixed periods during weekdays and closed on weekends. Digital asset markets, on the other hand, are active 24 hours a day, every day of the year.

Divisibility

Art, real estate and other high-value assets, once represented by tokens, could be opened up to investors who would not be able to invest otherwise. For example, we could have a painting worth $5,000 million that could be tokenized into 5,000 coins, so each would be worth $1,000. This would significantly increase accessibility, while providing increased levels of granularity on investments.

It should be noted, however, that some financial tokens may have a divisibility limit. In some cases, if voting or dividend rights are conferred as with shares, there may be a limit on the divisibility of tokens for execution purposes.


Financial or utility tokens, what is the difference?

Financial and utility tokens have many similarities. Technically, the two are the same. They are managed by smart contracts, can be sent to blockchain addresses, and are exchanged on exchanges or through peer-to-peer transactions.

Where they differ is mainly in their economic model and the level of applicable regulations. They can be issued during initial coin offering (ICO) or initial exchange offering (IEO), so that start-ups or established projects can finance the development of their ecosystems.

By contributing funds, users receive these digital tokens, which allow them to participate (immediately or in the future) in the project network. They can confer voting rights to their holder, or serve as protocol-specific currency to access products or services.

Utility tokens have no intrinsic value. If a project is growing, investors are not entitled to a share of the profits, as would be the case with some traditional securities. We could compare the role of tokens to loyalty points. They can be used to buy goods (or can be sold), but they offer no ownership interest in the company distributing them.

Therefore, their values ​​are often driven by speculation. Many investors will buy tokens in the hope that they will appreciate in value as the ecosystem grows. If the project fails, the holders are hardly protected.

Financial tokens are issued similarly to utility tokens, although the distribution event is called a financial token offering (STO). However, from an investment perspective, the two types of tokens represent very different instruments.

Even though they are issued on a blockchain, financial tokens are still securities. As such, they are heavily regulated in order to protect investors and prevent fraud. In this regard, an STO is much closer to an IPO than to an ICO.

Typically, when investors buy a financial token, they are purchasing stocks, bonds, or derivatives. Their tokens effectively serve as investment contracts and guarantee ownership rights to off-chain assets.


What makes a token a financial security?

Currently, the blockchain industry lacks legal clarity. Regulators around the world are still trying to adapt to a wave of new financial technologies. There have been instances where issuers believed they were issuing utility tokens, which were subsequently deemed securities by the Securities and Exchange Commission (SEC).

Probably the most famous metric for trying to determine whether a transaction constitutes an “investment contract” is the Howey test. In short, it is a question of determining whether an individual investing in a company expects to benefit from the efforts of the promoter (or a third party).

The test was produced by US courts well before the advent of blockchain technology. It is therefore difficult to apply it to the myriad of new tokens. That said, it remains a popular tool for regulators attempting to classify digital assets.

Each jurisdiction, of course, will adopt a different framework, but many follow a similar logic.


Tokens financiers et finance programmable

Given the size of current markets, tokenization could radically transform the traditional financial domain. Investors and industry institutions would benefit immensely from a fully digital approach to financial instruments.

Over the years, a centralized database ecosystem has created a lot of friction. Institutions must dedicate resources to administrative processes to manage external data that is incompatible with their own systems. The lack of industry-wide standardization adds costs to businesses and significantly delays settlements.

A blockchain is a shared database with which any user or company can easily interact. Functions previously handled by institutions' servers could now be outsourced to a distributed base used by the rest of the industry. Thanks to the tokenization of securities, we can connect them to an interoperable network allowing rapid settlement times and global compatibility.

From there, automation can take over otherwise time-consuming processes. For example, KYC/AML compliance, locking in investments for a specific period of time, and many other functions can be handled by code running on the blockchain.

If you would like to learn more on the subject, visit How Blockchain Technology Will Impact the Banking Industry.


To conclude

Financial tokens seem to be a logical development for the financial sector. Despite their use of blockchain technology, they are much closer to traditional securities than cryptocurrencies or even other tokens.

However, there is still work to be done on the regulatory front. With assets that can be easily transferred around the world, authorities must find ways to effectively regulate their issuance and flow. Some speculate that this too can be automated thanks to smart contracts that encode certain rules. Projects like Ravencoin, Liquid and Polymath already facilitate the issuance of financial tokens.

If the promise of financial tokens comes to fruition, the operations of financial institutions could be significantly simplified. Soon, the use of blockchain-based tokens in place of traditional instruments may very well catalyze the merger of traditional and cryptocurrency markets.