The digitalisation of the financial ecosystem has accelerated in recent years thanks to the widespread adoption of the internet and its consequent development.
This, together with the rise of mobile devices, allowed people to manage their finances from anywhere and access financial services and products online, where the average user is able to manage them through the bank and without intermediaries, something inconceivable until then.
Blockchain technology has also recently played an important role in the digitisation of finance, offering new opportunities for secure, transparent, and decentralised financial transactions, as well as the rise of DeFi (decentralised finance), opening up a new range of financial products and services outside the banking system.
Latest revolution driven by Blockchain and decentralised networks is the tokenisation of assets.
Tokens, NFTs, Cryptocurrencies…
As we have discussed previously in this blog, tokens are a digital representation of a physical asset through a code that is usually stored on the blockchain. The simile can be like a casino chip, where that plastic coin represents a real monetary value.
The best-known uses of tokens are cryptocurrencies and NFTs. When we talk about NFTs, we mean non-fungible tokens, i.e., they are unique and cannot be replicated or replaced by an equal.
This is not the case with cryptocurrencies, where we can replace one Bitcoin with another, and both will have the same value and utility. The logic of the tokens is programmed in a Smart Contract, where all the attributes that define it and the actions it can perform, such as the transfer of ownership, are specified.
Just as NFTs are one type of token, there is another that is the basis of asset tokenisation, security tokens.
Before defining what they are, we must understand that a security is a financial instrument that represents ownership of an underlying asset, such as a company share, a bond or real estate, and is governed by the laws of the capital markets of the country or area where it is issued and traded. An example of a traditional financial market where securities are traded is a stock exchange such as the Madrid Stock Exchange or the Nasdaq.
On the other hand, if we transfer the same concept of security to the decentralised world,
A security token is the representation of a security but created using Blockchain.
This allows the same benefits as traditional securities such as ownership and voting rights, dividends, etc., while increasing the efficiency, transparency, security, and liquidity of these assets. An example of an exchange that allows transactions with these securities is Bitfinex.
But what guarantees do I have if I own one of these tokens against fraud such as the recent FTX or Terra fraud?
These types of securities are subject to regulatory requirements established by the financial regulator where they are issued.
In Europe, they must comply with MiFIDII regulations and are issued through an investment vehicle with an ISIN, the international securities identification number, so they offer the same guarantees as traditional securities.
Given that “tokenising assets” can be a somewhat abstract concept, let’s look at some examples of assets that can be digitally represented by a token and converted into a security.
Telefónica Tech has already carried out a case study in which we tokenised the network of antennas and base stations managed by Atrebo, not only increasing the traceability of each of these infrastructures, but also increasing the efficiency of the management and transparency of the network. These tokens could be converted into securities so that investors can become owners of these antennas.
However, the truth is that these types of installations are very expensive, and the owners are usually large companies or institutional and professional investors, but with tokenisation we can enable the fractionalisation of these assets and make them multi-property, increasing the liquidity of the underlying asset but offering the same rights.
A security token can be purchased by an individual investor without the need for an intermediary such as a bank or broker.
Other examples can be:
- Any kind of infrastructure or real estate
- Financial instruments (equities, derivatives, debt…)
- Patents and intellectual property rights.
How does asset tokenisation work and why it can revolutionise the financial industry and access to capital markets
Asset tokenisation has many benefits beyond those mentioned above and the inherent advantages of a security. One of the biggest use cases is the launch of a Security Token Offering (STO).
An STO is a public offering of security tokens similar to an Initial Public Offering (IPO) and an Initial Coin Offering (ICO), but with a number of fundamental differences that make it much more attractive to certain companies.
- An ICO is not a security and is therefore not governed by the same regulations, which greatly limits investor protection against fraud.
- The valuation of these cryptocurrencies is very volatile and unstable, as they tend to be highly speculative, which implies large losses for investors.
According to one study, 81% of ICOs failed in 2018.
On the other hand, an IPO involves a complex and costly process both in terms of time and resources. Companies that wish to go public must disclose large amounts of information about their operations and business, and it is usually a process that is carried out by companies with a certain maturity and a stable business as a method of raising more capital, so for small companies and start-ups it is often unfeasible.
They need to seek funding through angel or seed investors, and it usually involves giving a large stake in the company to these professional investors, which makes the cost of accessing capital very high but at the same time necessary to continue to grow and keep the company afloat.
However, with an STO, you have the legal certainty of owning a security but at the same time it is a much more accessible process for small and medium sized companies.
In addition, it has a number of added advantages such as access to this type of offerings by private investors, making access to private investment much
Advantages for companies
There are also numerous advantages from the point of view of the company wishing to launch these tokens, as the asset to be tokenised can be very varied.
- Companies that need to raise capital to reduce investment in CAPEX and have recurring income, such as a SaaS, can issue a token that represents a share in the company with the right to a fraction of future profits for a specific time as a dividend, and by being registered in Blockchain with the Smart Contract, these operations can be automated, which are also much more traceable and transparent.
- It can also be a mechanism for issuing corporate debt or simply represent a real estate asset such as a windmill and fractionalise its ownership among different individual investors who receive a series of rents from the activity of their windmill. One of the advantages of issuing debt or bonds on the Blockchain is that they are established immediately, whereas with traditional methods it takes 2 days from issuance.
We are facing a new revolution in the way we understand asset management and trading.
More and more institutions are launching these initiatives, such as Goldman Sachs with its DAP platform together with the EIB (European Investment Bank) which issued bonds worth 100 million euros for 2 years and were established on a private blockchain for the Venus project.
This new way of understanding digital assets could revolutionise both the methods of investment and capital acquisition by allowing private crowdfunding, but giving rights to investors, and the management, purchase and sale of real estate and infrastructures.
It will also be important to see how the regulatory environment changes with the entry into force of the MiCA (Markets in Crypto-Assets) through which the EU intends to establish a legal framework for the control of this type of asset.