What Are Stock Tokens?

As one of the largest cryptocurrency exchanges in the world, Binance has been aggressively pursuing and exploring a wide range of services for its users. Its latest initiative is to allow users to trade ‘stock tokens’ that represent shares of publicly traded companies.

The transactions are settled in stablecoin, Binance USD (BUSD). Since 12 April, Binance has released stock tokens for Tesla, Coinbase, MicroStrategy, Apple and Microsoft. This is a milestone in the tokenization field as it opens up the security tokens to the masses. In fact, Binance is not the first company to do this, as FTX and Bittrex, two other cryptocurrency exchanges, started tokenized stocks trading back in late 2020.

It is worth noting that all of these tokenized stocks are mirrors of securities, meaning that the tokens are not shares and only give exposure to the underlying shares. In other words, investors don’t have direct ownership of the shares, and the tokens are not transferable between investors. The digital asset marketplace (Binance, etc.) is the issuer, controlling the tokens for its token holders. It is a delegated system.

So Why Does It Concern Regulators?

Binance has also declared that holders of their stock tokens will qualify for economic returns on the underlying securities, including potential dividends, making the tokens securities. As those familiar with legislation on security tokens, tokenization doesn’t change the fact that they have to comply with securities regulation, especially when they are distributed to the public. Digital securities must be issued as permissioned tokens to comply with international regulations.

Permissioned tokens apply compliance checks during transfers to make sure that only eligible investors can hold the security tokens. And Binance’s stock tokens don’t appear to have been issued as permissioned tokens. They control the stock tokens for their users. No surprise that it didn’t take long for BaFin, Germany’s financial regulator, to knock on Binance’s door. On 28 April, BaFin has published a note on its website warning Binance that they are selling shares in Germany in the form of stock tokens without offering the necessary prospectuses. This could result in a 5-million-euro fine or a forfeit of 3% of Binance’s 2020 turnover.

Security Token Protocols Are Getting Traction

It’s essential for securities issuers to choose a resilient infrastructure and the right security token protocol to issue securities on blockchain in order to properly enforce securities regulation. This infrastructure should provide solutions for issuers to natively tokenize shares with compliance rules embedded in the security token smart contracts. There are plenty of open-source protocols in the market that can provide these services, such as the T-REX Protocol, the most adopted one used for tokenizing securities, having issued over €8.5 million assets to date. Here, we compare the differences between delegated security tokens and native security tokens issued via T-REX Protocol in the table below:

Issuers also need to keep in mind that they must be authorized by regulators to distribute securities. In Binance’s case, there are certain documents such as prospectuses that need to be provided to investors. And these documents should be easily accessible by investors.

Binance is not a regulated exchange for securities, but they have apparently chosen to distribute securities to their users and to keep their security tokens in custody. It is not hard to see why regulators are looking into them. Unlike unregulated exchanges, broker-dealers, ATS, regulated exchanges, asset managers, and many other players are already allowed to distribute securities to their clients. These entities should launch Digital Assets Marketplaces (DAM) and be sure that they only accept native security tokens in order to remain compliant.

What are the key components of a security token marketplace?

• Select serious securities issuers;
• Onboard investors and verify their eligibility;
• Distribute security tokens with documents required by regulators;
• Issue and allocate permissioned security tokens to investors’ wallet;
• Authorize transferability in P2P.

With the right protocol, marketplace operators will be in line with lawmakers, allowing their investors to benefit from fractional and direct ownership, while receiving all the rights that directly associate with that securities.

Overall, we are pleased to see the progress that has been made in the tokenization market, as well as the attention it has recently attracted. Now, the technology is ready, and mass adoption will come as soon as institutions start to move and choose the right infrastructure.