There is a general consensus in the financial industry that tokenization is a revolutionary technology that disrupts the industry. However, there is a lot of confusion around the specific benefits of tokenization. Most tokenization providers use an overly complex or vague language full of jargon. Moreover, it is often unclear how security token offering is different from IPO or equity crowdfunding.
In this article, we explain the specific benefits of tokenized securities and why they are so disruptive. Our focus at Stobox is primarily on the access to capital and liquidity for private companies, not the efficiency of public markets or Central Securities Depositories.
For private companies, there are three principal benefits:
1. The ability to raise capital from small investors
When processes are manual and physical, dealing with thousands of investors is expensive. Tokenization streamlines processes and makes crowdfunding feasible.
The benefit of working with small investors is two-fold:
- a) Reduced cost of capital because of higher bargaining power when dealing with small investors compared to big ones.
- b) Creation of the community that can support with connections, expertise, etc.
A reasonable objection is that equity crowdfunding platforms already provide the same service. Many people forget about them as a natural competitor to tokenization.
However, they have two limitations caused by the fact that these are centralized platforms that have to be regulated:
- Lack of international exposure. Such platforms need licensing in each country from which they accept investors, so very few provide cross-border access to capital.
- They charge a share of equity or proceeds raised. This is acceptable for startups but not for more mature enterprises. If they change the pricing model, this becomes too expensive for startups. Their minimal cost is higher because of the need for reporting and legal compliance.
These drawbacks are inherent in the business model of the crowdfunding platforms and cannot be removed.
In contrast, tokenization allows each company to sell securities on its own behalf. Selling your own securities is regulated but does not require licensing, which means you are not geographically limited, and the costs will be much lower as well.
It may be argued that these platforms provide benefits to businesses by reducing the cost, especially for marketing. In reality, however, when you are competing with dozens or hundreds of other projects on the given platform, the cost is not reduced much
2. The ability for private companies to make their shares traded.
This is tricky as well. I am skeptical about centralized security token exchanges because listing on them requires the company to basically go public, undergoing all the related compliance costs, reaching hundreds or thousands of dollars annually.
However, tokenization enables the creation of a liquidity pool, separate for each company and operated by a company. It falls under the regulation of private transactions between counterparties outside regulated trading venues, which do not require a company to go public and undergo compliance costs.
The opportunity to trade the company's shares reduces the investors’ risk, which means it is easier to attract them and lower the cost of capital. Currently, only 0.4% of all shares globally are traded, which brings companies into an elite club at a fraction of cost.
3. Flexibility of what can be done with your shares
Let’s say, for example, you are not conducting an official crowdfunding campaign. Instead, you can simply allow your customers, among other things, to invest in you via your app or website. Or you may award your shares as a part of the loyalty program. Or you can distribute profits to investors automatically daily. The opportunities are endless, and I am a big believer in the creativity of founders.
Also, notice that this third point makes tokenization relevant for a wider pool of companies. Not every business needs to raise capital at the moment, but other use cases may be interesting.
Having some kind of program in which your customers become members of your shareholder community will become a new norm due to its impact on customer loyalty and cost of capital.
Focus on community-building and democratization are already existing trends, even without tokenization, which is only the tool for these trends to grow even higher. And the business that can leverage them will become the next unicorn.