The actual benefits of asset tokenization.

If you keep up with financial technology, you've undoubtedly heard a lot of good things about asset tokenization; it is believed to be a disruptive technology that transforms capital markets. However, professionals often speak in very abstract terms and it’s hard to get a grasp on what are the real benefits of tokenization and how a business owner can leverage it.

What is tokenization: benefits and explanation

Tokenization is a combination of technical and legal processes that transfer the ownership of an asset into the form of tokens on the blockchain. Such an asset may be corporate equity, debt, real estate or a financial instrument. Tokenization makes investing in these assets much more accessible because it allows breaking large, expensive items into small fractions, which are cheaper and may be conveniently purchased online. Usually, with tokenization companies raise capital from numerous individual investors. Also, tokens are easier to trade than conventional forms of securities, which makes them even more attractive to investors.

Advantages of tokenization compared to loans

The crucial advantage of tokenization compared to loans is that it's significantly more accessible. For projects without hard assets that can serve as collateral or in the case of raising capital for a new project or a newly incorporated special purpose vehicle, you may not be eligible for a loan at all. And even if you are eligible, the interest rate may be too high and make the business less attractive overall, because the cost of capital is too high. If you want to find out more about the cost of capital, check our video “What is the biggest benefit of fundraising via STO? What is the cost of capital?”, devoted to this topic.

Another advantage is that tokenization provides a better "loan-to-value" (LTV) ratio. This ratio determines which share of the project may be financed with debt. In the case of banks, the LTV ratio typically does not exceed 65%, depending on the industry. This means that the rest 35% should be financed with your own capital or other financing methods. If you offer tokenized debt securities, you can get any LTV as far as you can find investors for whom such an offer would be compelling.

Difference from the institutional private placement

Private placements are fundraising rounds that suggest getting capital from large institutional investors, like venture funds or private equity funds.

The problem with institutional capital is that big investors have a high bargaining power due to their size. It means that they can demand better terms, such as a higher equity stake, a place on the board of directors, and other conditions. These conditions often may be highly unfavourable for your business. For example, due to the so-called "liquidation preference", you as a founder may not get anything at all at an exit unless the company hits the outlandish growth targets.

Usually, funds significantly intervene in the business and your strategy, making you spend time focusing on negotiations and managing relationships with them. You can even get fired from your own company if investors disagree with the direction you are taking the company in. You should also anticipate having differences in the vision of values with your investors because their motives are different. You can be getting decent returns as dividends and have a good lifestyle if you develop a stable, well-functioning, and steadily growing business, but funds usually can get returns only if you are acquired or do a public offering. For this, the business needs to grow fast, even if this creates unbalanced economics, makes the company unprofitable, and increases the risks.

With tokenization, the choice of investors is flexible, which allows you to set your own terms and generally get higher bargaining power. Additionally, as tokenization enables trading even without an IPO, investors get higher flexibility for a cash-out, which means they now do not have to make the company chase ridiculous growth targets.

If you wish to find out how tokenization enables trading without the need to go public, watch our video “Trading without IPO: Liquidity for Equity Crowdfunding and Private Placements with DS Swap” on the topic.

Tokenized securities and equity crowdfunding difference

Equity crowdfunding emerged and has grown in popularity in the recent decade as an alternative to banks and institutional financing. Even though it has been first introduced for startups, it has spread to other industries as well, such as real estate. Still, equity crowdfunding has several severe limitations.

The first problem is that shares sold by doing crowdfunding cannot be traded. This is a massive handicap because most investors are used to investing in highly liquid assets like Tesla or Bitcoin, and they are not ready to get only dividends or wait for years for a chance to get a return on their investment. Investors for whom this is a good deal are, first of all, institutional ones, as mentioned above. Unlike shares sold on crowdfunding campaigns, tokenized securities can be traded, which makes them much more attractive.

Another problem with crowdfunding platforms is the fact that they are geographically limited to a single country or region. This is because such platforms require a license, which is valid only in a single country where it has been granted. Such a pattern is especially problematic for developing economies with limited local capital markets.

Lastly, many businesses don't want to share their platform with hundreds of others. If you are a large real estate developer or asset manager or want to create your own separate venue devoted to a certain type of investment, you need your own branded platform. This is available with certain tokenization providers, such as Stobox, but not with traditional equity crowdfunding.

Stobox Digital Securities Dashboard is a white label solution to tokenize digital securities and conduct all operations with them in a convenient digital environment. Sell the shares, pay dividends, conduct corporate voting and corporate actions in a new, digital way. Raise capital and steamline investor relations.

Difference between tokenization and public offering

As something that provides access to investors and trading, tokenization seems to be similar to a conventional public offering. From a legal perspective, a security token offering may be conducted in different ways, using the regulation either for public offerings or private placements. But usually, tokenized securities are not listed on traditional stock exchanges and not regulated as fully public offerings.

If you want to learn more about the difference between public offering and tokenization, please see our video “Private placement vs public offering: two forms of security token offering”.

IPO has a very significant implication for cost, as it’s very expensive. According to the PwC, the average price of a small IPO in the US is $7.3 million. This number doesn't take into account the additional annual reporting burden for public companies. Security token offering may cost ten to a hundred times cheaper depending on the size and other factors.

The drawback, however, is that stock exchanges usually provide better access to investors, and trading there is easier. With security token offering, you need to put in additional efforts to find investors, and trading is limited compared to stock exchanges, even though still much better than in the case of equity crowdfunding and private placements.