It has been more than 10 years since the first ever crypto-currency (Bitcoin) was unleashed. Since its inception, Bitcoin has spawned a number of imitation digital currencies and new asset classes, including initial coin offerings (ICOs) and tokenised securities.

The technology – Blockchain – which is used to facilitate Bitcoin transactions – is also being beta-tested across securities markets by established infrastructures and custodian banks, a number of whom believe its immutability and real-time recordkeeping will help rationalise their operating costs by removing inefficiencies and duplication.

Digital assets have come a long way and are now on the verge of wholesale institutionalisation, thanks in part to the work at SIX Digital Exchange (SDX). But how will digital securities re-shape the traditional stock exchange operating model?

In the beginning, there were Bitcoins and then ICOs
Since the emergence of Bitcoin, crypto-currencies have undergone a number of peaks and troughs. Their appeal is well-documented. Through the use of private or public keys, crypto-currencies can be exchanged between counterparties via a Blockchain without intermediation from banks, brokers or infrastructures thereby reducing transactional costs.

Today, the market capitalisation of crypto-currencies stands at $262.45 billion, although Bitcoin, Ethereum and Ripple account for 71.95% of that.1 Despite the asset class’ volatile tendencies, institutions have recently become more open to the idea of trading crypto-currencies and Bitcoin futures. State Street, for example, found nearly a quarter of asset managers were trading crypto-currencies/Bitcoin futures, a five-fold increase since 2019.2

Despite this, a lot of investors are apprehensive about trading Bitcoin, citing concerns about cyber-security, volatility and the lack of proper regulatory oversight. Research by KPMG found that $9.8 billion of digital assets have been stolen from public Blockchains since 2017 – a massive deterrent (even for organisations thinking about trading via private Blockchains) for investors subject to regulations such as the EU’s Alternative Investment Fund Managers Directive and UCITS V.

Although crypto-currencies appeal to some investors, ICOs – a type of Blockchain enabled crypto-currency fundraising process modelled on IPOs (initial public offerings) albeit for much smaller companies – have all but evaporated. This was because many were revealed to be frauds. “While they were innovative, ICOs were prone to abuse as they had no governance or regulatory oversight,” says Monica Singer, South Africa lead for Consensys.


ICOs in numbers

% of ICOs that were fraudulent 80%
$ amount of digital currencies stolen through hacking in 1H 2018 $1.1 billion
ICO issuance volume in 2018 $11.4 billion
ICO issuance volume in 2019 (up to May 2019) $40 million (a 97% year on year decline)

The market matures: Tokenised securities
While crypto-currencies and ICOs have largely been shunned by mainstream institutions, organisations are paying close attention to some of the breakthroughs happening in asset/ security tokenisation. “Asset tokenisation is an untapped market, and it is an innovation that is being actively explored by SIX Digital Exchange (SDX) and driven by the Swiss Stock Exchange. In summary, tokenisation is something which can be applied to non-bankable, non-tradeable assets,” says Rupertus Rothenhaeuser, head of clients and products at SDX. 

As a result, Rothenhaeuser believes that tokenisation could have a transformational impact on market liquidity in asset classes long considered to be illiquid or untradeable. There are clear parallels here between asset tokenisation and securitisation.

Imagine we have a tangible, illiquid, unlisted asset like a work of art or a shopping centre, for instance. Although a very large institution could purchase these assets directly, others may choose to gain indirect exposure by allocating capital into an infrastructure or private equity fund. For retail investors, access to such funds is heavily restricted because they are only marketed to institutions and have very high minimum investment thresholds. Through tokenisation, illiquid assets like real estate can be fractionalised and digitalised allowing them to be traded on the secondary market via a Blockchain infrastructure.

The value of digital tokens directly correlates with the underlying price of the real asset. As these tokens are divisible, ordinary retail investors can buy them fairly easily as the minimum investment thresholds will be much lower.  Rothenhaeuser says that while private markets, structured financial products and certain OTC instruments such as illiquid bonds are ideally suited for tokenisation, he cautions against trying to tokenise liquid financial instruments. “Fractionalised ownership is better placed to support certain asset classes over others. Trading in equities, futures and options along with high-frequency trading is automated so there is little value add in trying to tokenise these markets,” he comments.

Complementing the existing listing process
Even though there may be limited purpose in tokenising highly liquid blue-chip equity securities, experts at the Swiss Stock Exchange believe tokenisation could play an integral role in supporting the work of the traditional exchange business, by helping smaller companies go public.
Initial digital offerings (IDOs, also known as initial securities offerings) share a number of commonalities with IPOs, but they could help make the listing process become more accessible to boutique companies who may not have normally gone public on a stock exchange but instead sold out to private equity investors.

Whereas IPOs will typically have a minimum valuation threshold, often in the range of around $25 million, IDOs are targeting enterprises with market caps of between $5 million - $25 million. “Tokenisation will democratise the IPO process, and could result in a number of traditional IPOs being disintermediated, especially if tokens can be sold directly to investors,” adds Singer.

Moreover, as a growing number of privately-held companies opt to delay their listings and new trading platforms come to market, Singer says that SDX’s forward-thinking approach to tokenisation will pay dividends over the long-term. “What SDX is doing is brilliant. Over the last five years, a number of stock exchanges have been gradually losing liquidity as new platforms have come to market, which in turn has led to changes in trading behaviour. Providers like SDX understand that major transformations are happening in the market which could potentially render the traditional exchange model obsolete,” says Singer.

Tokenisation as a differentiator
In addition to generating deeper liquidity pools and widening investor participation in certain asset classes, tokenisation could also confer a number of other benefits to market users. Rothenhaeuser points out tokenisation is underpinned by smart contracts – a computer protocol whereby an agreement between participants is embedded in code – which should facilitate automation of once antiquated processes.

“Smart contracts are autonomous and they automatically recognise processes such as stock dividend payments and coupon payments, for example. This reduces administration allowing for efficiency gains to be realised, which helps market users obtain cost benefits,” he continues.

This new market model will break down a number of existing barriers. Most significantly, trading and settlement will no longer be separate activities on SDX, but instead will operate on the same cycle. At SDX, this is called riskless trading, a mechanism which effectively guarantees that every matched order is settled through a process commonly known as atomic settlement.

Atomic settlement – put simply – is when both legs of a transaction (the delivery and payment) occur simultaneously to each other. Due to the instantaneous nature of the transaction, settlement, clearing and counterparty risk are negated (unlike in the current T+2 or T+3 trading cycle), meaning centralised clearing is no longer necessitated.
Tokenisation could also play a major role in promoting greater transparency in the market. “A security token is capable of having the token holder’s rights and legal responsibilities embedded directly onto the token along with the immutable record of ownership. These characteristics promise to add transparency to transactions allowing you to know with whom you are dealing what your and their rights are, and who has previously owned this token,” says a Deloitte white paper.4 This could be a game-changer for asset classes which are heavily intermediated and document-heavy like real estate.

Overcoming the sceptics
Crypto-currencies traded on crypto-exchanges along with ICOs have long been susceptible to cyber-crime and hacking. This was because a number of crypto-exchanges stored private keys online, and did not have adequate safeguards in place to mitigate the threats posed by bad actors.

Rothenhaeuser says the mechanisms at SDX to protect clients’ tokenised assets against cyber-crime are watertight. Conscious of the increasingly sophisticated cyber-risks faced by its clients, SDX has partnered with securosys to design a solution that protects each node in the network using industry standard HSMs. SDX has also worked with Riddle&Code, a start-up focused on building secure controls for distributed digital networks, so that transactions taking place on SDX are insulated from cyber-threats.

Other impediments also need to be addressed. While it is generally accepted that existing securities rules apply to tokenised assets, regulations are not yet harmonised. “Regulatory acceptance and approaches towards tokenised securities vary across jurisdictions,” says a paper by ASIFMA.5

Again, this could open the market up to potential arbitrage. Rothenhaeuser says SDX has engaged with local regulators including FINMA and the Swiss National Bank about establishing a well-supervised digital asset ecosystem. If tokenised assets are to thrive, it is crucial that regulators develop rules which protect the interests and rights of investors, while simultaneously ensuring the market is ripe for innovation.

“One of the biggest challenges facing crypto-currencies is that the asset class is totally unregulated. We are conscious that if tokenised securities are to become more institutionalised, there needs to be a well regulatory environment promoting asset safety and investor protection. If such market discipline – coupled with the technologically empowered transparency needed in this space - can be established, then more investors will trust and trade tokenised securities. For us, SDX is well-placed to achieve this balance,” explains Avi Ghosh, head of marketing at the Swiss Stock Exchange.

At the same time, the industry needs to collaborate closely in order to create standards around tokenised assets, so as to facilitate interoperability and growth. As we have seen in previous market initiatives – such as the roll out of universal financial messaging – standards are integral to success. Rothenhaeuser says SDX is actively working with a broad range of clients to develop firm standards on tokenised assets. He adds that the exchange is also co-creating products through proof of concepts with individual clients, pointing out that some of these initiatives could be used as the basis for future standardisation templates.

1 Coin Telegraph (August 17, 2019) A different look at crypto market and top assets: how dominated is it?

2 Global Custodian (March 11, 2020) Institutional uptake of crypto-currencies on the rise as the need for custodians intensifies

3 Coin Telegraph

4 Deloitte – The Tokenisation of assets is disrupting the financial industry: Are you ready?

5 ASIFMA (November 2019) Tokenised securities: A Roadmap for Market participants and regulators