Stock Tokens Are Coming to the US. Are They Good for Investors?

Key Takeaways

• Stock tokens, which are digital representations of traditional shares housed on a blockchain, are being touted as the next frontier for digital assets.
• Proponents say blockchain technology makes stock trading faster, reduces costs, opens US markets to global investors, and gives investors greater control over their shares.
• Critics question the use case of stock tokens for most investors, say the marketplace is prone to price inconsistencies, and note many of the purported benefits could increase cybersecurity and other risks.

With cryptocurrencies having largely entered the investing mainstream, digital investment boosters are touting a new frontier: stock tokens. Advocates say they’re a natural next step for the markets that will make trading faster and more efficient. But critics see little need for stock tokens among individual investors and question whether their main beneficiaries are the brokers and exchanges pushing their adoption.

Stock tokens were thrust into the limelight thanks to a recent public feud between the CEOs of AMC Entertainment AMC and Robinhood HOOD over the structure of tokens linked to AMC stock. Then last week, the Securities and Exchange Commission announced it will allow US investors to trade tokenized shares under certain conditions.

While trading volume in stock tokens is little more than a blip compared with the established stock market, proponents of stock tokens, which are blockchain-based representations of traditional shares of a company, say they empower investors and lower their trading costs by improving the market’s speed, efficiency, and transparency.

Then there are views like that of Lee Reiners, a lecturer on financial technology law and policy at Duke University. Reiners doubts the extent to which the purported benefits of tokenized trading serve everyday investors. Many of the improvements touted by the industry appear to be “of limited use to a select group of people,” he says.

What Are Stock Tokens?

Stock tokens are among the latest digital technologies that seek to leverage the blockchain, which is a decentralized digital ledger recorded across a network of computers. In this case, the tokens represent shares of a company.

“This is not a reworking of the entire financial system,” says Billy Miller, COO of tokenization platform Securitize. “This is just modernized, more efficient technology that’s improving how we engage with the financial products that we all do today.”

Tokens generally fall into two categories, Reiners says. “The first is a native token where the issuer issues its stock directly on a blockchain, and that’s where it lives and trades.” Owning one of these issuer-sponsored tokens “is no different from holding a normal share,” he says. It grants the token holder the same economic and governance rights as traditional equity; it just happens to be blockchain-native.

“The second kind of tokenization is the more common one right now,” Reiners says. These stock tokens are on-chain representations of existing shares. “It represents a claim on a share of stock,” he says. When an investor buys one of these tokens, their brokerage buys a share of the company for the token to represent, mints the token, deposits it in the investor’s wallet, and retains custody of the share.

Historically, these third-party tokens have not always conferred the economic and governance rights of conventional equity. That distinction was at the heart of the AMC-Robinhood feud. “We have no connection to this at all, and do not condone it in any way,” AMC CEO Adam Aron wrote on X after he discovered Robinhood allowed some international investors to trade tokenized versions of his company’s stock.

Aron’s complaints—that Robinhood did not ask AMC’s permission to tokenize its stock, and that the tokenized shares did not offer investors voting rights—seem to have been heard by the SEC. Regulators on Thursday said US-traded tokens must offer the same rights as traditional shares and must be approved by the company whose stock is being tokenized.

The market for tokenized stocks has ballooned by more than 500% in the past year, according to industry tracker rwa.xyz. Still, it represents a tiny sliver of the equity market. As of Monday, $3 billion of stock was tokenized, about 0.5% of the Nasdaq’s average daily volume last week. But traditional financial firms have been anticipating stock tokens’ arrival in the US and laying the groundwork for their wider adoption. The New York Stock Exchange and Nasdaq are both developing token trading platforms. The Depository Trust & Clearing Corporation—the custodian of more than $114 trillion in assets—plans to launch its tokenization service next month.

Can Tokenized Shares Really Benefit Investors?

Advocates for stock tokens argue the technology is beneficial for both investors and issuers. Securitize’s Miller says that issuer-sponsored tokens, like those his company specializes in, make trades faster with instant settlement, more efficient, and less expensive by cutting out intermediaries. Proponents say tokenization also improves equity’s utility. Investors can borrow against their tokens at advantageous on-chain rates outside of standard working hours, according to Miller, or pledge their tokens to a liquidity pool to generate yield.

Reiners is skeptical. Round-the-clock trading, for example, is “just not something I hear a lot of the investor community clamoring for,” he says. In addition, he says 24/7 trading has its drawbacks. “In periods of stress, time off has played an important role in mitigating some of the panic and the contagion. We have circuit breakers for a reason,” he says.

Reiners says present versions of on-chain trading deliver speed and efficiency by cutting corners and abandoning the decentralization principles that underpin blockchain technology. The bitcoin blockchain, he explains, has built-in cryptography and incentive mechanisms that forge trust across the network of computers maintaining the ledger. “But to implement all that takes time,” he says. Speeding up a network comes with sacrifices that can concentrate power within the network, diminishing its resilience and giving rise to conflicts of interest.

“Unless there’s going to be one blockchain to rule them all, which I don’t foresee happening, the benefits will always be illusory in my view,” says Reiners.

What Are the Risks of Tokenized Stocks?

According to Reiners, stock tokenization introduces risks to both individual investors and the broader financial system. Under the SEC’s new guidelines, “trading venues will not have the same customer protections as exist with traditional securities intermediaries,” he says. He is also concerned that the SEC’s decision to exempt token venues from some of the rules governing exchanges and brokers will reduce market surveillance and make it more difficult for watchdogs to track manipulation.

In addition, questions remain about how tokens will function in the financial system, Reiners says. “It’s just not clear if tokenized stocks—the mirrored version at least—are compatible with the National Market System.” Brokers are required by law to compare prices across trading venues and execute a trade where conditions are best for their customers, but today’s token-trading venues are vertically integrated and siloed. “On Robinhood, if you want to trade your tokenized stock, you can only do it with another Robinhood customer,” says Reiners. The SEC has exempted token venues from the best execution requirement, which “leaves open the possibility that customer trades will be executed at stale prices,” says Reiners.

Reiners and Miller say the siloing of trading venues leads to “liquidity fragmentation,” which occurs when the same asset trades in multiple disconnected markets. Fragmentation can lead to wider bid-ask spreads (the gap between the prices a buyer will pay and a seller will accept) and price variations across venues. It could even siphon liquidity from traditional markets, though Reiners says volume will need to be much higher for that to be a meaningful risk. For now, the absence of common standards across platforms at times causes large price dislocations, with some tokens reportedly trading at 4 times the underlying share price, according to The Wall Street Journal. So-called bridges can connect blockchains and reduce fragmentation, but they’re notoriously vulnerable to hacking.

The blockchain’s vulnerability to cyberattacks could threaten the wider financial system’s stability if equity markets move on chain, says Reiners. “The big risk, which no one’s talking about, is quantum computing, because quantum computing breaks the underlying cryptography that all blockchains rely on,” he says. The Treasury Department last month launched a Quantum-Readiness Task Force to facilitate the financial system’s transition to post-quantum cryptography. Still, Reiners fears that “we’re just kind of sleepwalking into existential risk.”