The tokenization of corporate capital stock via cryptographically secured equity tokens
What does tokenization mean?
Tokenization is the process of converting the rights to an asset into a digital token on a blockchain. You can represent ownership stakes on any asset with a token – basically, by “tokenizing assets,” you can represent your ownership of a particular asset through your ownership and control of a blockchain token.
The tokenization of corporate capital stock refers to using equity tokens as a means of representing ownership interests in a company. This is similar to someone holding a paper stock certificate made out to their name represents that person’s ownership of the shares of stock identified on the certificate.
Benefits of Asset Tokenization
By representing such securities in token form, you will make them more convenient to own. You would encourage more people to buy them, trade them, and hold them more often, thus creating more of a market for them and improving price discovery and investment interest in these assets.
Tokenizing the corporate stock of privately held companies could make that stock more convenient and attractive to hold, track, and trade on Alternative Trading System (ATS), thus leading to greater liquidity, market depth, and price discovery, increasing efficiencies of the private equity markets.
For companies that are already public and thus already have highly liquid stock, tokenizing the stock could offer benefits in terms of reducing the need for or importance of traditional institutions and intermediaries that are otherwise necessary for stock administration and trading. One example would be simplifying the mechanics of the holding, voting, trading, clearance and settlement of public corporate stock, which are highly complex and require the involvement of numerous intermediaries and agents standing between corporations and their beneficial stockholders.
Such intermediaries include:
- Cede & Co. (the record stockholder of most public stock)
- Depository Trust Company (the custodian of most public stock and a maintainer or a private ledger for banks and brokerages)
- Banks and brokerages (each of which maintains a private ledger for their customers, some of which are OBOs (objecting beneficial owners) and others of which are NOBOs (non-objecting beneficial owners)
- Transfer agents of the corporation, which attempt to keep comprehensive lists of record and beneficial stockholders (excluding the OBOs)
- Broadridge, an investor communication firm
- Proxy solicitation firms
The complex public stock mechanics result in stock trades being relatively slow (T + 2 business days) and create risks of error, legal foot-faults, and disenfranchisement and delays. Eliminating or reducing the importance of such intermediaries could reduce transaction costs and trade settlement times, and thus, again, encourage participation, increase liquidity and improve price discovery.
Tokenizing assets is not best conceptualized as “digitizing” or “converting” assets in some metaphysical way. Instead, the tokenization of assets is best understood as a new way of doing something that humans have been doing for several centuries—that is, representing rights to assets with instruments, which in this case happens to be digital tokens that live on a blockchain.
At Ohanae, we call them Equity Tokens. Equity Tokens are better than any other technology at enhancing individual asset sovereignty, as compared to other ways of digitizing securities.
Stock vs. Securities
Capital stock is a specific kind of security issued and sold by a corporation (often for cash), which typically confers upon a stockholder the following cluster of default rights:
- the right to receive a pro rata share of the “equity” (i.e., the excess of assets over liabilities) of the corporation in specified circumstances, such as a liquidation of the corporation;
- the right to receive dividends or other distributions from the corporation in specified circumstances;
- the right to vote on, among other things, the election or removal of directors, amendments to the corporation’s certificate of incorporation and certain extraordinary strategic transactions (such as mergers or sales of all or substantially all assets of the corporation);
- the right to generally be shielded against responsibility for liabilities of the corporation beyond the capital the stockholder put at risk to purchase the stock (this is called “limited liability” and historically is seen as the preeminent benefit conferred by the “corporate franchise” in the evolution of finance);
- the right to have the directors and officers of the corporation act as fiduciaries of the stockholders who are charged to act with the duties of loyalty, candor and care toward the stockholders; and
- the right to receive certain kinds of disclosures from the corporation, including copies of the corporation’s books and records and notices of impending events such as stockholder votes or dividends.
This cluster of default rights is generally unique to corporate capital stock. Although other equity securities may share some or all of these rights, only corporate capital stock has them by default. All the more so, debt-based securities such as bonds, debentures and asset-backed securities will have very different features from corporate capital stock. For example, debt-based securities typically represent the right to receive specific payments denominated as “debt” rather than a potentially uncapped equity interest, which typically does not entitle the holder to vote on general governance issues of the issuer, and typically does not entitle the holders to treat the corporation’s directors and officers as fiduciaries.
In the United States, this means dealing with state-specific corporation statutes and commercial codes. By far the most popular U.S. state for incorporations is Delaware, which has turned corporate law into its primary export and become the preeminent corporate law jurisdiction not just in the United States, but the world.
The Delaware Blockchain Amendments
In 2017, Delaware passed a number of amendments to the Delaware General Corporation Law (DGCL) intended to enable corporations to take advantage of blockchain functionality. These amendments embody a particular set of expectations and assumptions regarding how corporations can best be blockchainized.
The 2017 amendments primarily addressed themselves to the stockholder listing and stock ledger formalities imposed on corporations by the DGCL. They worked as follows:
- eliminated all requirements that stockholder lists and stock ledgers be produced or maintained by a particular natural person or in a particular form reducible to paper;
- expressly allowed delegation of stock ledger administration to third parties; and
- expressly allowed storage of stock ledgers on, and the transmission of stockholder notices through, “one or more electronic networks or databases (including one or more distributed electronic networks or databases)”.
These changes opened the door to the corporation outsourcing stockholder list preparation and stock ledger maintenance in any number of ways—to an officer, to a transfer agent or even to some automated (and potentially blockchainized) process. The idea, of course, is that a Delaware corporation can now use a permissioned blockchain as its stock ledger. However, such a stock ledger must still meet the legal requirements for a stock ledger in Delaware, which means, among other things, that the stock ledger must record the legal names and mailing addresses of the stockholders.
Blockchainizing the Enterprise
The tokenization of corporate capital stock can solve some problems that are quite specific to corporate capital stock and not shared in common with most other types of assets, whether they be securities like bonds or tangible assets like fine art. Essentially, the tokenization of corporate capital stock can reduce the mediation and inefficiencies. Besides solving current problems and inefficiencies, the tokenization of corporate capital stock can create the opportunity to do new things in new ways with corporate capital stock, particularly when combined with smart contracts running on a permissioned blockchain.
The tokenization of capital stock is uniquely different from the tokenization of assets generally or even the tokenization of securities generally because:
- capital stock confers a unique cluster of default rights that differs from the rights associated with owning other securities or other assets;
- capital stock is subject to a U.S. state corporate statute such as the Delaware General Corporate Law (DGCL) or Wyoming Business Corporations Act (WBCA), as well as the common law of a U.S. state, in addition to being subject to securities laws generally;
- there are both historical and sound policy reasons why capital stock is treated somewhat differently from other securities; and
- it is the basis for the vast majority of significant legal entities in the United States of America.
A hypothetical case study: Equity-backed Tokenization
A Turning Point for Reg A+ Offerings
The Securities and Exchange Commission (SEC) issued final rules on Dec 19th, 2018 to allow public companies to use Regulation A. This is good news as public companies will have access to less expensive capital. In 2019, we expect to see many more Reg A+ offerings qualified along with increased liquidity through expansion of Alternative Trading System (ATS) in the marketplace. It would be interesting to watch how the “SEC+FINRA” will handle the many companies who have pending Reg A+ offerings for token securities and ATS applications for token securities exchanges.