The Modern Security: Why Tokenization Matters

The Modern Security: Why Tokenization Matters

By Lee Saba, Head of Market Structure, Rialto Markets

Introduction

If you work in financial services, you have almost certainly heard about tokenization.  If so, you may reasonably wonder what all the fuss is about.  What is tokenization?  Is it a logical evolution of financial market infrastructure, or a solution looking for a problem?  And how, exactly, does it make issuing, administering, and investing in securities more efficient for issuers, investors, and intermediaries alike?  This article explores those questions – and does so without the legalese.

To begin with, why is it called a token?  The term evokes a physical coin or chip – something tangible you can hold in your hand – which makes it an imperfect label for something entirely electronic.  There is nothing physical to hold.  It is not truly a “token” at all.  But until the market settles on a better term, the label remains useful shorthand.  It is also one of many traditional words now being repurposed to describe a decidedly nontraditional system.

At its core, tokenization is the recording of ownership interests in a real-world asset – such as equity, debt, real estate, or another asset – in electronic form on a distributed ledger. Tokenization does not, by itself, change the underlying asset or the legal framework in which that asset exists. Tokenized securities are not cryptocurrencies; they represent regulated ownership interests in assets and remain subject to existing securities laws and regulatory requirements.

One of the most important aspects of tokenization is that ownership rules, transfer restrictions, and other attributes can be programmed into the token itself.  In other words, a token can be “smart” (hence the term “smart contract”).  It can evaluate who is attempting to buy or sell, whether that person is permitted to do so, and whether the transaction satisfies applicable restrictions.  Those checks can happen in real time, often in seconds, rather than through manual review processes that may take days or weeks.

Ownership of assets – especially publicly traded securities and cash – has been represented in digital form for decades.  Your shares of Apple are not sitting on a paper certificate at your financial adviser’s office, and most of the money you spend never changes hands in cash.  Ownership and transfer of these assets are already handled electronically through well-established systems.  But that was not always the case.  At one point, ownership was represented almost entirely in physical form, and purchasing, trading, and settling those instruments was inefficient, time-consuming, and expensive – particularly where transfer restrictions applied.  Digitization improved the movement of money and registered securities, but those benefits did not extend uniformly across the broader asset landscape.  A vast universe of assets – trillions of dollars’ worth, still sits outside modernized workflows.  Privately issued securities, for example, are often tracked through paper records or issuer-maintained spreadsheets.  For many such assets, tokenization offers a way to close that gap.

Many market participants view the tokenization of traditional securities and assets is a logical next step in financial-services innovation.  But moving an asset into tokenized form still requires thoughtful decisions about regulation, market structure, operations, and technology.  The challenge is not simply to digitize an instrument, but to do so in a way that preserves legal integrity while improving how the market functions around it.

Because we are dealing with securities, tokenization does not eliminate regulatory obligations. Existing securities-law frameworks still apply, even if tokenization can materially improve parts of the workflow.  It is also important to note that securities – regardless of the medium in which they are represented, are generally not bearer instruments.  In most cases, the asset is reflected in the owner’s name on an issuer’s records, at the DTCC, or with a registered transfer agent or other regulated intermediary.  Tokenized securities are no different in that respect; the difference is that tokenization can provide more efficient, auditable, and programmable evidence of ownership.

What tokenization requires

Regulated digital securities require infrastructure and oversight that, in many respects, resemble traditional markets.  The principal considerations include the following:

• Primary issuance and capital formation
• Secondary trading venues, including Alternative Trading Systems (ATS’s) and exchanges
• AML and KYC / customer-identification controls
• Identity, eligibility, and transfer-restriction logic
• Security identifiers (for example, CUSIP, ISIN, FIGI, or SEDOL, where applicable)
• Ticker symbols and issuer symbology
• Selection of a blockchain or tokenization platform, whether public-permissionless, public-permissioned, or private-permissioned
• The role of transfer agents, custodians, and, where relevant, DTCC connectivity
• Custody design, including qualified custody, wallet control frameworks, and key management
• Settlement design, including delivery-versus-payment and cash-leg mechanics
• Fee models, including network fees, regulatory fees, and broker commissions

Each of these components matters.  Aside from the choice of blockchain and the potential for network fees, the overall process is more similar to existing market structure than many people assume.  Where tokenized securities can offer a meaningful advantage is in their use of a shared, tamper-evident record of ownership and transfer activity.  That may reduce reconciliation friction, improve trade matching, and streamline settlement, depending on market structure, participant adoption, system design and regulatory requirements, although such benefits may not be realized in all implementations, while preserving a durable audit trail.  For anyone familiar with post-trade operations, the potential efficiency gains may be meaningful in certain workflows: less manual processing, fewer breaks, faster exception management, and potentially lower operating costs over time, depending on implementation design and transaction volumes.

It is also worth discussing blockchain transaction fees, often referred to as “gas” fees.  These fees compensate network participants for processing and validating transactions.  Depending on the network design, they may introduce operational, cost, or compliance questions.  On public-permissionless networks, participants may have limited control over who ultimately receives those fees.  Some networks also prioritize transactions based on the fee offered, which can create cost volatility during periods of congestion or front-running by MEV operators.  By contrast, permissioned networks designed for regulated assets can offer greater control over participant access, identity verification, and compliance screening.  That does not eliminate every legal or operational concern, but it can materially reduce certain risks in regulated use cases.

Another important issue is the still-limited range of secondary trading options for digital securities, particularly in private markets.  That is beginning to change as more regulated venues, and market operators explore compliant pathways for trading private and tokenized securities.  The broader opportunity is not simply to put private markets on blockchain, but to make access, transfer controls, reporting, and liquidity management more efficient within existing regulatory constraints.  Private markets remain significantly larger than public markets in many segments, and tokenization may help widen participation over time, subject to regulatory requirements, investor suitability and availability of compliant trading venues- provided investor protection and market integrity remain central to the design.

Tokenization within the traditional securities framework

The legacy infrastructure supporting publicly listed securities generally works, even if its limitations occasionally become visible under stress.  At present, blockchain technology may offer a more immediate leap forward for assets such as private placements and other less-automated markets.  Over time, the efficiencies of tokenization may become compelling for public-market infrastructure as well, but migration from legacy systems will be gradual given the scale, complexity, and interdependence of those systems.

There are compliant ways to issue tokenized securities without the Clarity Act being finalized. Tokenization does not change the regulatory framework that governs a compliant offering.  Reg A+, Reg CF, and Reg D all retain their existing legal requirements even when the underlying security is represented digitally.  What tokenization can add is a more programmable method for enforcing transfer rules, improving traceability, and creating a clearer operational record.

Importantly, tokenization operates within – not outside, the securities regulatory framework.  Existing exemptions such as Reg A+, Reg CF, and Reg D continue to govern how securities are offered and sold, regardless of whether those securities are represented digitally.  Tokenization can enhance how those rules are implemented, particularly with respect to transfer restrictions and recordkeeping, but it does not replace them.

The summary above is illustrative and does not describe every condition, limitation, or regulatory requirement applicable to a particular offering.

Private offering pathways

Reg A provides a pathway for companies to raise capital from the public, subject to SEC qualification of the offering statement.  Tier 2 permits offerings of up to $75 million in a 12-month period and can be used by both accredited and non-accredited investors, subject to applicable investor limits and ongoing reporting requirements.

Reg CF is designed for online capital formation through an SEC-registered intermediary, such as a broker-dealer or funding portal.  It currently allows eligible issuers to raise up to $5 million in a rolling 12-month period and permits participation by both accredited and non-accredited investors, subject to investment limits and disclosure requirements.

Reg D private placements remain a core framework for exempt offerings, particularly for accredited-investor capital raising.  In practice, many tokenized offerings rely on Rule 506(b) or Rule 506(c), depending on whether general solicitation is used and how investor eligibility is verified.

For modern tokenized offerings, the most common Reg D pathways are Rule 506(b), which prohibits general solicitation but can include certain non-accredited investors, and Rule 506(c), which permits broad solicitation provided all purchasers are accredited investors and the issuer takes reasonable steps to verify that status.

Blockchain technology is not a substitute for securities regulation, but it can be a meaningful improvement to the way regulated securities are issued, tracked, and transferred.  Its value lies in the combination of traceability, controlled transfer logic, and a more auditable operational record.  The traditional requirements of capital markets- AML, KYC, security identifiers, broker-dealer rules, transfer-agent functions, settlement design, and disclosure obligations – remain firmly in place.  What changes is the infrastructure through which those requirements are implemented.  If deployed carefully, tokenization can make the market’s underlying plumbing more efficient, transparent, and resilient.  And, as with many durable changes in financial services, the most important transformation may begin behind the scenes long before it becomes obvious to the end investor.

Important Disclosures

The information contained herein is for educational and informational purposes only. References to tokenized securities, blockchain technology, and market infrastructure are general in nature and do not constitute a recommendation, solicitation, or offer regarding any security or investment strategy. Regulatory requirements and market practices may change over time.  Tokenization is not a universal solution and may not be appropriate for every asset class, issuer, or market structure. Implementation introduces technology, governance, operational, and regulatory considerations that must be carefully evaluated against anticipated benefits. Tokenization does not guarantee liquidity, active secondary markets, investor demand, or successful trading outcomes.

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Lee Saba is the Head of Market Structure at Rialto Markets, where he applies over twenty-five years of financial services experience to modernize private markets through asset tokenization and advanced transfer agency. He also co-chairs the FIX Trading Community’s Global Steering Committee and serves on its Board of Directors, helping shape global standards for electronic trading. His recent thought leadership includes Building Investor Choice as Infrastructure in Private Markets, which examines how equity design and investor holding preferences are becoming part of private-market infrastructure, and the recent FIX paper Blockchain Basics, which offers a practical bridge between traditional finance and blockchain-enabled market structure. Previously, as a Managing Director at Wellington Management, Lee led multi-asset electronic trading initiatives and early blockchain innovation efforts.