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RECENTLY, The Wall Street Journal ran a story about a new type of investment known as a digital stock token. For now, they aren’t available in the U.S., but they’re coming soon, so it’s worth taking a closer look.
What are stock tokens? At the most basic level, they’re a technology designed to make stock market investing quicker and easier than it is today. With tokens, trading won’t be limited to traditional business hours. Instead, investors will be able to trade 24/7. And token trades will settle instantly, allowing investors to deposit or withdraw funds from an investment without the overnight delay imposed by traditional stock exchanges.
An additional benefit: Tokens will allow investors to purchase fractional shares. To see how this would work, consider Microsoft. Today, its share price is around $370. Through the token system, though, an investor with a modest budget could gain exposure to Microsoft with just $5 or $10. There will also be index-based tokens, so an investor could gain exposure to the S&P 500, for example.
In many ways, stock tokens are the equivalent of cryptocurrencies but for stocks, allowing investors to trade more quickly and easily. That’s their key appeal, and it’s part of the broader trend toward digitizing the financial system. Along the same lines, a number of retailers are pursuing so-called stablecoins as an alternative to costly credit card networks.
Stock tokens do carry risk, though. You may recall an episode that occurred in 2022, when a digital currency called TerraUSD, which was designed to maintain a fixed value of $1, suddenly lost most of its value. In that case, there was a breakdown in the algorithm that was supposed to prevent Terra from dipping below $1, and that caused the equivalent of a run on the bank.
Supporters of stock tokens will tell you that Terra’s failure can be attributed to its primitive structure and that today’s technology wouldn’t be similarly vulnerable. That may be true, but stock tokens carry other potential vulnerabilities.
For starters, they’re complex and rely on a significant amount of financial engineering. Unlike a share of stock which is simply an ownership stake in a business, tokens are more of a synthetic financial instrument. That’s why the recent Journal write-up referred to them as “digital avatars.” When you buy a token, you aren’t buying an actual share of stock. It’s more like a chip issued by a casino or a gift card issued by a retailer. It looks like real money, and under ordinary circumstances, it probably will function like real money. But in times of stress, they may not perform as expected.
The financial firm Robinhood, which has already created a family of stock tokens for international investors, acknowledges another risk: Because tokens don’t represent actual shares of stock, they carry what’s known as counterparty risk. Under the hood, tokens are actually financial contracts, which means that the party on the other side of a given contract needs to remain solvent in order for a token to maintain its value. On its website, Robinhood includes this disclosure: “Investors may lose up to the full amount of their invested capital due to market conditions or the insolvency of Robinhood.”
To be sure, counterparty failure is usually a low risk, but it isn’t zero, and actual shares of stock don’t need disclaimers like this.
Even under ordinary circumstances, stock tokens’ prices likely won’t move in lockstep with actual share prices. That’s for a few reasons.
First, because tokens aren’t real shares, they don’t pay dividends. While that might not seem like a significant factor, dividends do add up. Over the past 15 years, they’ve accounted for about 20% of the total return of U.S. stocks.
Also, stock tokens don’t carry the voting rights associated with real shares. That might also seem insignificant to everyday investors, but because it is important to larger, institutional investors, it means that tokens will probably always trade at a bit of a discount to real shares.
A final risk is one that is longer term but much more serious: Stock tokens are built on blockchain technology, and that means they’re vulnerable to hacking. Of most concern is the fact that blockchain technologies rely on cryptography to secure investors’ holdings. While blockchain encryption has never been cracked, advances in computing power—and specifically, a technology known as quantum computing—could one day compromise a blockchain. Most experts believe this is 10 or more years away, but companies including Google and IBM are actively working on it, so it’s worth bearing in mind.
The bottom line: In thinking about this new innovation, I’d lean on a concept known as Lindy’s law. This is a rule of thumb which postulates that the future life expectancy of an idea is proportional to its current age. In other words, the longer an idea has stood the test of time, the more likely it is to continue to stand the test of time in the future. That’s how I’d look at stock tokens. They might or might not be a good idea, but it’s too soon to tell. And since the benefits they offer are more in the category of convenience rather than investment performance, I see no particular need to own them. For that reason, it might make sense to wait and watch until any bugs are worked out.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
Adam, excellent article and explanation—thank you.
Stock tokens are one more investment “innovation” I will happily avoid.
Thanks for explaining this so clearly. I infrequently buy or sell, and am fine focussing on funds and ETFs, doing so during normal hours, and am virtually never in a hurry.
Now what was that other article, something about doing nothing? Seems to me stock tokens might be appealing to the day-trading set, but for those of us who are adhering to a more boring regimen of buying index funds and tuning out the thrum of the news cycle they have not a lot to offer.
My other observation is related to the techies who are behind these. “Techies are gonna tech.” They’re enamored of new software and technology tricks, and love finding ingenious ways of putting them to work – sometimes regardless of the actual value their innovations create by way of improved quality or productivity.
Witness earlier years of the web when Java Script and Flash were just coming into play. There was an old joke around Silicon Valley about web developers penchant for playing with new toys: “OK, yeah sure, the UI sucks, but look at that Flash.” In other words, admitting that all their coding work didn’t really do anything to improve the user experience, but the page sure did look cool.
So now we have stock tokens.
Looks like a solution in search of a problem. I’ll stick with my boring index funds, thank you.
Are there smart people for whom the convenience of stock tokens would outweigh the risks?
I am not an early adopter, and this product does not seem to offer me any benefit I can think of. The history of the financial services business is rife with new products that seemed to meet a need for a while and then did not. Of course, someone made money and others lost out. I remember portfolio insurance as one of the products that seemed like a great idea until everyone headed for the door at the same time. Also, any product promoted by Robinhood should immediately be suspect.
Howard, I totally agree. Almost every tax client I helped, who presented Robinhood documents, fell into one of the following; un-sophisticated investor, day trader wannabe, young with a lot to learn or old who never did.