YZi Labs Investors: Five Reasons for Stock Tokenization and Three Types of Startup Opportunities

Author: RickyW, member of YZi Labs investment team

Compiled by: Jiahua, ChainCatcher

Recently, I have been delving into on-chain stocks, and one idea has been lingering in my mind.

If I believe in a certain development trend, why can't I turn that judgment into an investment portfolio, buy in with cryptocurrency, and let others follow suit?

For example, if I think AI will significantly increase electricity demand, I might want to invest in power generation, the grid, and related equipment manufacturing companies. What I want is not just to have a chatbot provide five stock codes, but to understand what this portfolio specifically targets, acquire this set of assets, and continuously adjust and utilize it as my judgment changes.

This is a product I genuinely want to try.

But then I keep asking myself: can't such a product be created directly on the basis of a regular securities account? What exactly does putting it on-chain improve?

Before getting excited about these products, I want to clarify how they operate at their core. Who holds the stocks? What do the tokens represent? How can funds be retrieved? What real business can startups conduct in this process?

What exactly are you buying?

Buying stocks has long felt digital. Open the app, press a button, and a number changes. The digitization of stocks is not due to blockchain.

Behind this button, brokers process your orders, trading venues match buyers and sellers, and the clearing and settlement system calculates the funds and securities owed to each party and completes the delivery, while custodians and registrars are responsible for safeguarding securities and maintaining ownership records. Some institutions may perform multiple functions simultaneously.

In a common securities account arrangement, you are the actual beneficial owner of the stocks, while the registered holder is an intermediary or nominee holder. There is already a complete set of records and legal relationships between you and the listed company. Investor.gov provides a simple explanation of this distinction.

"On-chain stocks" may refer to several different things:

• Tokens linked to actual share ownership or legally recognized indirect securities rights.
• Stocks held elsewhere as support, issued by a third party.
• Derivatives that track stock prices but do not confer stock ownership.

The second category is the most confusing. A product may have sufficient stocks as support but could merely be a certificate issued by another company, rather than equity in the company corresponding to the token name.

For example, xStocks describes its products as fully collateralized tracking certificates rather than direct equity and explicitly states that these products do not grant holders voting rights as shareholders. An overview published by SEC staff also explains why different tokenization structures confer different rights to investors.

Therefore, I will break the question into two parts: what assets back this token? What rights can I assert as a holder?

Just because a token has the name Apple on it does not answer either of these questions. Moreover, what happens to your rights if the issuer goes bankrupt?

How does a stock become a token?

Let’s illustrate with a simplified stock-backed product. Suppose one share of Apple stock is worth $100. This is just an example, not the current stock price.

The issuer arranges for the real stock to be stored in a designated securities account or custodial account. The issuer is responsible for setting up the product, brokers assist in buying and selling the stocks, and custodians are responsible for safeguarding the assets. Apple itself may not necessarily be the issuer of the token.

Subsequently, the issuer creates, or "mints," the token according to the product terms. Suppose initially one token corresponds to one share of stock. This does not mean that another share of Apple stock has been created; rather, it creates a token representing rights related to existing assets. Dividends, stock splits, and product design may cause this exchange ratio to change over time.

Some systems allow authorized entities to convert between stocks and tokens. Other systems allow eligible customers to directly purchase and redeem tokens after completing account opening and verification. Alpaca's authorized participant guide is a concrete example.

Next comes distribution. Exchanges or investment applications offer these products to eligible users. Market makers provide buy and sell quotes and take on risks using their own inventory and funds. The exchange is the trading venue, and market makers are one of the participants within it.

You can hold tokens through the platform or, if the product supports it, place the tokens in your own wallet. However, holding tokens independently does not mean the underlying custodial institution disappears. Blockchain can show token balances but cannot independently prove that the corresponding stocks are indeed stored in a certain securities account.

Finally, you have two exit options, which are not the same:

• Sell: Another buyer takes over your existing tokens.
• Redeem: Process through the issuer's procedures, tokens exit circulation, and you receive the assets stipulated in the product terms, which may be cash, stablecoins, or securities.

Being able to buy a certain token does not automatically mean you qualify for direct redemption. Minimum amounts, fees, processing times, and eligibility requirements are all important.

Additionally, if a token changes hands ten times, it does not mean that ten new shares of stock have been bought in the market. Trading volume and the asset scale behind the product are two different numbers.

What keeps token prices close to stock prices?

Suppose the stock price is $100, and the token price is $105. Eligible institutions might buy stocks, generate tokens, and then sell the tokens. If the price difference is sufficient to cover costs and risks, this transaction can be profitable. An increase in token supply helps push the price back down. When token prices are too low, buying and redeeming can also have a reverse effect.

This is arbitrage. The key is whether these transactions can actually be executed, not just whether there is a real-time price on the screen.

Now, suppose it is Sunday. Tokens are still trading, but the underlying stock market is closed. How easily can market makers hedge their risks? Is there anyone who can process redemptions? At what price can they redeem?

Therefore, I would not equate "around-the-clock trading" with being able to transact at reasonable prices at any time. The bid-ask spread may widen, and token prices may deviate from stock prices. On this point, xStocks' explanation of the primary and secondary markets is worth reading.

What are the responsibilities of each party in this industry?

The simplest division I have found so far is:

Stocks → Brokerage and Custody → Legal Structure and Token Issuance → Trading and Distribution → Portfolio, Lending, and Other Applications.

Upstream is responsible for assets and their corresponding rights. Midstream transforms these rights into products that people can access and trade. Downstream is responsible for creating applications that people want to use.

Additionally, there are functions that support the entire system's operation:

• Blockchain and smart contracts record balances and execute preset rules.
• Stablecoins and payment channels facilitate fund flows while also bringing their own issuer risks and redemption risks.
• Wallets and security systems manage keys, authorizations, and permissions.
• Market data and oracles bring prices and external information into applications. Price oracles do not equal proof of reserves.
• Compliance systems determine who can buy, hold, transfer, and redeem based on relevant rules.
• Ongoing services handle events like dividends, stock splits, and mergers. Reconciliation is used to verify whether token balances, custody records, and customer accounts are consistent.

A transfer confirmed on-chain does not mean that all underlying securities or banking processes have also completed settlement at the same moment. This still involves institutions, business processes, and legal obligations.

Moreover, each participant needs a business model. Brokers and custodians charge service fees; issuers may charge product fees or fees for subscriptions and redemptions; exchanges charge transaction fees; market makers earn the bid-ask spread while managing risks; infrastructure companies sell software; applications need to generate revenue through users or distribution channels.

As an investor, I am concerned about: who is solving the problem and getting paid for it? A large volume of transactions passing through a network does not automatically mean it can generate substantial revenue; a well-run company does not automatically mean its token holders can share in the profits.

Why must these be put on-chain?

Traditional brokers have long offered fractional share trading, portfolios, and securities-backed loans. These are not inventions of the crypto industry.

What truly interests me is: what happens when people can invest in stocks through the same infrastructure while holding stablecoins, trading, lending, and building financial products?

In my view, there are five reasons worth noting.

1. Investing with stablecoins makes assets more accessible.

Not everyone around the world can easily open a good securities account. For those who already hold stablecoins, exchanging stablecoins for fiat in a bank account and then transferring funds to another account adds another layer of hassle.

Tokenized stocks can provide a more direct path for eligible investors to transition from holding stablecoins to stock investments. This makes investment products easier to market to different markets, especially to those already using cryptocurrencies. It does not eliminate local regulations or account opening review requirements, and specific products still have regional restrictions, but it can significantly simplify the process of fund transfer and product distribution.

2. Developers can create more products without building everything from scratch.

Suppose you want to build an investment portfolio around the judgment that "AI will drive electricity demand." You need more than just a list of companies; you need to be able to buy assets, hold assets, adjust allocations, and access financing services when needed.

With interoperable tokens and protocols, developers can reuse existing wallets, trading venues, lending infrastructure, and smart contracts. This creates space for indices, derivatives, automated portfolios, and products we have yet to conceive.

The advantage is that the startup costs for trying new products are lower. A small team can focus on delivering the differentiated part of their experience.

3. Investors can transfer holdings, not just funds.

If I discover a better application, I would prefer to directly transfer my existing holdings rather than sell, withdraw cash, and then buy back in another place.

Traditional brokers already support transferring holdings without selling assets. The opportunity on-chain is to make it easier to transfer and utilize holdings across compatible wallets, applications, and protocols.

Transferable stock tokens have the potential to achieve this across compatible wallets and platforms. For example, xStocks' design supports usage across wallets, exchanges, and DeFi protocols.

Compatibility remains important. But being able to take assets with you will change the relationship between investors and applications. Applications must continuously provide value to retain your business.

4. Holdings do not have to just sit in accounts.

Eligible stock tokens can be used as collateral for loans or margin. This is already happening: Kamino allows users to collateralize part of xStocks products to borrow USDC.

With the support of relevant products and platforms, holders can also lend tokens and earn interest paid by borrowers; they can also provide liquidity to automated market makers and earn trading fees. These fees come from real trading activities, as demonstrated by Uniswap's fee mechanism.

These are additional options, not risk-free benefits. Borrowing brings liquidation risks, and lending assets or providing liquidity introduces risks beyond merely holding assets.

5. Trading and settlement can run continuously like the internet.

News does not stop when the stock exchange closes. Token markets that support extended trading hours can continue to operate at night and on weekends, allowing investors to react to news without waiting for the next opening.

There is also an independent benefit in settlement: stock tokens and stablecoins can be exchanged in the same atomic transaction on-chain, meaning that delivery by both parties either occurs simultaneously or not at all. This reduces the risk of one party delivering assets without receiving assets from the other.

The distinction here is important: tokens trading around the clock do not guarantee that investors can access the underlying stock market at all times, nor do they guarantee that primary market token subscriptions and redemptions are always open. A continuously open market does not necessarily mean that the bid-ask spread will be small.

In summary, these are the reasons I am optimistic about this direction. More people can access these assets, developers can build products around them, and investors can make their holdings serve more purposes.

Returning to the initial investment portfolio idea, this means that the path from "I believe the world will move in this direction" to having a portfolio that can be bought, transferred, and utilized can be shorter.

Compared to just putting a stock code in a crypto wallet, such opportunities are much more interesting.

Where are the opportunities for startups?

Three areas are particularly worth noting: turning investment ideas into investable products, enabling scalable business operations, and providing genuinely useful financing support.

1. Turning investment ideas into portfolios that people can actually buy.

Judgments like "AI will drive electricity demand" still leave users with a lot of work: selecting assets, understanding risks, executing trades, and continuously updating portfolios. Startups can integrate these steps and, where rules permit, allow others to follow this strategy for investment.

The opportunity lies in providing a complete user experience for a specific group. AI-generated stock code lists are easy to replicate, but distribution channels, credible historical performance records, and a product that users are willing to continuously invest in are much harder to come by. On-chain must genuinely improve the holding and transfer of portfolios or enable them to be used in other scenarios.

2. Enabling tokenized stock businesses to scale across service providers.

Even if trades fail, redemptions are delayed, or stocks undergo dividends or splits, records between issuers, brokers, custodians, and applications must remain consistent. Startups can provide software to verify these records, coordinate information updates, and assist operators in handling exceptions.

A pragmatic entry point is to find a costly business process with clear paying customers. Supporting multiple service providers can allow independent products to extend beyond a single issuer's internal system. Reliable system integration and experience in handling complex situations can increase the cost for customers to switch service providers; however, if every customer requires endless customization work, it will be impossible to build a scalable software company.

3. Allowing eligible stock tokens to be used as collateral.

Only when lenders can value stock tokens, understand their corresponding legal rights, and recover funds by disposing of collateral when borrowers default can they be considered useful collateral. Market closures, redemption restrictions, and differences between issuers make this far more complex than simply connecting to a stock price data source.

Startups can develop collateral assessment, risk management, and liquidation tools for lending platforms without having to become lenders themselves. The value lies in helping platforms decide which collateral to accept, how much funding can be lent, and how to exit during market pressures. This relies on reliable data and real usable liquidity; merely having smart contracts is not enough.

These are three different businesses: user-facing investment products, operational software for financial institutions, and infrastructure serving lending. Each requires clear customers and a reason for existence that goes beyond "putting tokens on-chain."

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