by Alex Broudy, Technical & Financial Writer
Apr 26, 2022
Said simply, securities are financial instruments with monetary value that can be bought, sold, or traded on exchanges and other platforms. While seemingly simple by definition, this asset class is at the center of a multi-trillion dollar market globally. According to The World Bank, domestic securities made up more than $93 trillion dollars of the global markets in 2020.
From stocks and bonds to exchange traded funds and digital asset securities, the security as a financial instrument can take on many forms. Generally, securities are divided into four categories which determine how they operate: debt, equity, derivatives, and hybrids. These same categories apply to digital asset securities, which will be discussed in more detail below and in upcoming articles.
Debt securities often take on the form of bonds, treasuries, and certificates of deposit by allowing governments, corporations, and other entities to borrow money by issuing bonds (debt) and investors seeking to earn interest by purchasing these bonds. Debt securities earn interest and this interest is distributed according to the terms of the debt security. As a fundamental financial instrument, debt securities provide potential downside protection in the form of fixed income and can often constitute up to 40% of a balanced portfolio.
Equity securities represent partial ownership of an entity, often a company, with the goal of accruing capital gains over time. Since equity security owners are also partial owners of the companies in which they have invested, they may have the ability to vote on certain company decisions like board membership. Unlike debt securities, equity shareholders do not receive periodic interest payments; instead, investors may receive stock or cash dividends if the company chooses to pay dividends. Growth companies often choose to reinvest the excess earnings in the company rather than paying dividends; hence, they are known to pay little to no dividends.
Derivative securities, as the name indicates, derive value from underlying assets. Derivative securities typically establish a contract between two parties to purchase or sell an asset or pool of assets underlying another. For instance, a derivative contract can trade options to buy or sell shares of corn futures without necessarily needing to take physical ownership of the underlying asset, corn. This type of security is often used as a way to hedge other investments.
Hybrid securities combine debt and equity into a single offering so that the security takes on features of both financial instruments in one form. For instance, the most common hybrid security is called a convertible bond, where investors receive regular payments (e.g. fixed income) and the security may be converted into shares of equity that can be sold on the market at will. This type of convertible security can be used as a way to balance risk and value in volatile markets.
From Paper-Based and Electronic Securities to Digital Asset Securities
The next step in the evolution of digitization is beginning to unfold as tokenization, which enables the movement of both paper-based and electronic securities onto the blockchain. In some cases, blockchain technology can complement book-entry accounting to maintain traditional securities management best practices.
“Another benefit of blockchain technology is that it enables smart contracts, which firms like Securitize use to manage regulatory compliance and improve operational efficiency overall."
— Alex Bojinov, Director of Broker Dealer Operations at Securitize Markets
Digital Asset Securities take on the regulatory attributes of electronic and paper-based securities but in a digitally native form. This means that they abide by the same rules as existing securities while providing digital asset security owners with increased transparency, portability, and proof of ownership. All at a lower marginal cost. To learn more about digital asset securities and the future of digital investing, subscribe for updates below.
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