Not all Digital stocks are created equal

Only one thing appears true from the recent Binance Stock Tokens: not all digital stocks are created equal.

Binance has been leading the charge in its creation of ‘stock tokens’ linked to Tesla, Apple and Coinbase. In doing so, it is clear that an abundance of demand exists for an ever-growing number of asset classes in the crypto and digital space. While FUSANG is excited to see such innovative products being offered, FUSANG questions what is going on beneath the surface in relation to Binance's Stock Tokens, and why they are not listing shares for real. Additionally, FUSANG believes that consumers should be better informed about what rights they actually have, and should be guided through the risks associated with this new wave of digital assets with ease.

Given that the regulatory framework for securities exists first and foremost to protect investors, it is worthwhile for us at FUSANG to clarify the legal nature and risks associated with the Binance Stock Tokens. In short, we should be concerned about the fact that these tokens are unreal, unknown, and unregulated.

First, we find the Stock Tokens to be UNREAL. It appears that the tradable Stock Tokens are not actual shares; instead, they seem to be mere contractual entitlements that replicate the shares. These may or may not in fact follow the share price. In essence, the Binance Stock Token seems to be a derivatives instrument – more specifically, a contractual entitlement that derives its value from an underlying asset, without involving any actual ownership of the underlying. There is no ownership of any share, meaning that there is no automatic entitlement to declared dividends, and no assurance that the token would track or even closely match the price of the ‘replicated’ share.

Second, we find them to be UNKNOWN. From the wording of the agreement, there is no way of finding out with any clarity what the investors’ rights are. This uncertainty is crippling – investors cannot know what their entitlements are because this simply cannot be deduced from the text of the agreement. Even the type of contract cannot necessarily be ascertained: is this a perpetual futures contract? Or is this merely an investment contract? Or is it something even less? An earlier version of the Binance website said: “The tokens confer no legal rights in and of themselves.”

Third, it is extremely concerning that they are UNREGULATED. In spite of the ambiguity about investors’ entitlements, there is no doubt Binance markets these Stock Tokens as a tradable instrument that replicates the market value of the underlying companies. This in itself should warrant regulation under any credible securities regime. A security is a tradable financial instrument, which is precisely what the Binance Stock Token is – plain and simple. This is absolutely paramount because in the securities context, investor protection concerns come to the very forefront.

The fact that the Stock Tokens are unregulated is jarring. Clause 8 of Binance’s agreement provides that it has a right to “terminate Binance Stock Tokens (sic) trading service at any time”, which means there is no guarantee that investors would receive any return. Although reputational consequences may well disincentivise Binance from exercising such a clause, the very existence of this clause strikes at the heart of the investor protection imperatives that underpin all robust securities regulation regimes.

Indeed, German watchdog BaFin seems to be cognisant of the fundamentals of crypto-tokens and when they would properly fall within the regulatory remit: “if tokens are transferable, can be traded at a crypto exchange and are equipped with economic entitlements like dividends or cash settlements, they represent securities and are subject to the obligation to publish a prospectus.”

The fact that the Binance Stock Token is unreal, unknown and unregulated is a cause for serious concern. FUSANG’s CEO, Henry Chong, believes that as a result, Binance will “likely get into trouble for fraudulently marketing” these Stock Tokens. He continues: “Their marketing is very strongly claiming these are fractional shares… If you promote the product as a Stock Token, but then in fine print declare they are not in fact Stock Tokens, that just seems kind of dodgy. The honest truth is, especially for retail investors, they don’t look that closely. They just kind of go with what you claim.”

Indeed, on Binance's Stock Token page (https://www.binance.com/en/stock-token), the headline displayed is "Stock Tokens: Trade equity shares through crypto coins". Although this may be said to be a loose reference to a token that is somehow linked to ‘equity shares’ and ‘stock’, the truth is that (as we have established) there is no actual entitlement to the underlying shares. Given that the headline states ‘Trade equity shares’ in unequivocal terms, with no qualifier whatsoever, this headline is (at best) highly misleading. We believe that this marketing campaign is likely to catch the eyes of many regulators worldwide.

According to Chong, only two options exist for Binance’s Stock Tokens. The first is that ”these really are shares, stocks, as they call them, in which case it seems downright illegal for them to do what they’re doing,” he said. “Binance isn’t registered as a stock exchange to list and trade stocks in that way.” The second is that Binance is now acting as an agency broker and just passing the trades through to someone else. “Again, it doesn’t seem like Binance is licensed to do any of that,” Chong said.

Watch out for this space. It’s exciting and dangerous at the same time – we are here to help you navigate your journey #WithEase and separate out what’s exciting from what’s dangerous...and what's real from what's not.