Ready or Not, The Digital Stock Market Is Coming

MIKE TOWNSEND: Back in 2021, there was a bit of a craze for non-fungible tokens, or NFTs. As digital currency and the concept of a blockchain was hitting the mainstream, the idea of tokenizing just about anything exploded. For a few months, there were NFTs of bored apes, famous and not so famous artworks, football highlights, the first tweet ever sent by the founder of Twitter, and much, much more. Whatever someone could think of tokenizing would be tokenized, packaged, and sold to some investor. In 2020, about $82 million in non-fungible tokens were traded. In 2021, that number shot up to $17 billion, an increase of nearly 21,000%. And by mid-2022, that number had collapsed. By 2023, it was estimated that more than 95% of all NFTs were worthless. 

It was a classic, if a bit bizarre, speculative bubble. The NFT craze may have faded as quickly as it came, but the idea of tokenization did not go away. Today, the idea of tokenizing stocks is already reality in many foreign countries, and it's coming to the USA. Major exchanges are preparing to launch tokenized stock trading. Regulators in Washington are drafting a set of rules for doing so. Congress is holding hearings about tokenization and moving forward on legislation that would create the regulatory framework for moving stocks onto the blockchain. If all that sounds a little dizzying, well, you are not alone, but it's on its way, and every investor should make sure they understand its implications. 

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend. And on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to. Coming up in just a few minutes, I'm going to be joined by my colleague Jim Ferraioli, director of digital currencies research and strategy at the Schwab Center for Financial Research, for a great introduction to the coming world of tokenized stocks. We'll discuss the pros and cons of tokenization for investors, exchanges, and companies, and why investors need to get educated about how trading and investing might change in the not-too-distant future.

But before Jim joins me, here's a quick look at what's going on in Washington right now. First, a new era of leadership at the Federal Reserve is finally here. After months of speculation, delay, and uncertainty, Kevin Warsh will take the oath of office as the 17th chairman of the Federal Reserve during a White House ceremony on May 22. Warsh was confirmed by the Senate by a vote of 54 to 45 on May 13. Just one Democrat, Senator John Fetterman of Pennsylvania, joined all 53 Republicans in supporting Warsh's confirmation, resulting in the slimmest margin for any Fed chair. It's a sign of how deeply partisan the Senate has become.

Jerome Powell was confirmed twice by wide margins, 85 to 12 in 2018 and 80 to 19 in 2022. Warsh faces a daunting task at the Fed as he enters under intense pressure from President Trump to cut interest rates. But the 12-member Federal Open Markets Committee, or FOMC, the rate-setting body of the Fed, has made it plain that few, if any, of its members think that economic conditions right now warrant a rate cut. In fact, three dissented from the most recent monetary policy decision in April to hold rates steady because they felt that the Fed should be more clear in articulating that a rate hike is a possibility. 

While Jerome Powell's term as chair has ended, he chose to continue with his term on the seven-member board of governors, which runs until January of 2028. Stephen Miran is resigning his seat on the board so that wars can be sworn in. Miran was confirmed by the Senate last September to fill the remaining few months of an unexpired term and has dissented from every FOMC decision since, always in favor of a steeper rate cut. Now the president's most vocal advocate at the Fed for cutting rates is no longer on the board, making Warsh's job even trickier. In the months ahead, attention will turn to what changes Warsh tries to make in how the board operates.

Warsh has argued that the central bank over-communicates, noting in particular that forward guidance on where each member thinks rates are headed is inappropriate. He has also indicated that he may end a practice started by Powell of holding a press conference after every monetary policy meeting. And one of Warsh's other priority is to shrink the Fed's balance sheet, a process that is likely to be implemented slowly so as not to disrupt the markets.

For now, however, expect the Fed's personnel drama, which has dominated headlines for nearly a year, to fade into the background as Warsh settles in. With the Supreme Court poised to deny President Trump the ability to fire Fed Governor Lisa Cook, there are no more vacancies on the horizon.

Another issue is one everyone is aware of: the high cost of a gallon of gas. On May 18, AAA reported that the national average for regular gasoline was $4.52 per gallon, and it was more than $6 in California. With the war with Iran still unresolved and the critical shipping lanes in the Strait of Hormuz still shut down, politicians in Washington are looking for any way to provide some relief to the consumer.

That's why President Trump recently endorsed the idea of a federal gas tax holiday. He said he'd be in favor of waiving the 18-cents-per-gallon federal tax, 24 cents for a gallon of diesel, for a period of time until gas prices come down. But it's Congress that would have to implement a gas tax holiday, and the reaction on Capitol Hill thus far has been decidedly mixed. Republicans in both the House and Senate quickly introduced legislation to suspend the tax and discovered that several Democrats in both chambers had already introduced bills earlier this spring to do the exact same thing. But there is not consensus within either party that it's the right thing to do. 

First of all, there's uncertainty about whether it would have a meaningful impact on the consumer—18 cents a gallon is 18 cents a gallon. But for the average fill up of 12 to 14 gallons, we're talking about a couple of bucks in savings. But the impact on federal revenue would be significant, an estimated $3.5 billion per month. And that gas tax funds the Highway Trust Fund, the primary source of federal funds for local infrastructure projects like roads, bridges, and public transportation. Congress will be required to find that money elsewhere. For now, there doesn't seem to be much momentum for a gas tax holiday on Capitol Hill. But if gas prices remain elevated as we get closer to this fall's midterm elections, that sentiment may change. 

Finally, there's an unusual clash between the White House and the Senate on one side and the House of Representatives on the other over a bipartisan affordable housing bill. The bill contains a package of reforms designed to boost housing supply, reduce regulatory red tape, and encourage affordable housing. In February, the legislation passed the House by a vote of 390 to nine, nearly unheard of in today's partisan atmosphere.

The Senate made some changes to the bill and passed the revised version 89 to 10 in March. It seemed like a rare bipartisan success story. But not so fast. House Republicans were not happy about some of the changes the Senate made, including stripping out some provisions to help community banks make loans and adding in a requirement that institutional investors that build single-family homes as rental properties would have to sell those properties within seven years. Senate leaders told House leaders to just take it up and pass it—this was the best deal they were going to get. And then the president weighed in publicly calling on House Republicans to pass the Senate version and send it to him so he could sign it into law. This week, however, House Republicans defied the president and the Senate, making further changes to the bill, passing it by strong bipartisan vote and sending it back to the Senate. Now it's unclear what the Senate will do and when or if the legislation will make it to the president to be signed into law.

It's a sign of how bogged down Congress has become. This is a bill that has overwhelming bipartisan support in both chambers, a bill designed to address the issue of affordability, which will be the buzzword of the 2026 midterm elections. But even that is apparently not a recipe for getting something across the finish line on Capitol Hill. And how this gets resolved is anyone's guess.

On my deeper dive today, I want to take a closer look at what some people think is the future of the markets, tokenization. It's a term that's long been part of the cryptocurrency world, but it's become something of a hot topic on Wall Street as the major stock exchanges push toward creating a digital stock market. 

Proponents argue that trading in tokens that represent shares in a specific public company will revolutionize trading by allowing for trades 24 hours a day, seven days a week, with instant settlement and rapid cross-border transactions. Skeptics worry that they will exacerbate sharp swings in price and limit the ability of regulators to surveil bad actors and catch fraud and market manipulation. None of it is even legal in the United States yet. So what is all the hype about?

To help explain tokenization and whether it's the next revolution in the global markets or just the latest technological fad, I'm really pleased to welcome to the podcast Jim Ferraioli, director of digital currencies research and strategy at the Schwab Center for Financial Research. Jim joined Schwab last year after more than a decade at Morgan Stanley. Jim, welcome to WashingtonWise. It's great to have you on.

JIM FERRAIOLI: Hey, Mike, thanks for having me on.

MIKE: Well, Jim, let's start with the basics. Tokenization essentially means creating digital tokens that represent a real-world asset on a blockchain. So theoretically, just about anything can be tokenized, right? I keep seeing articles that mention tokenizing the world, but what are we really talking about here?

JIM: The idea of tokenization means creating a digital representation for a tangible asset. And this is an interesting time in digital assets because people have spoken about tokenization for years, and it's finally happening. And so if you've been a skeptic on Bitcoin because you don't necessarily see the value in it, the concept of a smart contract blockchain, it's different. This is technology that's being adopted. And so we think it's a good thing to learn about and be familiar with.

And we're now seeing that large financial institutions are looking to use blockchain technology to improve some of their business operations. So this represents a new era in digital assets. You're seeing the traditional financial ecosystem adopt this other financial ecosystem that has historically been separate. And so it's not a fork in the road, but it is a new path, so to say.

MIKE: Let's go back to the early days or maybe the early days when all of this kind of got into the average investor's consciousness. And I date that back to 2021, early 2022, when there was a real frenzy around NFTs, non-fungible tokens, for a while there. It seemed like everyone was hawking an NFT, whether it be some kind of cartoon ape or a picture of a big slam dunk in an NBA game.

But the problem was that there just wasn't much underlying value to most of it. And now that NFT craze, well, it just seems kind of silly. So how is the push toward tokenization of stocks of real companies—how is that different?

JIM: So the summer that you referred to back in 2021 is often called DeFi, which means decentralized finance. So "DeFi Summer" in the digital assets community. And the idea of NFTs was right. It was a way to apply digital scarcity to assets that traditionally couldn't be scarce. But the market definitely went overboard.

As an example, I minted a couple NFTs as a joke in 2021 called Art Critics, and they're now worth the same as when I minted them, which is nothing. But jokes aside, the idea of digital art did get out of hand, but the idea that media assets could benefit from being tokenized isn't really that far-fetched. Think about it. We work at Charles Schwab. The company has trademarked the right to use the Charles Schwab name and logo.

And so that's really not that different than tokenizing a media asset. If I had to take a guess what the future of NFTs would be, it's probably boring use cases that you wouldn't really get excited about but are ultimately useful, things like trademarking. So you can easily prove your ownership of a tokenized asset. This isn't something that deserves a giant multiple, as it's essentially an infrastructure play, but there is a use case—just not cartoon apes. But tokenizing stocks and real-world assets, that's a significant change from what we saw back in 2021.

MIKE: Well, it's a significant change that the exchanges are embracing. Nasdaq and the New York Stock Exchange both actively moving forward with tokenizing stocks and being able to trade shares on the blockchain. You can already do so in some foreign countries. So what's in it for the exchanges and the brokerages? Why does it make sense to them? Is it just about saving money for these businesses, or is there a way for them to actually make a profit?

JIM: If you're tokenizing stocks, from an exchange point of view, it does simplify things like trade settlement. Blockchain transactions are instant. You don't have counterparty risk. And counterparty risk is the risk that the person or the institution that you're dealing with doesn't hold up their end of the deal. So if you think about the volume that these exchanges are trading in, if you can make that more efficient, there's a benefit right there.

Now to be clear, the New York Stock Exchange and the Nasdaq have stated they plan on using blockchains to make their businesses more efficient. The value is not necessarily going to accrue to tokens of large public blockchains. There are private blockchains, and then companies may also choose to build their own. And so if I had to take a guess, the future looks like a combination of public and private blockchains. If you're a large financial institution, there's an efficiency aspect to being able to seamlessly and instantly move money around for your needs. But you don't necessarily want to broadcast that out for the world to see. But on the other side, there's a lot of money on public blockchains. And so you want to have access to that as well. And so again, there is a place for private and public in this world.

But if we go back to the exchange example, one of the features could be lower compliance and operational costs that would make your business more efficient. You could probably go ahead and do an exercise to try and quantify what this impact could have on a business.

Following the dot-com bubble and the great financial crisis, compliance costs have been one of the largest areas of cost growth for the finance industry. And if you look at large investment banks, and I did this, I looked at the three largest, they're 10Ks, you can see that typically compensation represents 50 to 60% of total operating costs.

And so a meaningful amount of that is tied to non-revenue generating functions such as operations, risk, and compliance. To be clear, I'm not trying to diminish those areas. They're very important. But non-compensation expenses account for that remaining cost base. And that's things like technology and post-trade operations. Collectively, this has a big structural cost burden on a company's operations. While these figures are approximations, I want to make it clear, they do highlight that regulatory and operational infrastructure accounts for a meaningful share of total expenses. As a result, if tokenization and blockchain-based market infrastructure provides a potential path to cost reduction by streamlining trade processing and maybe reducing settlement friction, it can then benefit those businesses.

Just in a hypothetical bull case, maybe tokenization can bring the cost of trade settlement, which is maybe around 15%, down to low single digits. And then potentially there's room where the costs associated with hiring compliance people might fall slightly too. 

So again, there's a real feature that financial institutions may find attractive when using blockchain technologies.

And to be clear, tokenizing is unlikely to completely replace the needs of people in these area. Historically, what we've seen is technology just shifts people to more productive roles within an organization. I think this is an efficiency increase for the business, and you get people focusing on higher value tasks than maybe the lower value tasks for a portion of their day.

MIKE: Well, you've made the case for how this might matter to the businesses, but I think the key question for our listeners is what's in it for the average investor?

JIM: That's the million dollar question, or maybe the 12.5 Bitcoin question since crypto is mainstream. But most of the movements in equities markets actually happen after hours. Earnings are reported by the news when the market is not opened yet or after it's closed. And usually other important announcements come out around those time periods as well. Institutional investors already have access to aftermarket trading. So they can react to earnings news when retail investors are cut off. Firms do offer extended hours trading when most of these news items affect market prices even though retail investors may not take advantage of those opportunities. The benefit of tokenized stocks is they trade 24-7, and that actually levels the playing field. Retail investors are able to make decisions around these key events when other larger institutional investors are already doing that.

And then there's a benefit for investors who don't have access to U.S. markets. Generally, investors have preferred to own dollar-denominated assets, and the U.S. stock market's no exception. The U.S. is known for having some of the biggest and most innovative companies in the world. But not all investors can access these markets. And so it actually democratizes access to these markets for global investors.

In recent years, companies have been staying private for longer. Some of this stems from the dot-com bubble where increased compliance costs for publicly traded companies made it more attractive to stay private, especially when there's really been an unlimited amount of private capital that these companies can raise in private markets. That means shareholders of these companies are kind of stuck without the liquidity that they typically would have seen in previous decades. Tokenization of private shares has emerged as a way to help these shareholders obtain liquidity, but it also gives the everyday investor access to these companies' shares because they may not traditionally meet the minimums to get access to pre-IPO companies, which has been the traditional way, through private placement vehicles.

If you take that a step further, we've seen other illiquid holdings get tokenized in recent years, and that's a benefit for price discovery and efficient markets. This includes things like private credit and real estate. The feature that blockchain technology brings to financial markets is really transparency and liquidity.

MIKE: Well, how about the downsides to tokenization for both companies and investors? What are the risks?

JIM: The number one risk is that transactions on public blockchains are not reversible. So regardless if you're sending or receiving a tokenized asset or a native asset like a cryptocurrency, if you send it to the wrong place, you're not getting it back. There are also regulatory and cyber risks. Just a few weeks back, an application on the Ethereum blockchain was hacked, and that resulted in the equivalent of $300 million being stolen from a lending application called Aave.

And with any digital platform, there's always the risk of cyber intrusions, but it's very difficult to reverse a crypto transaction. And so that provides the additional risk. And then another feature of a lot of public blockchains is that they're permissionless. There's no central authority who approves transactions. If someone steals your credit card number and makes a bunch of transactions, you can call your credit card company, report the card stolen, have the transactions canceled and any fees that you are charged credited back to you. There's not someone who can do that in a public blockchain. And so that can be a negative. 

From a regulatory standpoint, we still lack permanent guidance around the digital assets industry. Several weeks back, the SEC issued guidance about how it views cryptocurrencies, some of the regulatory impacts to blockchain developers, and other related issues. A future administration could undo these. The point is not to sound partisan here. The digital assets industry has bipartisan support in Congress and trade groups that actively work with elected officials across the political spectrum. In general, investors dislike uncertainty. So without regulations or rules being signed into law, it's hard for many institutions to step into this area. While investors may be benefitting from an administration that's perceived to be crypto-friendly, that could easily change again in future administrations. 

I want to emphasize I'm not offering an endorsement or a criticism of any political party here, but we've seen a similar feature in equities markets around energy for the past decade or so. It's hard to make long-term business decisions amid an unclear regulatory environment.

MIKE: Well, it's really important to remember that as of today, tokenization is still a theoretical for U.S. investors because as you point out, regulators have not yet granted approval for U.S. investors to own tokenized stocks. And I think that makes Washington kind of the center of the tokenization debate right now. The regulatory agencies and Congress are going to be the key decision makers here.

In January, the SEC, as you just mentioned, issued guidance on tokenization that distinguished between tokenized securities issued by the companies themselves and those issued by a third party, such as exchanges. Earlier this week, Bloomberg reported the SEC was poised to release a full rule proposal on how tokenized stock trading would work. Federal banking agencies also getting in on the act. They recently stated that for a bank to hold tokenized assets as real assets on their balance sheets, the tokenized assets must grant investors the same legal rights as the original security. And then in late March, the House Financial Services Committee held a hearing on tokenization, which they kind of framed through the lens of modernizing the capital markets. The chairman of the committee, Congressman French Hill, a Republican from Arkansas, called tokenization a significant transformation in our financial landscape. But he also said that tokenization raises legal and regulatory policy questions and that ensuring adequate investor protections was a core principle that needs to guide the answers to those questions. So you can see it's kind of a tricky balance to strike. 

And then last week, Congress took a notable step forward on legislation that would create some rules of the road for the crypto and blockchain space. The Senate Banking Committee approved the Digital Asset Market Clarity Act, which everyone just refers to as the Clarity Act. It would create a regulatory framework for digital assets that doesn't really exist today. The hope is that by putting in some regulatory guardrails and investor protections, it will unleash more investor confidence in the technology. The bill still has some hurdles to overcome to pass the full Senate, and that's going to require additional negotiations between Republicans and Democrats, but those discussions are taking place now in the hopes that an agreement can be reached this summer.

But Jim, while we wait on the powers that be to get guardrails in place, tokenization has already started in the markets with some government bonds and money market funds and other assets. So what's out there that is tokenized right now? And is that something investors should be thinking about yet? Or are we in a bit of a wait and see how some of these regulatory questions are going to play out?

JIM: There's been a huge amount of tokenized real-world assets. There's about $36 billion of tokenized assets today. About $6 billion is in tokenized commodities. The bulk of it is in tokenized money market funds, and there's less than a billion in tokenized stocks. Stablecoins, which I have not included here—they're typically considered crypto native asset, which is why I don't group them in with the real-world assets—but they're really just digital dollars. There's about $300 billion in stablecoins. So it's a sizable amount. Last year, there were no tokenized real-world assets. There were very low amounts. So going from where we were last year to $36 billion in a year is actually a significant jump. But overall, this is a drop in the bucket compared to the broader financial system. It is a big moment for the digital assets industry as this new use case does come online.

MIKE: Well, Jim, picking up on sort of where I think you're going, Bloomberg had an interesting article recently that made the case that investors will drive adoption, not regulators. Regulators may be creating the opportunity, the playing field, for investors to drive adoption. So what will it take, and maybe how long will it take for investors to opt in? Will it start with traders, or is this something ordinary investors are going to be likely to be interested in?

JIM: So to date, I would say that the investors have really driven the adoption. This is, again, before a few years ago, if you wanted access to these things, you needed to access them through crypto-native applications. And as they grew and the space grew, traditional financial institutions realized that there was customer demand here. And if you're not going to meet your customers where there's demand, they're going to get it somewhere else. And so that kind of led the adoption now. But where I see that going is really on the institution side, adopting measures to move on from just meeting investor demand but to actually incorporate this technology into their businesses.

And I don't expect this to change overnight by any means. It's not efficient to issue stock and then tokenize it. That's double the cost, even if tokenizing is relatively inexpensive. And so over time, I would expect that new issuances of equities or other instruments are directly issued in token form.

If you think about some historical narratives that actually support the idea of this will roll out in stages, in 2018 I was working on an equities trading desk, and for the two year prior to that, 2016 to 2018, the SEC ran a tick-sized pilot program for small-cap stocks. They took about 1,200 small-cap stocks that were quoted in five-cent intervals instead of one-cent interval.

And the idea was to see if that would increase liquidity for these smaller, less-traded issuers because it forced more orders around certain prices. Ultimately, they did not enact that rule beyond the program, and they wound it down in 2018. But I would expect tokenization of securities to look something like this. Even if it's not government mandated, such as the Tick Size Program, U.S. exchanges and financial institutions are some of the biggest operators in the world. And so I think it's realistic to start with a small pool of issuers and see how it works from there. 

Exchanges are not just going to flip a light switch and turn tokenization on overnight. I would expect it to come in test periods. And I think a realistic timeframe is five to 10 years for a fully tokenized financial system. Five years may seem soon. But again, if it takes a year or two to roll out tests on different groups, and it's working, maybe five. But I would expect 10 years to be on the higher-end range of adopting this for their businesses.

MIKE: Interesting, Jim. This has been a great conversation. I feel like you've really helped demystify tokenization. So why don't we wrap up here? Given where we are now and where you think things are going, what are your big takeaways for investors right now? 

JIM: I hope I don't come across as promotional. I want to make it clear the takeaway here is not that I am saying to go buy cryptocurrencies or rush into tokenized opportunities today. If this is a new area for you, you should take some time to learn about it, understand it, and see if it's appropriate for your portfolio.

As the digital assets industry continues to mature, the different use cases for different technologies is becoming more apparent. And so it goes back to my comments earlier, may not feel Bitcoin's right for you, and that's fine. Not everyone has to have the same investments in their portfolios. You may not think it makes sense to have exposure to different cryptocurrencies as well.

But the underlying blockchain technology that powers cryptocurrencies is now being adopted. And so we think it's an important thing to learn about. There's a lot of misinformation out there about digital assets. There's a lot of excessive hype. And sometimes investors feel pressured because they think they're missing out.

And that's why it's important to educate yourself on this space. The same way you should have a basic understanding of how stocks and bonds work, how the economy can impact these instruments, we think it's important to educate yourself about digital assets, too.

MIKE: Well, this has been a really informative and interesting conversation. And I certainly hope some of our listeners will take the time to get more educated on tokenization because it's definitely coming and coming fast. Jim, thanks so much for taking the time to talk to me today.

JIM: Thanks for having me on, Mike. This has been fun.

MIKE: That's Jim Ferraioli, director of digital currencies research and strategy at the Schwab Center for Financial Research. You can find his great writing on schwab.com/learn.

Well, that's all for this week's episode of WashingtonWise. We'll be back in two weeks with a new episode. Take a moment now to follow the show in your listening app so you get an alert when that episode drops and you don't miss any future episodes. And don't forget to leave us a rating or a review. Those really help new listeners discover the show. For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript.

I'm Mike Townsend and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.