8 Simple Steps - Tokenizing Your Bond

The financial world as we know it has changed dramatically over the last few years, thanks to the advent of blockchain technology, which has increased clarity, democratization, mobility, and liquid markets that are often a monopoly of institutional investors. Among the numerous innovations within the niche of blockchain, the most promising is certainly the prospect of bond tokenization, that is, when bonds can be represented digitally in the form of tokens that represent parts of ownership rights of a bond. Bond tokenization allows the issuers and investors of such instruments to step up their game and go out of their comfort zones, looking for things that never existed before.

If you’re interested in how to tokenize a bond, please read this manual which contains 8 steps basic principles describing the entire process from explaining what tokenization is to how to sell the tokens on a secondary exchange.

1. Understanding Tokenization and Its Benefits

The concept of tokenization will be discussed further along and so before heading to the ‘how’ phase, it will be important to note what tokenization is and its significance.

Tokenization is the conversion of any form of asset ownership (for example bond) into digital units on a blockchain. Each token is owned by many other investors who buy and sell portions of these tokens much to the amazement of everyone. In case of bonds, tokenization leads to the following:

Enhanced Liquidity: Investors can easily buy or sell his or her share in bonds and this in turn leads to speedy access to cash.

Fractional Ownership : Smaller investors are enabled access by able to buy small portions or fractions of the bonds.

Trust and Safety: Once decentralized digital currency is used to conduct any form of business the transaction is almost timelessly recorded in the blockchain.

In other words, if you decide to tokenize your bond, it helps you to attract more kinds of investors and makes such a financial instrument more liquid and flexible.

2. Choose the Right Blockchain Platform

The selection of a blockchain platform is a strategic move, since each one of them has its strong and weak points that affect the safety, the enlargement, and the cost of all transactions made.

Here are a few blockchain solutions that can be used for purposes of tokenization:

Ethereum: As a result of its inventive structure, the complex of smart contracts built on Ethereum has attracted a large number of admirers. Therefore, there are many tokenization projects utilizing this network. But transaction fees may be extremely high during certain times.

Tezos: A cheaper version of the two above, Tezos is smart contract-enabled and is designed with the possibility of future upgrades which makes it perfect for projects with longer duration.

Stellar: Stellar has good transaction speeds and charges low fees which are helpful in cases where there is a need for trading within tokenized assets and frequency.

Factors like transaction fees, risk mitigation, service availability scale, and availability of developers should inform your decision. For example, popularity of Ethereum assures users of great community assistance but the settlement processes has different fees, while Stellar is affordable and quicker but rigid.

3. Decide on the Token Standard

To represent your Bond and assigning it a representation on the blockchain, it is imperative that you identify the most appropriate token type. There are different standards of tokens, but the following tend to be the most common;

ERC-20: This standard applies to fungible tokens – where each token is the same with the other. If your bond tokens are interchangeable like traditional shares, then ERC-20 is appropriate.

ERC-721 (NFT): Non fungible tokens are non interchangeable tokens whose assets are unique. Although they are largely used for artwork and similar items, if ever a token would represent a unique claim or bond each with specific details, then usage of ERC-721 can be considered.

Most bond tokenization projects often opt for ERC-20 token, given that each token embodies an equal right over the bond value of the underlying. Nevertheless, should your bond framework illustrate complexities or embodies various bonds, consider looking up for ERC 721 or any other standard.

4. Consult with Legal and Regulatory Experts

Although the process of tokenization of bonds is not straightforward as it appears, it brings legal and regulatory issues. Just like any tokenized securities, bond tokens also fall under regulatory restrictions. Therefore, since issuance of bond tokens involves selling securities, it is the responsibility of the issuer to follow the appropriate laws and regulations governing securities business. It is very important to engage in-house and external lawyers who have a specialization in this field.

Here are the issues that should be dealt with:

Geo Limits: Look into the policies within each nation where you intend to make your tokens available. Understand that law is not the same everywhere.

Offering Memorandum: Certain jurisdictions will expect an investor or a prospectus to be provided for investment. Ensure that your answer is without omissions and all the facts required are stated.

KYC & Anti-Money Laundering Policies in Place: Ullage and KYC regulation are almost always compulsory. The names of your investors will have to be collected and checked.

Securing legal counsel from the outset will assist in managing these issues and help prevent breaches of regulations in the future.

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5. Set Up Smart Contracts 

Smart contract that has been coded and placed on the blockchain. Its significance is paramount in tokenization projects. For one such bond wherein tokens will be issued to every bondholder, this means that smart contracts will perform the tasks of generating and allocating tokens, paying dividends or coupons, and ensuring that the issued bond adheres to the country legislation.

Thus, when developing a smart cod, the following notes should be taken into consideration:

Token Issuance: State how many tokens will be generated, how these tokens will be allocated and to what privileges will the owning members have.

Compliance and Restrictions: Smart contracts could be programmed to automatically restrict token transfer e.g. to verified investors only.

Interest Payments and Redemptions: Bonds normally offer interest payments to the bond owners and have a fixed time of expiration. These smart contracts will assist in managing the payment of coupon and the redemption of the fractional ownership tokens at the end of the maturity period.

While the risks can be handled by an internal team, it is advisable to engage qualified external blockchain developers. Further, ensure that potential weak points found in smart contracts are corrected by engaging the services of independent computer security experts.

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6. Mint and Issue the Tokens

The only thing that remains is to mint program eligibility tokens after all the smart contracts have been developed. Minting refers to the creation of tokens on the blockchain, which will act as a share of your bond.

The process of token issuance by the issuer can be broken down into the following parts:

Smart Contract Initialization: Introduce the smart contract to the blockchain that has been completed.

Token Provisioning at the Beginning: Tokens will be minted, with respect to the bond’s value.

Distribute The Tokens To Your Address: At the start, the tokens will be kept by the issuer in their wallet, waiting to be issued to the investors.

Plan the sale of the newly created tokens: Establish in what manner the investors will acquire the tokens: by means of direct sale, a tokens offering or listing on the exchange.

Tokens can then be issued to initial investors, meaning that they will have fractional digital ownership in the bond.

7. Distribute Tokens to Investors

Once the tokens are created at the primary level, the subsequent action is to allocate them to the investors. At this level, the regulatory aspect becomes very essential as you will have to do the following:

Establish Procedures to Validate Investor Identities: Every single investor must be KYC and AML compliant to the required regulatory level.

Implement a Fair Process: State the specifics pertaining to the bond to be offered to the investors, even where the tokens come with certain restrictions.

Enforce Regulations: All token movements must be regulated to curb issuance of tokens without proper authorization especially if the bond is only meant for accredited investors.

In this case, you may opt for a token sale platform or an exchange dealing with security tokens, and the process will be conducted in an orderly and compliant manner.

8. List Tokens on a Secondary Market for Liquidity

In the end, if you want your bond to be fully liquid, you will have to list your tokens on a secondary market. This allows the investors to conduct buy and sell transactions on the tokens to their full extent in real time.

Some options to consider include:

Decentralized Exchanges (DEXs): Exchanges such as Uniswap allow users to trade tokens directly through the blockchain without a third party.

Security Token Exchanges: Some SIC exchanges like INX or tZERO are constructed with the purpose of security token compliant trading.

Market Makers and Brokers: For more significant bond token offerings, issuers may engage broker-dealers that may include market makers to enhance liquidity through buying and selling the tokens.

Do not forget that once your token is listed on a secondary market, it not only offers liquidity to the token but also increases the token’s exposure and may entice additional investors.

Conclusion: Embrace the Future of Finance

Bond tokenization is not just a cognitive process. Instead, it is a means of modifying a conventional financial instrument into a more digital, dynamic, and available resource. Within the 8 steps detailed in the guide, anyone can execute the process of bond tokenization and access a global market based on the blockchain technology. This brings about improved liquidity, lower costs of transacting, and a wider investor base accessible.

Similarly, With the evolution of the finance sector towards more digitalization, the idea of tokenized bonds provides an interesting avenue for both issuers and investors to engage with tomorrow’s finance.