Journal for Policy & Market Research

I. Executive Summary: The Tokenization Imperative and the Legal Nexus

The convergence of distributed ledger technology (DLT) and established securities law presents a transformative, yet legally complex, opportunity to modernize capital markets. This report analyzes the mechanisms required to confer stock ownership within a decentralized business structure, outlining the legal safeguards, technical standards, and operational architecture necessary to move corporate equity onto the blockchain in a compliant manner.

A. Strategic Transition to DLT-Based Capital Markets

Tokenization refers to the use of DLT to issue or represent assets in a digital tokenized form.[1] This movement is evolving rapidly from an experimental concept to a viable financing and trading option.[2] The primary driver is the modernization of issuance and trading, enabling 24/7 fractional trading of assets outside of traditional market hours.[2] Projections for the tokenized stocks market are significant, moving from a nascent valuation (around $424 million market cap as of mid-2025) to potentially surpassing $1 trillion, propelled by institutional adoption.[2] This rapid growth is supported by demonstrated institutional interest, with a 2025 survey indicating that 42% of institutional investors plan to begin investing in tokenized equities by 2026.[3]

B. The Fundamental Legal Hurdle: Security Status Confirmation

A Security Token (ST) is explicitly defined as a blockchain-based representation of a traditional security, functioning like any legally recognized financial instrument such as equity or debt.[4] Crucially, the process of applying a “digital wrapper” or assigning a new name (like “token”) to an asset does not fundamentally alter its legal classification or exempt the issuer from existing securities laws.[4, 5] Tokenized securities are subject to the same legal framework that has governed capital formation for decades.[5] Therefore, the issuance of tokenized corporate shares requires a “compliant-by-design” technological architecture that respects and enforces regulatory mandates from the point of creation.

C. Prescriptive Recommendations for Hybrid Decentralized Structuring

While Decentralized Autonomous Organizations (DAOs) offer an alternative model for member-owned, collaborative governance [6], the pure DAO structure inherently carries unacceptable legal risk. Operating with no intentional legal structure [7], a pure DAO exposes participants to potential unlimited liability under general partnership laws.[8, 9] Successful implementation of decentralized ownership over regulated corporate equity demands a hybrid structure. This approach, often referred to as “wrapping the DAO,” involves anchoring the smart contract-based coordination system to a formal, regulated legal entity.[7] This legal entity provides the necessary structure for regulatory liability, oversight, and accountability, while DLT is utilized for transparent and automated operational management.

II. The Regulatory Landscape of Digital Securities

The definitive classification of tokenized equity as a security is consistent across major global jurisdictions, necessitating adherence to established financial regulatory frameworks.

A. Defining Tokenized Equity under Global Frameworks

Security Token Offerings (STOs) involve the public or private sale of a security evidenced by a digital token.[5] The analysis begins by applying jurisdictional-specific frameworks:

• The US Howey Test Application: In the United States, the Securities and Exchange Commission (SEC) applies the Howey Test to digital assets to determine if they constitute an “investment contract.” This test focuses on the investment of money in a common enterprise with a reasonable expectation of profits derived from the efforts of others.[10] Regardless of the technological medium, tokenized, blockchain-based versions of stocks, bonds, or other securities remain subject to existing federal securities laws.[11]

• European Regulatory Architecture: Within the European Union, the MiFID II framework defines financial instruments, applying directly to tokenized equity and debt.[4] The Markets in Crypto-Assets Regulation (MiCA), while instituting uniform rules, specifically covers crypto-assets that are not currently regulated by existing financial services legislation.[12] Consequently, security tokens, being regulated instruments, fall under MiFID II. Crucially, the DLT Pilot Regime, in force since March 2023, provides a framework allowing market infrastructures to experiment with the trading and settlement of tokenized securities under specific regulatory exemptions.[4] This regime acknowledges that existing regulations, particularly those governing traditional centralized settlement models, are often structurally inadequate for native DLT operations such as instantaneous T+0 settlement. The regime thus functions as a regulatory sandbox, confirming that large-scale institutional adoption will likely require fundamental regulatory adjustments, not simply new interpretations.

B. Convergence and Progressive DLT Legislation

A significant observation in the global regulatory environment is the consistent preference for the function of the tokenized asset over its form (DLT versus traditional registry).[2, 5, 11] This technology-neutral approach dictates that if a token represents a share, it is treated as a security. This convergence provides necessary legal certainty for institutional market entry.

Progressive jurisdictions have implemented specific legislation to accommodate DLT:

• Swiss DLT Act: Switzerland has implemented a dedicated licensing category for DLT trading systems under its FMIA framework.[13] The DLT Act amended several pieces of legislation to clarify the legal treatment of tokenized shares and uncertificated register securities, offering a high degree of legal certainty for issuance and transfer.[13]

• Singapore (MAS): Singapore adopts a technology-neutral stance, ensuring that tokenized shares are governed under the existing Securities and Futures Act.[2]

C. Compliance Pathways for Security Token Offerings (STOs)

Issuance of tokenized equity in the U.S. necessitates that the offering either be registered with the SEC or qualify for an exemption from registration under the Securities Act of 1933.[8, 14] The most common exemptions utilized by security token issuers are:

• Regulation D (Reg D): Often used for private placements, particularly Rule 506(c). This permits broad solicitation and general advertisement, provided that the issuer takes reasonable steps to verify that all investors in the offering are accredited investors.[14, 15] Verification may involve reviewing documentation such as tax returns or bank statements.[15]

• Regulation S (Reg S): This exemption facilitates offerings made outside the United States, targeting non-U.S. persons.[14]

A significant challenge in private offerings is the mandated holding period for restricted securities. Tokens sold in an unregistered private sale typically require a lock-up period, often one year, before they can be sold publicly.[5] Blockchain technology provides an elegant solution here: the token can be “locked” using smart contract code, offering an enforcement mechanism superior to customary legends placed on paper certificates.[5]

III. Architecting the Decentralized Legal Structure: From DAO to Hybrid Entity

The core structural challenge for decentralized stock ownership is reconciling the transparent, automated nature of DLT with the requirement for centralized liability and regulatory adherence inherent in corporate law.

A. The Legal Status and Risks of Pure Decentralized Autonomous Organizations (DAOs)

DAOs function through smart contracts, enabling member-owned organizations to operate without central leadership, relying on collaborative governance via members’ voting rights on the blockchain.[6] While offering potential benefits like democratic decision-making and lower operational costs, the lack of an intentional legal structure in a “pure DAO” [7] poses severe legal risks.

In many jurisdictions, this legal vacuum means participants may be deemed partners in a general partnership, exposing all members to unlimited personal liability for the organization’s actions and debts.[8] Furthermore, a pure DAO structure struggles logistically to enforce the foundational requirements of securities law, such as performing Know Your Customer (KYC) and Anti-Money Laundering (AML) checks, or enforcing transfer restrictions.[8]

B. The Hybrid Model: “Wrapping the DAO” for Regulatory Certainty

The industry standard for achieving compliant tokenized equity is the adoption of hybrid arrangements.[7] This model deliberately centralizes the legal accountability while maintaining DLT for operational transparency and automated coordination.

• The Legal Entity Wrapper: The most prevalent structure involves establishing a traditional legal entity, such as a Special Purpose Vehicle (SPV) or a Limited Liability Company (LLC). This entity holds the underlying corporate assets or shares and issues tokens that represent claims against the legally accountable SPV.[16] The legal structure, defined by expert collaboration, ensures the digital tokens represent valid claims and comply with relevant jurisdiction-specific laws.[16]

• Digital Legal Entities: A sophisticated evolution involves an incorporated legal entity that officially integrates DLT and smart contracts into its operational and governance documentation, such as recording tokenized securities or on-chain shareholder resolutions.[7]

The necessary transition from a “pure DAO” to a hybrid arrangement highlights a fundamental paradox: to achieve the operational benefits of DLT (efficiency and transparency) for a regulated asset (equity), issuers must accept a defined degree of centralization. This shifts the focus from radical disintermediation to the automation of compliant intermediary functions through code, such as automating the verification steps typically handled by centralized parties.

The success of these hybrid structures relies heavily on governance layering: the corporate wrapper’s legal documents (e.g., bylaws) must precisely define how a vote executed on-chain via a smart contract—conferring voting rights on matters of corporate policy [6, 17]—is legally binding and recognized by the entity’s governing jurisdiction.

IV. Establishing Definitive Stock Ownership via Blockchain

Tokenization aims to replace traditional paper or book-entry records with an immutable, auditable digital record. The critical factor is establishing an authoritative legal link between the digital token and the real corporate share.

A. Legal Mechanisms for Chain-to-Share Linkage

Stock tokenization involves converting shares of a business (equity) into digital tokens, where each token conveys ownership rights akin to a traditional share, but managed electronically.[2] While earlier models often relied on the token representing a beneficial interest in an asset held by a custodian, the trend is toward native security representation. The most robust model aims for the token to represent the underlying share itself.[3]

B. The Role of the Regulated Transfer Agent

To ensure legal authority, the tokenized share must be integrated into the existing securities infrastructure. Modern, regulated models, such as those used by advanced platforms, anchor tokenized securities in U.S. securities law by utilizing an SEC-registered transfer agent.[3]

This transfer agent infrastructure continuously reconciles the on-chain tokens with the official, legally authoritative shareholder ledger (Cap Table), ensuring continuity with traditional book-entry requirements.[3] This structure is designed so that the tokenized shares are not merely wrappers, derivatives, or SPV claims, but the actual underlying shares represented digitally.[3] By linking the on-chain token balance directly to the mandated legal record keeper, the system achieves both the immutability of the blockchain and the enforceability of securities law, transitioning the blockchain from a mere parallel record to the legally authoritative shareholder ledger. This framework is crucial for attracting institutional capital which requires stringent regulatory assurances.

C. Cap Table Management Efficiency

DLT drastically improves the efficiency of managing the Capitalization Table. Traditional cap table maintenance can be costly.[18] DLT solutions automate numerous tedious procedures, including dilution modeling, vesting computations, and grant issuing, reducing manual effort and potential errors.[18, 19] Specialized DLT-friendly cap table software offers significant cost savings, with some platforms offering yearly subscriptions estimated to be 70%-80% cheaper than industry averages.[18, 20] This reduction in administrative overhead, including advanced features like waterfall analysis and financing rounds modeling [18], is a direct result of automation enabled by DLT.

The following table summarizes the legal classification of tokenized equity across key jurisdictions:

Table: Legal Status and Compliance Requirements by Jurisdiction

Jurisdiction/Framework	Classification of Tokenized Stock	Key Regulatory Compliance Point	Supporting Source
US (SEC)	Security (Investment Contract, subject to Howey)	Must use registered offerings or exemptions (Reg D, Reg S); KYC/AML enforcement via token standard and transfer agent.	[3, 10, 11, 15]
European Union (MiFID II/MiCA)	Financial Instrument/Security (MiFID II); MiCA covers non-security crypto-assets.	Subject to DLT Pilot Regime for market infrastructures; adherence to prospectus requirements or exemptions.	[4, 12]
Switzerland (DLT Act)	Legally defined DLT-based assets (Uncertificated Register Securities).	Licensing for DLT trading systems; provides legal certainty for issuance and transfer.	[13]
Singapore (MAS)	Security (Governed under existing Securities and Futures Act)	Technology-neutral approach; must comply with prospectus requirements or qualify for private placement exemption.	[2]

V. Technical Standards and Compliance Automation

The necessity of complying with securities law mandates the use of specific, permissioned technical standards that integrate regulatory controls directly into the smart contract code.

A. Mandating Compliance via Smart Contracts

A digital token’s behavior is dictated by the rules encoded in its smart contract.[21] For a security token, this requires moving beyond generic, permissionless token standards, such as ERC-20, which lack the features necessary for regulated assets. The future of compliant tokenized equity lies in standards built specifically for regulatory adherence.

B. Deep Dive into ERC-3643 and Permissioned Token Architecture

New standards, such as ERC-3643, are specifically designed for Real World Asset (RWA) tokenization and have garnered attention from institutions due to their comprehensive compliance features.[21]

• Permissioned Transfers: ERC-3643 tokens are inherently permissioned. Every transfer requires the smart contract to verify the eligibility and identity of both the sender and the receiver.[22]

• Integrated Compliance: This architecture implements critical compliance measures directly at the smart contract level, including KYC/AML status verification, investor accreditation checks, jurisdiction-specific trading limitations, mandatory holding periods (lock-ups), and transfer limits.[22] This structure ensures that regulatory compliance is baked into the code itself.[23]

• Token Lifecycle Management: The standard supports necessary administrative functions that govern corporate oversight, such as issuance, redemption, minting, and the critical ability to temporarily freeze or stop transactions in response to legal or regulatory mandates.[22]

This approach to coding compliance into the token contract essentially automates the role traditionally played by human compliance officers in vetting transactions.[22, 23] The consequence is that regulatory risk shifts from operational laxity to the auditability and security of the underlying smart contract code, making a globally recognized and highly audited standard a market prerequisite.

C. Automated Corporate Action Management

Smart contracts automate critical corporate actions inherent to stock ownership, enhancing efficiency and transparency.

• Smart Contract Dividend Contracts: Smart contracts are the core mechanism for on-chain dividend distribution.[24] These automated agreements execute when predefined conditions are met, automatically calculating and distributing the correct amount to each token holder’s digital wallet based on their holdings.[19] This automation streamlines the payment process, minimizing administrative overhead, ensuring accuracy, and providing verifiable transparency through the blockchain’s public ledger.[19] Tokenized equity can thus seamlessly confer cashflow and dividend rights.[17, 24]

• On-chain Voting Mechanics: For governance, programmable blockchain protocols are used to automate decision-making processes.[8] Tokens confer voting rights on matters of corporate policy.[6, 17]

The industry’s embrace of complex, compliance-focused token standards, coupled with the rising prominence of institutional infrastructure providers like Securitize (which recently went public with a valuation of $1.25 billion [25, 26]), signals a significant market maturation. The strategic priority is no longer maximum decentralization, but Regulatory Integration, utilizing DLT to execute the law more efficiently and transparently.

VI. Operational Benefits, Cost Efficiencies, and Market Dynamics

Tokenized equity provides compelling economic arguments for adoption by offering solutions to the structural inefficiencies and high costs pervasive in legacy capital markets.

A. Efficiency in Securities Settlement and Risk Mitigation

DLT fundamentally addresses the multi-day settlement cycles (T+2/T+3) common in traditional markets by facilitating near-instantaneous, atomic settlement (T+0).[27, 28] This velocity drastically reduces replacement cost risks and counterparty exposure associated with uncleared trades.[28] The ability to see real-time positions on a DLT-based system allows for more frequent and precise margin calculation, enabling incremental improvements in margin and default fund management.[28] Furthermore, tokenization supports asset fractionalization, which permits a larger pool of investors to participate, significantly increasing accessibility and market liquidity for previously illiquid assets.[16, 29, 30]

B. Quantitative Cost Reduction Opportunities

One of the strongest economic arguments for DLT adoption by traditional finance is the vast cost inefficiency of legacy infrastructure. Reports indicate that European Central Securities Depositories (CSDs) are notably expensive; European settlement fees are, on average, 65% higher than in North America.[31] Moreover, European CSD custody fees (safekeeping charges) are disproportionately high, ranging from 19% to 650% higher than those in the US.[31] DLT-based settlement systems fundamentally challenge this high-cost, opaque environment by allowing transactions to bypass many layers of middlemen (custodians, CSDs).[27, 28] Beyond settlement, tokenized solutions for capitalization table management offer demonstrated cost-effectiveness, with specialized platforms yielding potential yearly subscription savings of 70%-80% compared to traditional service providers.[18, 20]

The documented complexity and high costs of CSDs serve as the critical economic impetus for DLT adoption. If DLT can reliably achieve high efficiency and low costs per transaction [28], it will force existing market infrastructures to adopt or integrate DLT capabilities to remain competitive.

C. Market Dynamics and Institutional Adoption

The tokenized assets market is exhibiting high growth potential.[2] Key early successes demonstrating technical and legal feasibility include Overstock.com’s issuance of the first blockchain-based stock in a public company in 2016 [2], and Aspen Digital’s tokenization of private equity ownership in the Aspen Resort, which successfully delivered fractional ownership and liquidity.[16]

The recent public valuation of Securitize at $1.25 billion via a SPAC merger, positioning it as the first publicly traded company built entirely around tokenizing real-world assets [25, 26], confirms institutional confidence in the tokenization infrastructure space. While fractionalization benefits retail investors [29], the strategic impetus for the tokenization movement is largely driven by the desire to integrate with traditional finance and attract large-scale institutional capital.[9] This strategic focus ensures that the structures being developed prioritize institutional-grade risk mitigation and compliance frameworks.

Table: Comparative Analysis of Traditional Securities vs. DLT-Based Tokenized Equity

Feature	Traditional Equity (CSD/Broker Model)	Tokenized Equity (DLT Model)	Quantitative Efficiency Gain/Risk Profile	Supporting Source(s)
Settlement Cycle	T+2 or T+3; requires clearinghouses/custodians	Near-instantaneous (minutes); atomic P2P transfer	Significant reduction in counterparty risk; T+0 achievable.	[27, 28]
Administrative Cost (Cap Table)	High, complex fee structures (e.g., up to $10,800 annually for 100 shareholders)	Highly automated, streamlined management solutions	Potential cost savings of 70%-80% on yearly subscription fees.	[18, 20]
Settlement/Custody Costs (EU)	High CSD fees (average €0.38 per instruction); 19%-650% higher custody fees than US.	Potential for DLT to drive costs substantially lower through disintermediation.	EU settlement fees are 65% higher than North America, demonstrating cost urgency.	[31]
Compliance Enforcement	Manual verification; paper-based legends; intermediary management.	Compliance coded into token (e.g., ERC-3643); automated KYC/AML/lock-up checks.	“Compliant-by-design” reduces transfer violations and operational overhead.	[5, 22, 23]

VII. Risk Mitigation, Tax Obligations, and Future Challenges

While offering significant efficiencies, decentralized tokenized equity introduces unique legal and operational risks that must be proactively managed, particularly concerning the irreversible nature of blockchain transactions and complex tax compliance.

A. Legal and Systemic Risks

Regulatory uncertainty, though decreasing, persists.[1, 9] Tokenization carries inherent regulatory risk, especially if issuers are perceived as attempting to bypass established securities laws.[5, 9]

A major operational concern is the reliance on smart contracts. Transactions may be irrevocable [9], and the complexity of real-world legal agreements means that smart contracts cannot reliably cover all possible scenarios.[9] This necessitates stringent smart contract legal review and audit prior to deployment.[11] Furthermore, DLT systems present higher cyber and operational risks than traditional assets.[29] Proactive identification and mitigation of emerging risks are foundational to safeguarding market integrity.[32]

B. Tax Compliance for Tokenized Equity

Tax compliance remains a complex and mandatory requirement. The IRS treats digital assets, including cryptocurrency, as property.[33] This classification dictates that sales, exchanges, or uses result in taxable capital gains or losses.[33, 34] Income derived from tokenized stock, such as dividends, is taxed as ordinary income.[34]

Issuers and trading platforms face mounting regulatory pressure to comply with new IRS tax rules, including the issuance of Form 1099-DA.[35] Generating this form requires managing accurate W-8/W-9 records, determining withholding obligations, tracking transactions, and executing complex cost basis calculations.[36] The complexity of tracking these events across a decentralized ledger mandates the use of specialized technology solutions, such as GainsKeeper or Sovos.[35, 36] These solutions are necessary to support advanced features required for tokenized securities, including wash sales, basis adjustments related to the underlying security, and corporate actions.[35] The reliance on specialized traditional tax compliance software that can ingest DLT data demonstrates that the tokenization ecosystem is not a standalone DLT solution but a System of Systems, where compliant tax reporting is the final prerequisite for institutional viability.

C. Control and Decentralization Trade-offs

The high stakes of securities law, coupled with the need for investor protection and enforcement, inherently compromise absolute decentralization. The requirement for token standards to include functions like freezing or stopping transfers [22], and the necessary reliance on a legally accountable wrapper, confirms that institutional-grade risk mitigation requires sacrificing pure trustlessness and immutability. Legal and regulatory mandates take precedence over technological purity.

Table: Critical Risks and Mitigation Strategies for Decentralized Tokenized Equity

Risk Category	Observed Risk/Challenge	Mitigation Strategy	Relevant Data Insight
Legal/Regulatory	Regulatory Uncertainty and Potential for Bypassing Securities Laws	Adopt hybrid legal entity structure (LLC/SPV wrapper); utilize regulated transfer agents (Centrifuge model).	Tokenization risk may bypass securities laws, risking market trust.[9] Tokens remain subject to existing securities laws.[3, 11]
Operational/Technical	Smart Contract Limitations and Irrevocable Transactions	Use standardized, audited smart contracts (e.g., ERC-3643); incorporate lifecycle management (stopping/freezing) and human oversight for critical functions.	Smart contracts cannot cover all scenarios; transactions may be irrevocable.[9, 22]
Financial/Market	Increased Volatility and Market Panic (Retail Investors)	Enforce investor accreditation and suitability checks (Reg D, KYC/AML); restrict trading to regulated secondary venues.	Tokenized assets expected to attract retail investors prone to panic.[29]
Compliance/Tax	Difficulty in tracking tax liabilities (Dividends, CGT)	Integrate with automated tax compliance solutions (1099-DA support); ensure transparent recording of corporate actions and cost basis.	New forms (1099-DA) require advanced reporting solutions; digital asset income is taxable.[34, 35]

VIII. Conclusion and Strategic Recommendations

The use of blockchain to confer stock ownership in a decentralized structure is technically viable and economically compelling, provided the inherent legal friction between decentralization and regulatory accountability is resolved through sophisticated structural design. The future of tokenized equity lies in compliant automation, not regulatory arbitrage.

A. Best Practices for Issuers of Decentralized Tokenized Equity

Issuers must adopt a highly prescriptive and integrated strategy to ensure the legal integrity of their offerings:

1. Prioritize Legal Structure: The issuance of a security token must be anchored by a regulated legal wrapper (Hybrid DAO model) to maintain corporate liability, facilitate legal enforcement, and provide regulatory accountability.

2. Mandate Compliance-by-Design: Issuers must utilize advanced security token standards, such as ERC-3643, that hard-code essential compliance features—including KYC/AML verification, transfer restrictions, and administrative freeze functions—directly into the token contract itself.

3. Establish Authoritative Linkage: It is critical to engage regulated SEC-registered transfer agents to ensure continuous reconciliation between the on-chain registry and the official shareholder ledger. This step verifies the token as the definitive, legally recognized record of share ownership.

4. Integrate Tax Infrastructure: Specialized, integrated software solutions must be implemented to manage the complexities of digital asset transaction tracking, cost basis reporting, and automated generation of required tax forms, such as Form 1099-DA.

B. Outlook on Market Maturation and Institutional Adoption

The trajectory of tokenized equity confirms a strategic pivot toward regulatory integration. Legal convergence is stabilizing the regulatory environment, encouraging increased institutional capital flow, driven by the substantial, proven efficiencies achievable in cost reduction (70-80% savings in cap table management) and operational speed (T+0 settlement). The primary competitive advantage of DLT in this domain is its capacity to deliver compliant, highly efficient, and auditable automation across the entire lifecycle of a security. This systematic modernization is positioning tokenized equity as a foundational component of the next era of global capital markets.

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12. Markets in Crypto-Assets Regulation (MiCA) – | European Securities and Markets Authority, https://www.esma.europa.eu/esmas-activities/digital-finance-and-innovation/markets-crypto-assets-regulation-mica

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19. Top Smart Contracts for Easy Dividend Contracts – Nadcab Labs, https://www.nadcab.com/blog/dividend-contracts

20. 5 Best Cap Table Management Software 2025 | Cheqly, https://cheqly.com/best-cap-table-software-startups/

21. ERC-20 vs ERC-3643: Definitions, Key Features & Use Cases, https://medium.com/mvl-ecosystem/erc-20-vs-erc-3643-603f34e57121

22. ERC3643 vs ERC1400: Understanding Token Standards for Security Tokens – Rejolut, https://rejolut.com/blog/erc3643-vs-erc1400/

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24. On-Chain Dividends: Distribution Methods – RWA.io, https://www.rwa.io/post/on-chain-dividends-distribution-methods

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36. Sovos 1099-DA Reporting, https://sovos.com/trr/products/tax-reporting/sovos-1099-da-reporting/