Structuring the Secondary Market for Security Tokens
Table of content
The secondary market plays a vital role in security tokenization by providing liquidity, price discovery, and exit opportunities for investors. Unlike traditional assets, which rely on centralized stock exchanges, security tokens can be traded on both centralized (CEX) and decentralized (DEX) platforms, depending on regulatory compliance and market structure.
When structuring the secondary market for security tokens, issuers must address key considerations, including:
Regulatory Compliance – Ensuring that trading meets securities laws based on jurisdiction.
Trading Mechanisms – Deciding whether to use a Centralized Exchange (CEX) or a Decentralized Exchange (DEX).
Liquidity Provision – Managing who provides liquidity and how price stability is maintained.
Investor Eligibility – Determining whether accredited investors or the general public can participate.
A well-planned secondary market strategy ensures regulatory compliance, investor accessibility, and sustainable liquidity, ultimately enhancing the tokenized asset’s value and marketability.
Key Types of Secondary Markets for Security Tokens
There are several trading options available for security tokens, each with distinct regulatory and liquidity characteristics:
CEX – Public Market
Security tokens are listed on a licensed, regulated exchange for public trading.
Open to retail and institutional investors.
Requires full prospectus registration and regulatory approval (SEC, ESMA, FCA, MAS).
Liquidity provided by issuers, market makers, and investors.
A tokenized real estate investment fund listed on tZERO or INX.
CEX – Private Market
Security tokens trade on a regulated private exchange restricted to accredited investors.
Accredited and institutional investors only.
Operates under Reg D (U.S.), Private Placement (EU, UK), or other exemption frameworks.
Liquidity provided by issuers and accredited investors.
A tokenized private equity fund trading on a private securities marketplace.
DEX – Issuer-Controlled Liquidity
Security tokens trade on a DEX, but only the issuer provides liquidity, ensuring compliance.
Whitelisted KYC/AML-verified investors only.
Requires a regulated securities-compliant DEX. No third-party liquidity providers.
Issuer creates a controlled liquidity pool for trading.
A tokenized commercial property is traded on a private security token DEX.
DEX – Open Market (Regulated Third-Party Liquidity)
Security tokens trade on a regulated DEX, where third-party investors can provide liquidity.
Open to public or accredited investors, depending on compliance.
Requires securities regulations allowing external liquidity providers.
Both the issuer and third parties can provide liquidity.
A tokenized commercial real estate fund trades on a regulated DeFi exchange.
Private Secondary Market (Restricted Trading)
Security tokens are transferred through P2P sales or controlled investor networks.
Accredited investors, private placements only.
Compliant with exemptions such as Reg D (U.S.) or Private Placement (EU, UK).
Limited liquidity, no automated market making.
A tokenized hedge fund is traded via private investor agreements.
Centralized Exchange (CEX) Trading for Security Tokens
Centralized exchanges (CEXs) operate as licensed, regulated platforms that facilitate the trading of security tokens under securities regulations.
CEX Trading Models
Public Trading (Full Prospectus Registration)
Requires approval from a securities regulator such as SEC, ESMA, FCA, MAS.
Open to retail and institutional investors.
Higher liquidity and investor trust but involves strict reporting requirements.
Accredited Investor Trading (Private Market)
Operates under Reg D (U.S.), Private Placement (EU, UK), or similar frameworks.
Limited to accredited and institutional investors.
Less regulatory burden but restricts market access.
Example: Public vs. Private CEX Trading
Investor Type
Retail & institutional investors
Accredited investors only
Regulatory Framework
Full securities registration required
Exemption-based trading (Reg D, Private Placement)
Liquidity Source
Issuers, market makers, third parties
Issuers, accredited investors
Trading Restrictions
No restrictions after listing
Potential resale limitations
Decentralized Exchange (DEX) Trading for Security Tokens
A Decentralized Exchange (DEX) enables peer-to-peer trading without intermediaries, using blockchain-based Automated Market Makers (AMMs) to facilitate liquidity provision.
Key Features of a Security Token DEX
Non-Custodial Trading – Investors trade directly from their wallets.
KYC/AML Compliance – Security token DEX platforms require whitelisted investors.
Smart Contract-Based Trading – Eliminates intermediaries and reduces costs.
DEX Trading Models
Issuer-Only Liquidity Pools
Only the issuer provides liquidity, ensuring compliance.
Prevents unauthorized secondary trading.
Regulated Third-Party Liquidity Pools
Issuers and investors can provide liquidity if regulations allow.
Increases liquidity but requires legal structuring.
Example: Issuer-Controlled vs. Open Market Liquidity in a DEX
Liquidity Source
Only the issuer
Issuers + external liquidity providers
Regulatory Consideration
Controlled trading, lower compliance risk
Requires specific legal framework
Investor Access
KYC-approved investors only
Broader investor participation
Liquidity Management
Fully managed by the issuer
Open to investor-supplied liquidity
Understanding AMMs, Slippage, and Liquidity Pairs in a DEX
What is an AMM (Automated Market Maker)?
AMMs replace traditional order books with liquidity pools.
Investors trade against liquidity pools instead of matching buy/sell orders.
Liquidity providers earn fees in exchange for supplying tokens to pools.
What is Slippage?
Slippage occurs when the executed trade price differs from the expected price due to low liquidity.
Higher liquidity reduces slippage, ensuring better price stability.
How Are Liquidity Pairs Created?
In a DEX, each trading pair (e.g., Security Token/Stablecoin) requires a liquidity pool.
The issuer must allocate security tokens and an equivalent stablecoin balance (e.g., USDC).
Example:
Issuer deposits 100,000 Security Tokens and $50,000 USDC into the pool.
Investors trade against this pool, ensuring continuous price discovery.
Liquidity Management Strategy for Security Tokens on a DEX
To ensure smooth trading and price stability, issuers must allocate tokens strategically:
Initial Liquidity Allocation – Reserve 10-20% of tokens for the liquidity pool.
Dynamic Pricing Model – Allow tokens to be minted/burned at a fixed price to stabilize volatility.
Regulated Liquidity Participation – Ensure only compliant investors can provide liquidity.
Example: Managing a Security Token Liquidity Pool
Who Provides Liquidity?
Issuer only
Issuers + compliant investors
Liquidity Size
Controlled
Market-driven
Regulatory Risk
Lower
Higher, requires legal framework
Market Stability
More predictable
May experience fluctuations
Selecting the Right Secondary Market Model
CEX trading provides maximum liquidity but requires full compliance.
DEX trading is viable if issuers manage liquidity and compliance.
Private secondary markets allow restricted transfers for accredited investors.
Legal consultation is crucial to ensure compliance with securities laws.
Last updated
Was this helpful?