At a recent crypto event in London, a quote flashed up onto the screen stating, “2019 is the year for Tokenized Securities,” and certainly the numbers being quoted about firms looking to list securities suggest that we are going to see a lot more coverage of the tokenized securities market. In the crypto world we have been here before, very recently, with initial coin offerings (ICO).
Why are security token offerings (STO) so fundamentally different? ICOs dominated media coverage between 2016-2018, and their rise in popularity was matched only by the speed of their fall. Whilst some projects were undoubtedly ground-breaking, the majority were not. All were underpinned by tokenomics, a pseudoscience of future consumption and demand that was elevated to the status of academic relevance.
Unfortunately, the reality is that the majority of these projects have failed and investors’ capital has been lost as a result. What then can we learn from recent history and use to guide the development of the tokenized securities market?
Here are my pointers:
First, hype does not equate to quality. Businesses can pay for coverage in certain media outlets, but these mastheads serve the advertising company’s interests far more than their readers’ benefit. Free from the security of independent journalists, a company can make any number of claims about a product or service.
The antidote is to look at the business offer, management team and their background and experience.
Ultimately, the question is: are they qualified to deliver on their forecasts? In talking about the crypto market, too often we hear that people under 35 do not buy securities and prefer to buy cryptos. Wind the clock back to 1999-2000, and the same claim was made around buying the stock of internet and web-technology companies rather than solid blue chips.
It was hype then, and it is hype now. People of any age buy securities, if they can see value. The protection that securities regulation brings to capital raises for companies developing and deploying this new technology should make STOs more attractive to investors rather than less so.
So, my second point is regulation. Securities are regulated financial instruments, and the regulation has existed for a long time to protect the rights of the investor. Any firm coming to market with a tokenized security that is not subject to regulation should be avoided, particularly if they claim they don’t need it. Regulation is there, it is well understood and institutions such as the SEC act to make the market work, for the good of all. In the U.S., the securities regulations that can be applied to STOs are more than fit for purpose. The debate should focus on clearing requirements and the use of blockchain, which brings me to my third point.
What is the blockchain application in a tokenized security market? The opportunity for the growth of the tokenized market is to be able to settle trading accounts instantly on the blockchain without the need for third-party intermediaries. The benefit for consumers is that less of their money is eaten up in administration fees. As a tokenized security can represent ownership in a company or other asset, the opportunity for the STO market, is to provide direct access (for retail investors) through fractional ownership to asset classes that were formerly only available to institutional investors.
Real estate is a key application of this tokenization process. In the future, we will see an increasing number of other illiquid asset classes, such as commercial aircraft for example, being fractionalized with tokens that could represent ownership, income or appreciation rights.
The critical consideration in all of these cases is that the STOs that are created will have the prospect of secondary market liquidity, and that really is the fundamental change that blockchain technologies and the new STO market infrastructure promises to deliver. The tokenized security market should be treated as any regulated market, with good governance acting to support the investor. The role of blockchain should be recognized for what it is; a trusted, efficient mechanic for processing trades.
It is, theoretically, a better way of doing business but there are caveats: can trades be processed at speed? Can operations and smart contracts be delivered cost efficiently and in compliance with international securities laws? All of these need to be proven before we get mass adoption.
While ICOs underpinned by the ERC20 protocol helped put blockchain on the map and certainly helped create a global retail investor market they should really be viewed as blockchain’s initial public outing and version 1.0 of blockchain’s potential applications.
The advent of tokenized securities issuance and trading will establish blockchain as a viable technological platform to build a Securities 2.0 capital markets system. This will not replace the existing multi-trillion dollar marketplaces in the near future, rather it will act as a parallel evolution of the existing framework, with the exciting prospect of increased efficiencies, reduced costs and greater access to capital on a national and international basis.
