What Can Tokenized Securities Do for You?

The future and present state of the tokenized securities offering.
FROM THE ARCHIVE CIRCA 2023

A decade ago the birth of Bitcoin opened the world to a revolutionary wave of financial disruption, or better stated, financial improvement. Blockchain, The technology that drives bitcoin, has truly transformed our vision and approach to a surplus of problems ripe for improvement. With the introduction of Blockchain technology, innovators across nearly all sectors have completely changed their way of thinking. They are building new business models and structuring the foundation of what is certain to replace the entirety of our current financial system.

The business model disruption that came with the advent of the internet is all too familiar when viewing the blockchain industry from a high vantage point. In the early days of the internet, “the mass consumer base” faced a steep adoption curve. Investors analyzed the companies in this new space as just traditional investments of the time. Few users or investors saw the transformation and evolution of accessible, available information that came through the companies of the time. This vanguard expanded faster than anyone could have predicted across this new thing called the web. This would become known as “the internet of information”

Over the last 10 years Blockchain technology has been applied to nearly every industry and has in turn enabled “the internet of value”. While this technology has provided the basis for incredible innovation outside of the financial sector, many believe blockchain’s most transformative and lasting applications lie in the ground breaking re-imagining of the financial system and it’s products.

Unlimited potential and endless possibilities.

No one could have imagined what would come of the internet or how quickly it would develop and drive everything that we touch today- from simple emails to complex, elegant, yet powerful phones that can connect you to everything in an instant. Satoshi Nakamoto, the anonymous creator of Bitcoin, likely never could have imagined the way that his technology would inspire innovation as it has over the last 10 years. This is likely still blockchain’s first chapter; the new infrastructure being built with blockchain today will shape the financial world of tomorrow.

Imagine money, stocks and financial products with built-in trust, rules, regulations, and standards that can automatically(automagically) execute items, and tasks while protecting its users without the excessive need of third parties, or vulnerable centralized database authorities that we rely on in today’s economic system.

There is a need for the system to resist human error through technologies. That being said, a human touch will always be required, as well as governing regulations to attune these systems to properly fit and protect the people.

The traditional system is fragmented, built on slower, higher cost systems which cause friction, resulting in a higher cost of operation. The every day user experiences these costs in the form of various fees or inflated membership costs for our financial services. This is something that can be mitigated through better technologies and this “savings” will be passed on to the user through competitive businesses working to take market share.

Faster, Cheaper, Easier, and more secure.

Let’s do a short catch up on blockchain based securities. The digitization of securities has been coined with many terms; Initial Security Offering (ISO), Security Token Offering (STO), Digital Asset Security (DAS), Smart Security Offering, (SSO), Digital Security Offering (DSO) and more.

These terms are all used interchangeably to refer to a tokenized asset that is designed to comply with rules and regulations in one or more given regions. Tokenization is the process of converting the rights and interests, in and to an asset, into a digital token on a blockchain. The token represents a digital, programable, un-certificated ownership in an asset or company.

While the terms vary, the leading companies in Security Tokenization are of one mind and voice. They boast that flexible tokenization technology allows for the digitization, fractionalization, and globalization of individual assets allowing for lower cost of capital formation, lower investment minimums, higher numbers of participants, reduced liquidity premiums and greatly increased market depth. The security benefits provided by transparent blockchain secured ledgers will prevent innumerable database or human errors that often lead to massive losses. The combination of benefits depend on an individual offering’s choice of regulation.

Incremental or exponential growth?

Jump in the time machine- the creation of the New York Stock Exchange (NYSE) in 1817, the emergence of the spreadsheet and electronic trading with the creation of NASDAQ in 1971, and the subsequent race of incremental technological improvement. Improvement built on that system launched more than 2 centuries ago. Roughly 20 years ago, brokers on Wall Street talked about T5, a leap in progress for clearing trade transactions in just 5 days, presently we are at T2 in the traditional system (2 days). Now with the implementation of blockchain tech into trading systems we can clear these trade transactions in just seconds without the risk of the human error prevalent in our current system; a system driven and validated by the reconciliation of simple databases held by each major party involved in a trade.

Let’s paint a picture; The U.S. stock market capitalization is currently $34 trillion, compared to the rest of the world’s $44 trillion capitalization. The U.S. contains 43% of world market value, but it houses only 17% of the world’s stocks. Aggregate global wealth rose by USD 14 trillion to USD 317 trillion in 2018. The Global Private Equity Markets are currently valued at just over $70 trillion, while gold sits at $8 trillion, and global real estate sits at $228 trillion, not to mention the Global derivatives market. The effect of the blockchain and tokenized securities will gradually migrate these markets into a better system.

Imagine, across all of these key financial sectors, the amount of value lost to; a fragmented business, inefficient systems, hindered liquidity, human error or just a simple lack of access.

A lower barrier of entry for investors of all types

Due to regulation that lead to a high cost for an asset or company to “IPO”, publicly accessible investments have been reserved for top level companies within the fortune 1000.

Innovators in the tokenization of company offerings and financial assets have targeted the private securities market, it has unanimously been identified as the market with the greatest potential gain to be seen through the technologies implementation. By enabling the fractionalization of a private security while increasing the assets efficiency and adding the ability to self manage, and even self regulate, “going public” has never been more attractive or cost effective. I will discuss the token protocols that support this revolutionary change in a future article.

Why is this the case?

Let’s talk technicalities… Tougher regulations have contributed to a private equity boom, The most reported among these regulations is the Sarbanes-Oxley Act (SOX). Section 404 of SOX, requires external auditors to report on the adequacy of a firm’s internal controls, which in turn hurts smaller companies and assets seeking public offering status. This requirement alone is costing them 6x more in accounting fees compared to larger firms, according to estimates by the Securities and Exchange Commission (SEC). Prior to Enron and the SOX being enacted, the average age of a company at the time of its’ IPO was 3.1 years. Today, about 13.3 years, reported by S&P Global Market Intelligence. This means fewer public companies and fewer public investor opportunities.

According to the data provided by InvestX Capital, private market investments, dominated by VC firms and Accredited individuals, averaged 3–4% higher returns than the S&P 500 index.

This means that investors like you and I have virtually no access to companies during their growth phase where, these companies, and investments in them, mature much faster with a greater average of return.

These private market investments by the numbers far out perform stocks and bonds accessible through publicly traded stocks and indices.

Focus on these private securities for a second; a largely inaccessible market that contains everything from tech companies to real estate to media and entertainment assets. Assets like these are private for many reasons but most often it is the cost of taking it public and the maintenance surrounding ongoing compliance of the asset. According to United States regulations drafted and enforced by the SEC the majority of these assets would fall under Regulation D offerings and in many cases are only accessible to a limited number of individuals that qualify as Accredited Investors. This represents an incredibly small portion of the population, while these regulations are here to protect investors like you they create a few problems with the traditional technologies in use; cost of IPO leads to fewer public assets. These accessibility issues lead to the limiting of liquidity, which leads to a loss of asset value in its secondary trading market. This “liquidity premium” comes at a hearty cost to the investor, often 15–35%. This Liquidity premium could be mitigated entirely through a new system like “Tokenized Securities” built with blockchain technology.

The IPO has been redefined and Wall Street is catching on fast!

In 2017 the Initial Coin Offering (ICO) flooded the scene with incredible success, raising billions for blockchain and crypto currency projects. The ICO experienced so much success in fact that it became evident to regulators that this market needed immediate attention. Over the last 2 years regulators have entered the main stage. Quickly the issuers of these ICO’s scrambled to either; justify their position as “not a security” or file retroactive exemptions with the SEC and other regulators around the world. Throughout 2018 this served the industry by cleaning up the rampant stampede that resulted in the scams and chaff being cut out and in turn allowing for a new compliant, results driven mindset to take hold with leaders and innovators in the industry.

The Digital Securities offerings we see today have emerged on the radar of nearly every major player in the financial world. Apart from the ICO the STO is a clear redirect toward compliance and thus security Ofer the company and its investors. This evolution in capital formation has already created new opportunities for companies, issuers, and broker-dealers to build financial products in new ways and reach more investors than ever before. The ability to bring secondary market trading with a higher level of liquidity from expanded access will forever change the way securities are built.

William Hinman, director of the SEC’s Division of Corporation Finance, on June 14, 2018 at the Yahoo Finance All Markets Summit made one of the most important speeches on blockchain to date, declaring that “tokens from a network at least as decentralized as the Bitcoin and Ethereum networks were on June 14, 2018 are not securities”. We follow the guidance from this speech as the “Hinman Standard” an informal direction on what is “Sufficiently Decentralized”. This informal standard along with the supreme court’s Howey Test (1946), that was designed to determine what is or is not an “investment contract”, currently provides the clearest framework for these companies and networks today. For any network, token or application to fall safely within regulations it must determine wether it is sufficiently decentralized by these standards, if it is not, or if it will not be in the near future then it falls under the SEC’s jurisdictions. Check a networks users, are the majority there for the functional use of the token or the speculation of it? Is the network live, and if so is it sufficiently decentralized? more on this in one of my upcoming articles. In 2019 the industry looks to the SEC to bring this informal guidance into a formal stance.

SO… What can Tokenized Securities do for you?

Tokenization is not an incremental improvement to an existing system. The benefits are exponential in effect. Whether you are an asset issuer, a company seeking capital, an investor looking for strong returns, or just a consumer curious about how the shifting landscape will inevitably affect your bottom line, tokenized securities leaps our economic footing into a more stable, efficient and reliable position on every meaningful front. A tokenized economy is an inevitable eventuality. Those shaping the technology today will affect all of us tomorrow. Whether the regulators stifle innovation or enable it could immensely effect any given nations position in the global financial markets likely for generations. It is my belief that a tokenized, blockchain driven, economy will be safer, more accessible, transparent, and more cost efficient than the systems we rely on today. This will have a crucial effect on not just companies, but an individuals equality and wealth opportunity. Get involved, regulators and innovators need your voice.

Contribution, Feedback and Editorial thanks to
Ben Apple, Tyler Evans, Peter Chawaga, and Andi Whiskey

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