How Security Tokens(Blockchain) Will Rip Apart the Finance World

Business Tech Top July 12, 2018
Security Tokens Disrupt Finance

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How Security Tokens(Blockchain) Will Rip Apart the Finance World

Let’s talk security tokens. What are they? Why do they matter? And why should you care? A security token has nothing to do with security in the form of protection, it’s relating to the use of the term in finance. A financial security is anything that’s backed by an asset and has an expected profit in the future. That applies to most companies or assets out there.

Security tokens are any blockchain based representation of a security that is subject to regulation under security laws. That includes tokens representing traditional assets like equity in a company, debt, derivatives or options, real estate, etc. And there are many reasons why you would want your security based on a blockchain rather than simply the traditional way of having a paper or deed or database that hold those records.

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Advantages of Tokens vs Traditional (Paper & Databases)

Fractional ownership – This is a massive benefit. Right now, the average person has very limited options when it comes to investing their money because most people don’t have enough capital necessary to make an investment in many different capital-intensive markets. One of the biggest examples being Real Estate. To invest in Real Estate, you’re going to need an absolute minimum of $100k in cash to get started, and even then that’s not going to get you very far, especially in the US and Europe. The only way for someone to invest in real estate with lesser amounts of money is by investing in Real Estate Investment Trusts (REITs). Those are typically giant pools of properties where you don’t get a choice in the selection of any individual property, and the managers of those REITs take fees just for allowing you to invest with them. But now with blockchain, if the owner of a house wanted to, they could create a Security Token Offering (STO), that represented the deed to the house and sell off tokens that represented fractional ownership. They could create 100 tokens that each represented 1% ownership in the house and sell them off to investors, which would allow people who don’t have large amounts of money to still be able to invest. And this goes for any type of investment that requires large amounts of capital, whether it be art (not that I have the faintest clue as to how one evaluates the worth of painting, good luck with that) or start up investing, or lending. There are countless investment opportunities that are currently cut off from 99% of the population that would become available if security tokens were used. Security Tokens can democratize the investment world, opening it up to everyone rather than a select few.

24/7 markets – Unlike the regular stock markets or many other trading markets, which are only open for a few hours on week days, a blockchain based market is fully accessible 24/7.

Reduction in fees and middle men – This is another colossal reason why security tokens bring massive value to the market. Banks, investment banks, and most finance companies make huge amounts of money by charging mediation fees. Money transfers, currency exchanges, every day purchases, all manner of things that people need to do with money have middle men built into the system who profit from charging fees. Many of those fees will decrease to near zero or actually be zero. This ranges across the consumer level, where a 3% fee is charged every time you use a credit card, to the multi-billion-dollar corporation level where companies pay investment banks like Goldman Sachs, Morgan Stanley, and like millions upon millions of dollars to act as middlemen in acquisitions, transactions, shareholder distributions, etc. We could see hundreds of billions of dollars in finance related fees globally drop by over 90%.

Rapid Transaction Settlement – Another benefit is the speed with which blockchain technology is able to settle transactions. This ties back into the middlemen. Right now, if you were to go buy a stock of a public company it typically takes 2 or 3 days for that transaction to settle because it has to go through layers of middlemen. It starts with your broker then goes to a clearinghouse, then through a stock exchange, through financial custodians, all people or companies that take time to process and take fees. On the blockchain your share purchase can be completed simply between you and the seller and be settled within minutes, not days.

Increased liquidity for everyone – This harkens back to the real estate example. If you want to sell a home it can take months to find a buyer because you need to find someone willing to pay say $300k-$400k for it. Yes, there are a lot of people buying homes but still the pool of people is very limited. This is why selling a home often takes months. If you were to split your home into say 100 or even 1000 tokens, then you could sell pieces of your home very quickly because it would only cost a few thousand dollars. The pool of people with a few thousand dollars to invest in Real Estate is much larger than one containing only people who can spend $400k. This allows for increased liquidity in the private equity market as well. When you invest in a startup or private company your shares are locked for years because buyers do not come around often unless the company is raising money or putting itself for sale. In a tokenized system an investor can sell their shares without affecting the rest of the company or other shareholders. It brings private markets closer to public companies in that advantage. Small business is the true driver of economies and through the use of security tokens they would be able to draw in more investment and gain access to liquidity like never before.

SEC Headquarters
The Securities & Exchange Commission(SEC) Headquarters.

Ease of regulatory compliance – This is something that is very understated. Security tokens may make compliance so frictionless that regulators begin requiring securities to tokenize. This is because the tracking and reporting of financial statements becomes MUCH easier when it’s on a public ledger, meaning regulators like the SEC can check in anytime with ease. This might sound farfetched that it be required, but the SEC made electronic filing online required back in 1996. The internet was still in its infancy when the SEC made every public company required to file online. They could do the same by making every company use security tokens, or at lease very strongly encourage it. When securities are tokenized, compliance can be automated and by integrating compliance into tokens it would greatly simplify the complexity that is selling shares on public international markets.

There are even more benefits but let’s discuss some real-world implications, and what we can expect to POSSIBLY happen, again none of this is guaranteed. But the list above are all problems that can be solved with security tokens.

STOs could take over the small cap stock market soon. For companies that expect to IPO and be worth over $500 million it’s not a massive burden to go public. But for companies smaller than that it’s very expensive and resource intensive. By filing for and STO instead they could gain access to public market investors and liquidity without having to go through the same burdensome and costly process that is filing for an IPO. I think it’s reasonable to expect many companies in the $50-$400 million range(valuation-wise) to opt for STOs instead. Which could cause a massive boon in the STO world.

In fact, in Australia’s version of the NYSE, the ASX, is creating a new decentralized exchange. They are very much interested in the opportunity that STOs bring. The ASX is a $2 trillion market cap exchange, it’s certainly not small potatoes and could be the proving ground for STOs over the next few years. Even Nasdaq here in the United States has discussed the possibility of creating a Nasdaq STO exchange for many of the tech companies that are worth hundreds of millions or billions of dollars but have chosen to remain private because of the IPO burden. If that were to happen you would see billions of dollars from institutional investors flooding into STOs.

That’s the real key here. STOs allow for large mutual funds, pension funds, sovereign wealth funds, and other groups that have trillions of dollars at their disposal to invest in crypto and blockchain based tokens. I’m not an advocate for regulation because it can more often hurt businesses rather than help, but this is the real path to seeing wide adoption of blockchain tech. By companies offering themselves up to regulation via STOs in exchange for getting access to the massive pool of capital that’s in large institutions.

In summary what you need to know about security tokens is this:

  • They simplify financial systems, removing the need for central coordinators and middlemen without sacrificing trust. In fact, they increase trust by enabling easier regulation and by removing potential bad actors from the system.
  • By removing middlemen costs are reduced greatly for everyday financial services, and transactions can occur almost instantly rather than taking days or months depending on what it is you’re trying to do.

All of this is to say that there’s a tremendous amount of value in this technology existing and becoming the new status quo, the question is how long it will take, and which platforms will be the ones that enable this.

**This is not investment advice, do your own research** I think the most likely platform to push this forward is Ethereum. It’s the largest and most widely adopted platform in the world that has the scale to accomplish such a task. Now that is not a guarantee, there will be competitors, but I think Ethereum will be one of the major players due to its ubiquity and proven ability to have companies and platforms be built on top of the Ethereum protocol already.

Now how long? I would expect that by the end of next year, 2019, we will see the start of STOs becoming a serious alternative to traditional methods. We will likely see some companies and possibly exchanges like the ASX begin taking advantage of STOs next year. The SEC in the US has already been reviewing and debating for months now how to properly regulate cryptocurrencies and blockchain ICOs/STOs, and I would expect that by the end of next year we will also see at least some framework for how the SEC plans to handle the regulation of security tokens. Once that happens the floodgates could open and 2020/2021 could be a time of mass transition towards the tokenization of the finance industry.