Julianne Sloane

@juliannesloane

Can security tokens fulfill their promise of liquidity?

The security token liquidity hype is in full swing. Time and time again we hear: tokenization makes illiquid assets liquid. But just how much is security token liquidity a reality versus a dream?

I’ve decided to address this question by addressing 3 main areas:

  1. How do security tokens create private asset liquidity?

2. What is the state of liquidity for security tokens today?

3. What could security token liquidity look like in the future?

TLDR: Liquidity is coming, but it is not here (yet).

How do security tokens create private asset liquidity?

Liquidity is the ability to turn an asset into cash. Private securities have traditionally been highly illiquid. Take real estate for example. Even if you woke up determined to sell a property, you even had a buyer ready, it would still most likely take weeks if not months for a deal to close. Tokenized real estate on the other hand, you wake up one morning wanting to sell a property — you could complete the deal in minutes.

Tokenized private securities can be traded on the secondary markets without the administrative burdens of traditional private securities. Blockchain technology can create a simplified, automated transfer of ownership while still adhering to traditional private securities laws.

Harbor, one of the leading technology companies in the securities tokenization space outlines in their whitepaper the current market inefficiencies that create illiquidity of traditional private securities:

“Secondary trading of private securities often requires various middlemen (such as brokers and exchanges). In addition, the process for tracking trade activity is manual and costly, and there is a significant burden on issuers to safeguard against potential regulatory risk. These inefficiencies can often lead to issuers imposing trade restrictions, making private securities illiquid. To account for the lack of liquidity, the value of private securities is discounted (i.e. the “illiquidity discount”), preventing issuers from capturing the full value of the underlying asset.” Harbor Whitepaper

Their white paper even has this nice little diagram about it:

Blockchain technology holds the potential to solve this market inefficiencies via security tokens. The full scope of securities compliance and regulation can occur ‘on chain.’ All the necessary AML/KYC checks, investor accreditation checks, compliance checks in both the buyer and seller’s jurisdictions. Automatic integrations with institutions such as broker-dealers, custodians and transfer agents can allow these trusted intermediaries to execute their necessary roles without any friction.

Blockchain and security tokens create liquidity while remaining cost effective as they reduce administrative burden and eliminate middlemen.

Jamie Lynn, Co-Founder and President of Securitize, another security token market leader says:

“I have little doubt the future will be tokenized. I don’t know when it will happen … This is just fundamentally better.” Source

What is the state of liquidity for security tokens today?

A lot of people have promised a lot of things, but actual data backed proof of security token liquidity is not really here.

On June 28, 2018 OpenFinance was the first security token exchange to launch. OpenFinance brings liquidity by providing a compliant and efficient trading platform for security tokens.

In a letter from their CEO, he declared:

“Beyond just security token trading, OpenFinance Network has set out to fundamentally change how issuers and investors alike work with alternative assets. Our goal is to democratize finance and disrupt financial markets as we know them today.” Source

OpenFinance’s launch marks a major development in the security token ecosystem as it is the beginning for security token trading to be tested in the real world. While initial trading volume for OpenFinance has not been announced — their CPO Thomas Mcinerney stated in the OpenFinance Telegram channel that they “had a lot more signups than expected.” Demand is there.

While OpenFinace is the first to launch, it is by no means the only company in the security token exchange space. There are some major players that are trying to take a chunk of the security token trading pie — a good news for liquidity sake.

Some honorable mentions:

Coinbase:

Coinbase, you know, that unicorn with tens of millions of users, announced in June their intention to operate a regulated broker-dealer. In a blog by their President & COO, Asiff Hirji he explained that they have already acquired a broker-dealer license (B-D), an alternative trading system license (ATS), and a registered investment advisor (RIA) license. They hope to work alongside regulators to tokenize existing securities bring benefits such as: 24/7 trading, real-time settlement, and chain of title.

Bnk to the Future:

BnkToTheFuture is an exchange that has been trading since 2015. They have raised over $300 million over three years from more than 50,000 qualified investors, accredited investors, from the U.S. They are now focusing on security tokens.

In February, 2018 they raised an additional $33M to build a decentralized security exchange. Their goal: launch a compliance-driven, Blockchain based and transparent liquid secondary market for securities. They have a goal to launch by the end of 2018. View their token offering page: https://bf-token.bnktothefuture.com/

tZero:

tZero, a subsidiary of Overstock.com is building a security token exchange designed to trade security tokens in an “easy, compliant, and user-friendly manner.” They believe they will be instrumental at bringing greater efficiency and transparency to capital markets both in the US and abroad. Investors have noticed, during tZero’s Security Token Offering they raised 134 million. Furthermore, in August 2018 Chinese private equity firm GSR Capital announced they would lead a 270 million investment in tZero.

Swiss Stock Exchange:

In July 2018, the SIX Swiss Exchange announced their latest initiative — called the SIX Digital Exchange (SDX) — their first goal is to build up a regulated exchange platform. Their goal: have a full end-to-end and fully integrated digital asset trading, settlement and custody service.

According to Thomas Zeeb, Head Securities & Exchanges, SIX,

“The digital space currently faces a number of key challenges. These include the absence of regulation that ensures official safety, security, stability, transparency and accountability — all of which contribute to a lack of trust. The challenge is less in the trading of assets but rather in the custody and asset servicing, including asset safety. Do you adopt a model with many sub-custodians, including inefficient interfaces and with inherent risks, or do you go with a recognised and regulated infrastructure provider who provides all steps of the chain in an integrated and secure model? We believe that the latter has significant value. As the stock exchange infrastructure for Switzerland, we know what it takes to build and run mission-critical and scalable, systemically important services.”

The first services will be rolled out in mid-2019.

Nasdaq(?!):

While there is no official announcement of NASDAQ building their own security token exchange (yet) — the regulated exchange is already providing its technology to other crypto exchanges. Speaking on CNBC, NASDAQ CEO Adena Friedman stated:

“Certainly NASDAQ would consider becoming a crypto exchange over time,” she continued by emphasizing “I believe that digital currencies will be something that will continue to persist,” added Freidman. It is just a matter of time as to how long it will take for crypto to mature. Source

What could security token liquidity look like in the future?

In security tokens a day is a week, a week is a month, a month is a year. Things are moving fast… but, it is early days.

Security token liquidity is still more of a promise then a verifiable reality. That being said, more and more MAJOR players — think governments and unicorns — are announcing their intent to enter the security token space. A growing list of stakeholders are determined to make security tokens become the bridge between crypto assets with the broader financial ecosystem.

Right now security tokens are still nascent. In 5 years time, they could be the norm for how you raise capital. However for that to happen, major gaps in the security token ecosystem need to be solved. For the promise of security token liquidity to become an actuality, more and more people need to step up to solve these fundamental infrastructure level problems. The industry needs more people with deep technology, financial and regulatory know how building out the security token infrastructure.

Thankfully within the small yet mighty security token community— there is already signs of massive collaboration — an excitement to work together to disrupt a financial system that is hundreds of years in the making.

IMO: The potential for security tokens to achieve liquidity looks bright. 💡

About the author: Julianne is an analyst at Leaseum Partners. Leaseum Partners is a blockchain-based Real Estate investment manager.

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