How Blockchain Can Disrupt Private Equity and Capital Markets

Ishan Pandey:

Hi DH Kim, welcome to our series “Behind the Startup.” Please tell us about yourself and the story behind FinHaven?

About DH Kim:

Kim was born in Seoul and studied international affairs, law, and political philosophy in the United States. His degree was split into two halves because he returned home midway through his degree to serve in the military. After completing his last two years, he returned to Columbia University in New York to pursue his master’s degree, this time with an emphasis on international affairs. However, as the economy of several Asian nations, including South Korea’s, collapsed in 1997, he was obliged to return home to support his family, and he split his degree into two halves once more.

Defaulted loans, consecutive days of losses for the Korea Stock Exchange, and an emergency loan rescue to keep Kia Motors afloat were all part of the financial crisis in South Korea. Kim’s father’s firm was among those that failed. “As a result of it, I knew I needed to study a lot more about money, business, and accounting,” Kim adds. He changed his major to finance and business as a result. After graduation, he obtained a position at Merrill Lynch, which lasted almost a decade until the company collapsed and was sold to Bank of America due to the 2008 global financial crisis.

While Kim, a prolific entrepreneur, does not own a crypto corporation, he believes in the potential of blockchain—the technology that underpins cryptocurrencies—and is using it to develop Finhaven, a company at the vanguard of the transformation Kim discusses.

The firm just debuted as Canada’s first private securities marketplace to operate in several provincial jurisdictions, securing $7.9 million in seed and Series A investment. The marketplace functions similarly to a stock exchange, except it exclusively trades private securities.

It is an attitude and a vision that took decades to form, and it’s the result of years of experience working in a variety of industries in the United States, South Korea, and now Canada.

Ishan Pandey:

According to you, how can DLT disrupt capital markets?

DH Kim:

As one of the leading players in global FinTech efforts, I view blockchain technology as a glimmer of hope for such a turn of the tide. Simply stated, public capital market innovation aims to improve liquidity availability, and its success is determined by how safely it can provide liquidity to businesses in the primary market and investors in the secondary market. As a result, I think private capital market innovation should aim towards the same objectives.

Blockchain-based solutions can improve liquidity in private capital markets while also extending their usefulness to public markets over time. Without getting into too many technical specifics, I’d want to highlight a few key features of blockchain technology’s functioning in respect to capital market applications. The phrase “blockchain technology” is used in this article to refer to a distributed ledger system that includes encryption, wallets, and a consensus process.

The secure storage of securities is one of the essential functions offered by blockchain technology. Investors should be able to hold their own assets and generate liquidity without any friction due to technological advancement and innovation. To put it another way, investors should not depend on a third party to verify securities’ authenticity or trade them. Investors deposit their securities with a dealer (or its broker) in the book-based system to have liquidity of their securities in the traditional public capital markets system.

As custodians, registered dealers maintain the ledgers of investors. On the other hand, Blockchain technology allows investors to act as their own custodians and access liquidity online without going via a dealer, removing the need for a middleman.

Wallets on a blockchain store securities and cash for investors. Securities in wallets are referred to as “security tokens” or “digital securities.” We also refer to wallet cash as “crypto cash” (even if fiat currency is used to fund the crypto-cash in the wallets). Issuers no longer need to issue paper securities or book-based securities since these security tokens are issued in a legally effective way.

Furthermore, investors may use secure private keys to start and finish transactions using security tokens. Blockchain technology can effectively enable P2P transactions with a secure infrastructure in place. Buying and selling stocks in traditional public capital markets systems, on the other hand, requires several intermediaries or ledgers to execute a transaction. In addition, there is a significant regulatory burden in this procedure for minimising the associated risks. Nonetheless, before the advent of blockchain technology, these highly complex legacy systems were the best we had.

In other words, blockchain technology can replace our existing systems. We can simplify the process of buying and selling securities using a blockchain-enabled online P2P transaction model, resulting in a reduced risk profile and fewer regulatory requirements, thereby lowering the total regulatory burden on market players. The distributed ledger can check the legitimacy of securities ownership and the authenticity of each transaction. We may return to the primary trade arrangement between three parties: buyer, seller, and witness, using this new digital method.

While it is impossible to cover all aspects of P2P architecture for public capital market transactions in this short essay, I would like to present Finhaven’s private securities, or private security tokens, liquidity mechanism.

Private and public securities have distinct price discovery processes. Only when there is sufficient liquidity in the market can public assets find their optimum or correct price. When public security lacks sufficient liquidity, its market price does not correctly represent the underlying asset’s actual worth. Because private securities have even less liquidity than public securities, a simple copy of public markets for private issuers and investors will not be sufficient to sustain the price discovery process for these assets. In light of this, Finhaven’s liquidity solution is based on the following assumptions.

First, with adequate due diligence, an investor may accurately assess the value of a private security token. As a result, the Finhaven Investment Platform offers investors fast and reliable data to aid in their primary and secondary trading due diligence. Second, the market should guarantee a transparent price-setting mechanism. As is often stated, value is in the eyes of the beholder; as a result, investors on the Finhaven Investment Platform may submit Requests For Quotes (RFQs) to other investors and negotiate with them to arrive at the correct value for security.

They may also use their private keys to transmit their security tokens safely. Most importantly, investors may complete all of these legally binding transactions online, eliminating the need for physical delivery of papers, signatures, or in-person closure, which is a significant advantage in the current environment of COVID-19 restrictions. This liquidity solution will undoubtedly provide non-reporting issuers with improved liquidity.

Ishan Pandey:

What is the state of regulations regarding blockchain in Canada? Please enlighten us about it.

DH Kim:

There are no blockchain-specific regulations, to my knowledge. Instead, relating to capital markets, the regulatory focus has been on investor protection for investors in crypto assets. Some securities regulators are calling centralised crypto exchanges with Canadian investors to register as a marketplace in Canada. This is happening not only in Canada but also in other countries.

Ishan Pandey:

Can you explain how bonds are tokenised through digital securities or security tokens?

DH Kim:

In terms of tokenising, stocks and bonds do not have much difference. In order to have a real efficiency of tokenisation, intermediaries should be removed and real-time settlement should be possible. These things can be challenging in many countries due to the existing laws and regulations. One of the key elements can be corporate action management, which is usually done through transfer agents.

Can you automate the process and execution of corporate action management leveraging blockchain? This is one of the key efficiency points of tokenisation. In answering your question on bonds, automated interest payments and repayments of bonds with integrity without having layers of intermediaries (simply relying on a single blockchain platform) is key to bond tokenisation, not to mention creating efficient secondary bond markets.

Ishan Pandey:

Please tell us about fintoken and its utility. How can utility tokens be integrated with the capital markets platform? (Please provide a technical explanation of the token, we will remodel the answer if it is promotional to ensure it is non-promotional in nature).

DH Kim:

The current crypto markets have inherent problems of not clearly recognising the boundary of crypto (digital) securities (or security tokens) world and crypto commodities world (cryptocurrencies, or utility tokens. For example, as there is a wall, you cannot use your non-KYCed crypto wallets for the securities world. Finhaven starts from here. We will provide crypto FINWallet for our Gateway business users to have a KYCed wallet to move between fiat and crypto.

With the same wallet, people can move between crypto commodities and crypto securities based on our Gateway and Private Markets compliance framework. During this process, FINToken will work as a connector between fiat currencies, commodities and securities. Once FINToken is issued and circulated working as a connector, Finhaven team will keep working hard to enhance the innovative use cases of FINToken in capital markets.

Ishan Pandey:

What are your views on the state of regulations regarding security tokens? Do you think that regulations are the reason why security tokens have not been adopted widely by SMEs?

DH Kim:

I don’t think it is a regulation issue. Rather, it is an infrastructure issue. Blockchain technology showed us the possibility of having a new capital market infrastructure for better efficiency and integrity. However, markets have focused on security tokens financial products) with less concentration on the infrastructure. We at Finhaven spent years building this infrastructure for this reason. Now we are working on the market development for security tokens to be traded more efficiently based on the new infrastructure aiming to develop this market as global as possible.

Ishan Pandey:

Settlement of securities is done on a T+2 basis. However settlement with digital securities or security tokens is atomic due to the nature of DLT. Still, the regulators want to apply the T+2 settlement framework on security tokens. Do you think that regulators applying the existing securities regulations framework to DLT based digital securities is an impediment to its growth?

DH Kim:

T+2 is not a regulatory issue. It is a real challenge in the current capital markets dealing with book-based systems. You, as an individual investor, do not trade securities directly in our current systems. Your dealer trades for you, and dealers clear and settle all transactions through a centralised clearing agency. It is why it is hard to have a real-time settlement. The atomic transaction is truly possible when you can make P2P transactions.

Ishan Pandey:

What are your views on the FATF proposed recommendation that brings DeFi protocols under the purview of VASPs?

DH Kim:

It is an inevitable development considering that we live and do our business under sovereignties. However, these regulatory developments will reduce the chance of innovation and change, too many people’s disappointment, as the framework is not based on the new technology but on how the sovereignties have been regulating their businesses and money.

Ishan Pandey:

According to you, what trends are we going to see in the digital securities/security tokens market in the coming years?

DH Kim:

Please note two developments. One is the further development and growth of private capital markets. The other is the faster integration of global capital markets, capital crossing the borders more efficiently. Security tokens based on the new infrastructure will lead to these changes.

Disclaimer: The purpose of this article is to remove informational asymmetry existing today in our digital markets by performing due diligence by asking the right questions and equipping readers with better opinions to make informed decisions. The material does not constitute any investment, financial, or legal advice. Please do your research before investing in any digital assets or tokens, etc. The writer does not have any vested interest in the company. Ishan Pandey.