November 10, 2021 - 9 min read
While financial technology has grown by leaps and bounds, the financial industry isn’t always the fastest to adopt it, particularly at the institutional level.
New fintech products are launched on a daily basis, but many of them don’t provide the security, accessibility, or decentralization that customers want and need.
While blockchain has already created a multi-trillion dollar market for cryptocurrencies and other digital assets, it could also revolutionize traditional financial markets by utilizing its DLT (distributed ledger technology) to allow ordinary people to access new types of investments.
In addition to widening available investment options, blockchain could cut out expensive middlemen like brokers and brokerages, putting more power back in the hands of ordinary investors. Plus, blockchain systems could help produce better and more accurate financial records and reduce the amount of fraudulent activity occurring in exchanges, funds, brokerages, and other financial institutions.
In the United States alone, billions of dollars in stocks and bonds are traded via public exchanges each and every day. While stock exchanges such as the New York Stock Exchange (NYSE) provide an essential service to investors and institutions, such exchanges have inherent security risks, and many experts believe they could be vulnerable to hacking.
While most exchanges technically operate offline, it’s highly feasible that these systems could be vulnerable to hardware intrusion, such as a contaminated USB drive connecting to a computer connected to the exchange’s intranet.
In addition to external hacking, exchanges could also be vulnerable to internal glitches and data loss, which could be extremely costly, both from a reputational and regulatory perspective.
By creating an immutable, distributed ledger of all trades on a private, permissioned blockchain, blockchain technology can increase the security of exchanges while providing easier-to-access records of previous trades. This can make it much easier to retrieve market data of interest to traders, investors, regulators, and the exchange itself.
The Australian Stock Exchange (ASX) is currently in the process of implementing blockchain technology to clear and settle trades. Within the private blockchain of the exchange, all stocks, bonds, and other securities will be tokenized to create digital assets that will be exchanged using smart contracts. While the project has suffered several delays and full implementation has been pushed back to 2023, it’s likely that, in future years, nearly all exchanges will adopt some form of blockchain technology to tokenize assets and improve exchange security, record keeping, and data management.
In the case of the ASX, securities will only be tokenized within the private blockchain of the exchange. However, it’s easy to imagine a future in which all public securities will be tokenized into cross-chain tokens, perhaps using the ERC-20 standard or a similar future variant. This would allow investors to hold tokenized stock in companies like Google and Apple in their own blockchain wallet, eliminating the need for a traditional brokerage account.
Full tokenization of public securities could also allow them to be traded on current crypto exchanges such as Coinbase, as well as decentralized exchanges like dYdX or Uniswap. The trading of tokenized public securities on these exchanges, however, may be limited by regulation and could require exchanges to achieve specific licenses as well as to register with government bodies such as the SEC and FINRA.
Some large public companies are already planning to issue securitized token offerings (STOs) to the public. STOs will be legal in Japan by 2022 and are already legal in Singapore. However, it is still unclear exactly how these securitized tokens will interact with the current blockchain infrastructure and exchanges.
The ability to trade tokenized stocks on decentralized exchanges would be a massive game-changer, as it would better align incentives between customers and exchanges themselves– something which has been a problem in recent years.
For instance, Robinhood was touted as a low-to-no-cost brokerage for ordinary people, and despite its popularity, poor executive decision-making led to the company’s reputation being tarnished during the Gamestop scandal. Many other fintech products have faced growing pains due to a misalignment of interests between company owners and customers– something decentralized blockchain securities exchanges could easily change.
Investing in private securities, such as stock in private companies, and private real estate investments has always been a cumbersome process. Right now, only accredited investors are allowed to invest in private securities, also known as “private placements.” Currently, the bar for being an accredited investor is earning $200,000/year ($300,000 for married couples) or a net worth of $1 million, excluding the investor’s primary residence.
The main issue with private securities is that they have very little liquidity, meaning that they are difficult to buy and even more difficult to sell. For example, if you were to invest in a private real estate project with a 5-year time horizon, it would generally be very difficult to sell your shares before the investment manager returns your capital at the end of the 5-year period.
While you could attempt to sell to other investors in the deal, or friends who are also accredited, that process could take months or even years. The same goes for stock in private companies, which is often highly illiquid and difficult to sell until the company goes public (if it ever does).
As an aside, private securities can also come in the form of debt issues as notes or private bonds. In these situations, an investor provides a loan to a private company or real estate project. Such notes are also notoriously difficult to sell once they have been purchased.
By tokenizing private securities, it would allow these securities (both debt and equity) to be easily exchanged between investors on a 24/7 basis. This would greatly increase liquidity and decrease risks for investors. Until legislation changes, marketplaces would likely have to adhere to strict KYC (know your customer) protocols to ensure that only accredited investors utilize the exchange.
However, KYC could be achieved through smart contracts that would interface with an investor’s bank, brokerage, and exchange accounts, as well as any wallets they possess, in order to calculate their estimated worth.
Just like public stocks, private securities can be issued as tokens in a securitized token offering (STO). However, it is still difficult to buy and sell these private stock tokens, as few viable marketplaces exist. The development and implementation of these marketplaces will likely become a multi-billion, if not a multi-trillion dollar industry over the coming years.
Private stock tokenization can also make it easier for international investors to participate in private stock and real estate offerings in the United States. When buying tokenized securities, these investors might not have to undergo the time-consuming paperwork and registration process that comes with purchasing private stock in its traditional form.
In 2016, the Title III of the Jumpstart Our Business Startups (JOBS) Act created a new era for business and startup fundraising in the United States by allowing small companies to solicit funds from the general public without undergoing a costly and cumbersome IPO process. According to some estimates, the global crowdfunding market, which sat at around $20 billion in 2020, could skyrocket to more than $120 billion by 2024.
Much like the innovations in private securities that tokenization can provide, tokenization can also be a boon for the burgeoning crowdfunding industry. Unlike private stock, crowdfunded shares are relatively easy to purchase for members of the general public. However, like private shares, they are notoriously difficult to sell. The creation of tokenized crowdfunded shares could fix this dilemma by helping to create a stronger secondary market.
Just as in the case of private stock, crowdfunded tokens could be sold on both centralized and decentralized exchanges, and could also be exchanged directly by individual market participants. This could greatly increase market liquidity and encourage more investment in smaller companies by allowing investors to feel confident that they can sell their shares at any time– not just when a company goes public.
Regardless of where, how, or what they invest in, investors deserve to know exactly how companies they invest in are spending their money. This is particularly true in the case of publicly traded firms. While it’s true that public companies do have to make a wide array of financial and investor disclosures, provide an updated stock prospectus, and hold annual shareholder meetings for investors, there is still lots of room for public companies to commit fraud, “cook the books,” or engage in financially irresponsible behavior behind investor’s backs.
The American public saw the worst of this during the 2001 Enron scandal, in which the massive energy services company and its accounting firm, Arthur Andersen, were brought down due to widespread accounting fraud. The 2008 collapse of investment bank Bear Stearns conjures similar memories for much of the public, and, while the firm did not commit outright fraud, its secretive purchases of highly-risky mortgage-backed securities (MBS) lead to disaster.
While blockchain technology can’t change human nature, it can provide record-keeping solutions that disincentivize accounting and financial fraud, waste, and general corporate mismanagement. By creating a public, immutable ledger of financial transactions publicly traded companies could increase public confidence in their financials and encourage greater investment. While many companies may not wish to do this, if some begin to do so, it may give them a competitive advantage, encouraging others to do so.
In addition to public companies, private funds, particularly hedge funds, have a long history of misleading investors. Due to the fact that they aren’t required to make almost any public financial disclosures, fund managers often engage in high-risk or outright fraudulent investment methods.
The collapse of Bernie Madoff’s $60 billion hedge fund is only one example of private fund mismanagement, and, while SEC privacy regulations are unlikely to change, if more private funds adopt blockchain accounting and record-keeping, it could bring a greater degree of transparency to the industry.
Since blockchains are closed systems, they have difficulty intaking outside information. Blockchain oracles act as data bridges between blockchains and the outside world, providing smart contracts the “real-world” data they need to operate effectively. Tokenized ‘smart’ securities need real-time data from exchanges in order to determine current market prices. Exchanges also need real-time market trading data to help determine the price of these tokenized securities.
As the tokenized and blockchain securities market evolves, a greater diversity of financial products will be delivered to consumers, including tokenized derivatives. Synthetic tokenized securities and derivatives, which track the performance of (but are not backed by) real-world assets already exist and are traded on platforms such as Synthetix. This likely means that it’s only a matter of time before “real” securities and “real” derivatives are traded on similar exchanges. All of these products will require secure, accurate, and fast outside data in order to operate as intended.
Outside data will also be required to operate KYC (know your customer) and AML (anti-money laundering) functions for current and future brokerages, exchanges, and even wallets– and oracles will be required to pull this outside data from sources such as bank accounts, brokerage accounts, or even tax records.
Real-world data will also be required to power secondary functions of stocks and bonds, such as creating “real-time” ESG (environmental and social governance) ratings for securities.
Blockchain technology is poised to change the stock, bond, and private securities industries forever. Some of the changes will be invisible to the average investor and will focus on improving the security and liquidity of exchanges, brokerages, and other institutions.
In contrast, other technologies will revolutionize the investment experience for both ordinary and accredited investors, opening up new markets and investment opportunities, and hopefully spearheading a new era of financial innovation for smaller companies and startups.
If blockchain securities are to become the next big thing in finance, they’ll need a fast, secure data infrastructure, and SupraOracles is in an excellent position to provide that.
SupraOracles can provide exchanges, brokerage firms, institutions, and developers with the fast, secure, and accurate information they need, whether they operate private, permissioned blockchains or public, unpermissioned blockchains.
SupraOracle’s decentralized oracle consensus mechanisms will allow blockchain securities to be priced more quickly and accurately than ever before, providing fast finality and an incredible level of security through novel, randomized node architecture and cutting-edge cryptography.
By solving the oracle problem– the need to trust a third-party data provider, SupraOracles is positioned to help usher in the future of the financial markets, creating a freer, fairer, and more transparent financial system for everyone.
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