will blockchain tokenised securities make IPOs obsolete?
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Will Blockchain Tokenised Securities Make IPOs Obsolete?

Written for The Fintech Times by Jeffrey Sweeney (Chairman & CEO, US Capital Global)

Companies ‘go public’ to raise additional funds and provide liquidity to investors. Secondary market trading in private securities enables much of the same early investor liquidity. Equity tokens promise even broader participation and greater liquidity through more efficient primary and secondary market trading. In the end, however, it’s not just the equity token, it’s the regulated ecosystem and the asset itself that will challenge the public markets.

Why we IPO? And the downsides

An Initial Public Offering, or ‘IPO’, is considered the ‘gold at the end of the rainbow’ for companies. The event provides new cash infusions, liquidity for founders, employees, and early investors. The IPO process is well known to be expensive, time-consuming, and heavily regulated.

Aside from the complexities of an IPO, recent comments by Elon Musk about taking Tesla private highlight some challenges faced by public companies post IPO. As Musk painfully observes, in addition to complex reporting, public companies are under pressure to stifle innovation, creativity, and more patient strategic execution paths in favor of mediocre leadership, unimaginative management, and quarterly profit pressure. The dynamic leadership qualities that catapulted Musk and his companies to market leadership are heavily criticized now that he is running a public company.

The exclusivity of abundant liquidity and ability to raise money efficiently via the public markets is now being called into question. The fact is that Musk’s SpaceX is a private company which has tremendous liquidity in the private secondary market, and the robust valuation growth is certainly not lost on him. Likely these facts are driving his interest in taking Tesla private. We believe an equity token is an excellent idea for some of the capital Musk will raise in his privatisation of Tesla.

What about secondary markets?

Conventional private stock offerings and the secondary sales of those private offerings have their own specific set of complexities, challenges and inefficiencies. Restrictions on who can repurchase private securities, who is willing to sell, finding buyers and sellers, keeping track of who currently owns stock, excessively expensive transaction costs, and counterparty transaction risk are a few of those challenges. Despite all of that, there is a very robust market in large private secondary stocks, and the holding of private securities and private equity is over 3 times that of the public markets.

One of the problems is the activity of this market is currently limited to a few popular, very large companies like SpaceX, Spotify (prior to its IPO) Uber, Lyft, Palantir, etc. leaving thousands of sizable high growth private companies out of the active secondary marketplace.

A more efficient alternative – Equity Tokens

Now we have blockchain Equity Tokens, which may offer the first alternative to cumbersome secondary sales of private securities. Blockchain based Equity Tokens can provide a secure and reliable ledger of ownership for an asset, in this case private securities, as well as built in ‘smart contract’ features which indicate who is qualified to purchase or repurchase the security depending on the country of residence. Additionally, the digital nature of the equity tokens allows ease of listing on exchanges where people come to buy and sell assets electronically.

A seemingly ideal situation is developing for equity tokens and related markets, but there are some important caveats. Sadly, emerging digital equity technologies have been cesspools of fraudulent securities, pretend securities, glorification of money laundering, and assets of little to no value. And unregulated digital asset exchanges make regular headlines for theft and hacking of clients’ funds and assets.

Ultimately, It’s all about the ‘asset’

In order for equity tokens to be considered a viable and efficient method of private security exchange, certain minimum standards must be met by all issuers and investors. Firstly, we need to start seeing a wider variety of valuable asset classes available via equity tokens. We recently wrote an article about the vigorous and valuable market in Spotify private securities secondary sales well ahead of their successful IPO. We also mentioned SpaceX and several other valuable securities that have active secondary markets.

Secondly, equity tokens must be clearly identified as securities and regulated as such, by the SEC in the US and the appropriate regulatory bodies in other countries. Regulations are there for a reason and that reason is investor protections and preventing fraud, not to promote bureaucratic inefficiency. Not only are the securities regulated, but the trading platforms and marketplaces they trade on must be regulated as well. In the US, the SEC has created a regulated market license for Alternative Trading Systems (ATS), which can facilitate the exchange of equity tokens.

Thirdly, there is the necessity for regulated gating processes to screen offerings before they can be listed on the regulated exchanges. The accepted method for professionally launching an equity offering is for the principals to engage a licensed Broker-Dealer (BD) to do the diligence on the issuer. The BD would either approve or reject the offering as appropriate for investors if the financial and operational representations from the issuer are accurate and they have verified there are no ‘Bad Actors’ as either principals or investors in the company. Essentially, all of the functions in a traditional securities market – issuer, broker, compliance, exchange, transfer, custody, etc. – are essential in digital securities. Once we have an abundance of valuable assets, listed on trusted and licensed ATS’s, and screened by regulated BD’s, we have the beginnings of a system to rival the IPO’s listing on the public markets. The traditional private equity and debt security market is already 3 to 4 times larger, in market capitalisation, than the public market.

The Future? IPOs and STOs

Will blockchain equity tokens eventually ‘disrupt’ the public exchanges? We have shown non-tokenised private securities already are doing this vis-à-vis Tesla, SpaceX, Uber etc. Because private securities and their electronic manifestation, equity tokens, are currently only narrowly available to sophisticated, accredited, or qualified purchasers, by their nature they will have limited distribution. Retail investors, many pension funds, and retirement funds are restricted from investing in most non-public, private offerings.

It is safe to say that public market securities are here to stay because of their wide distribution and high level of regulation, which makes them safer for institutional and less sophisticated or less wealthy investors. It is also apparent blockchain equity tokenisation and related Security Token Offerings (STOs) are going to exponentially grow as a means for select investor classes to allocate investment to an evergrowing number of valuable asset classes being offered through the security tokens medium and on ATS exchanges. Valuable private offerings and assets, offered on regulated exchanges, screened by regulated groups is the formula where we will see amazing long-term and rapid success in tokenised blockchain securities

 

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