Alternative Asset Security ‘tokenisation’, is a major shift in Asset funding, promising improved transactional efficiency and wider access to larger markets. But technology alone is not enough. Investors want confidence and trust in the underlying assets, states Jeffrey Sweeney, Chairman and CEO, US Capital Global.
The Goal – Attracting Wider Interest in Alternative Assets
It is estimated that seventy five percent of the the multi trillions in worldwide wealth is held by persons over 60 years old, the baby boomers. The private investment market (including the bulk of alternative assets) is now somewhat larger than the public market, but ‘dry powder’ (uncommitted capital) at $1.7 trillion globally exceeds annual deal volume. How can this vast store of wealth be put to work to grow economies and provide retirement income for investors? Acceptance of Alternative Asset investments in later growth stage companies and highly valued assets, through blockchain enabled Security Tokens can provide a solution to this problem.
There is much talk about the need for widely accepted Security Token (STO) exchange platforms and investment in valuable Alternative Assets on those platforms. In the US, these markets are called “Alternative Trading Systems” or ATS which we will use as the reference here. These are Securities and Exchange Commission (SEC) regulated platforms owned and operated by FINRA Registered Broker Dealers and allow primary as well as secondary sales of Alternative Asset securities either electronically or conventionally. Currently modest acceptance of digital trading is almost entirely limited to cryptocurrencies, which do not require an ATS as they are generally considered Foreign Exchange or Commodities. Less than 7% of US investors hold some cryptocurrencies and over 75% say they will never invest in that asset class. But we are not talking about cryptocurrencies here, we are discussing private securities issued via STOs. What is it going to take to gain wider acceptance of Alternative Asset STOs?
The Technical Focus – Adoption of Digital Securities & DLT in Private Placements
Security Tokens / Equity Tokens, as distinguished from utility tokens are generally treated as equivalent to traditional securities by regulatory authorities. Digital Securities include shares of ownership, income streams (fractionalised loans or derivatives), etc. and includes private and public market offerings. Distributed ledger technology (DLT) is a consensus of replicated, shared, and synchronised digital data geographically spread across multiple sites, countries, or institutions.
“Digital securities have the same rights, preferences and privileges as traditional securities of the same class, but settle differently than traditional securities. Digital securities are uncertified securities, the ownership and transfer of which are recorded on a proprietary ledger that will be publicly distributed. The validity of publicly available copies of the proprietary ledger can be mathematically proven utilising cryptographically-secured distributed ledger network technology.” (Source: SEC tZero filing).
Security tokenisation can facilitate greater efficiency and visibility, wider access and additional liquidity. To deliver this promise the fintech industry is working on a number of technical hurdles, the specification of smart contract terms, new procedural definitions (e.g., methods of digital custody), multi-jurisdictional enforcement of KYC/AML provisions, and developing secondary market interoperability
The Real Core Issue – Building trust in the marketplace….
Perhaps the better question is not about wider acceptance of STOs, but what it is going to take to gain wide acceptance of Alternative Investments regardless of how they are held, paper or digital. Is the option to trade in a secondary private securities market and that offer of liquidity in an illiquid market really the problem? Perhaps it’s not just about the technology.
We have been here before, e.g., crowdfunding with general solicitation, and ICOs, but the broader market of investors wants trust in the underlying assets, their documentation, and management. It is essential that mature regulated market practitioners integrate professional standards, with the emerging technology, to be able provide that trust.
Beyond technical execution, the trading environment must be able to demonstrate these elements:
- Assets need to be easily verifiable as to high value
- Assets must be of a minimum value, similar to the hurdles to get on public exchanges such as NASDAQ
- The offering must be a regulated security
- The offering must be vetted and issuer representations verified by a financially regulated firm in good standing (in the US a Broker Dealer).
- The selling platform must be regulated properly for its domicile
To be sure, the emerging fintech platform developers must solve the technical issues such as digital security custody, and secondary market interoperability. But to provide the trust that will satisfy investors, the platform providers must work with the professional practitioner ecosystem [issuer, broker-dealer, KYC/AML, custodian, transfer agent, fund management, RIAs, investor, etc.] to elaborate business practices. This suggests the real key issue is that traditional forms of professional practice and self-regulation of the private securities industry must be extending to offer ‘digital security best practices’ that are accommodated by the new STO platforms.