Satoshi Nakamoto is destined to be legendary. A mysterious figure who created a renegade, untraceable digital currency for the masses to use anonymously, divorced from the control of governments and central banks? He (or she) is, for all intents and purposes, a modern-day Robin Hood. For those of you who haven’t guessed, the currency we are referring to is Bitcoin, which has now reached a market cap of more than $1 trillion and spawned a financial ecosystem that, among others, consists of exchanges that are potentially valued at almost $100 billion (and, by the way, are going public via Direct Listings).
But the primary innovation in Bitcoin is the blockchain technology behind it. Blockchain cannot be tampered with or hacked into, is completely auditable, and eliminates the need for a ‘middleman’ or a ‘trusted third party’ in a transaction via smart contracts (self-executing contracts with the agreement between buyer and seller written in code). To put it simply, any transaction conducted using blockchain is highly trustworthy. The technology makes it possible for entities to create tokens on the blockchain in a process called tokenisation. There are three types of tokens (i.e., Digital Assets) that can be created:
Asset Tokens represent real-world assets. An example would be a piece of art – let’s say Leonardo da Vinci’s Salvator Mundi, the most expensive work of art ever sold at $450 million. There could be a smart contract created on the blockchain that says ‘this is a digital representation of Salvator Mundi that is worth $450 million and is the property of Badr bin Abdullah Al Saud’. The smart contract will then create 450 million tokens that each represent $1 worth of the Salvator Mundi and deposit them into Mr. Saud’s account. Mr. Saud can go onto a marketplace (i.e., exchange) and sell any number of these tokens to just about anyone, and receive $1 for each token he sells. Let’s say you buy 1,000 tokens of the Salvator Mundi. Now you legally own $1,000 worth of a Leonardo da Vinci painting, and you know this token is legitimate since it was created on the blockchain, and cannot be tampered with. This begins to open up possibilities such as fractional ownership of items, which in areas such as property, could democratise access to these assets like never before.
Payment Tokens are mostly cryptocurrencies like Bitcoin or Dogecoin. These tokens are not backed by anything, and the only reason you will accept them as payment for a good or service is if you believe you can pay someone else using the tokens you have received. In most cases, these are used as a means of payment, but in the case of Bitcoin, are also used as stores of value since holders of Bitcoin believe its value will keep increasing and they would regret selling it. I mean, who would ever give away 10,000 Bitcoins for a couple of pizzas?
Utility Tokens are those created by different blockchain networks that can be used to transact on those networks, such as Ether on the Ethereum network, which powers smart contracts deployed on the protocol. Think of them as similar to the coins you can earn in video games which you can then use to buy things in that game. These tokens can confer rights upon the token holders within that platform, such as voting on changes to the platform or on which projects get funding, which was seen in the ICO boom a few years back.
All digital assets are transparent (with full ownership history, details and rights recorded on the blockchain) and can be transferred and settled immediately. They can also be bought and sold on digital asset marketplaces in the same manner as stocks are on regular exchanges. The marketplaces can have different functions; they can allow for the issuance and custody (safe holding) of digital assets and foremost provide an easy way for investors to trade digital assets. In almost all ways, digital asset exchanges fulfil the same role as regular exchanges, but offer private companies easier routes to external funding.
Issuing Shares on Digital Asset Marketplaces
In a departure from the norm, rather than going public via the traditional IPO process, SPACs or direct listings, private companies can choose to tokenise and issue their stock as tokens on digital asset marketplaces.
This has already happened; Quadrant Biosciences, a US biotech company, offered 17% of its equity via an asset token sale. It raised $13 million at $1.25 per share and issued the ‘Quadrant Token’, where one token is worth $1.25 and is equivalent to a regular share. The process of issuing ‘tokenised equity’ is beneficial in a number of ways:
The cost of raising funds is lower than for traditional methods of going public, primarily due to lower fees. As we have seen previously, the reasons for private companies to go public have been impacted by the large amounts of private capital available. Flexibility, ease and lower costs have become more important to them, and issuing asset tokens is cheaper than going through the bureaucratic traditional IPO process.
Issuing tokenised equity is also more efficient. Corporate actions like dividend management, shareholder voting and follow-on equity raises can all be automated by smart contracts, saving time and reducing costs throughout the security lifecycle.
It is seen as a more egalitarian process in a similar manner to direct listings; when interested investors participate in a tokenised share issuance, the forces of demand and supply determine the price per share.
The process can be seen as democratising funding for private companies; lower costs reduce the barrier to going public for many companies, allowing for funding at more points during the business lifecycle.
The clear benefits have prompted excitement and led the market to respond and signal its intent in three ways: firstly, financial market infrastructure companies have begun to explore, and in quite a few cases, productionise new marketplaces to exchange digital assets with improved clearing and settlement processes and custody solutions. Secondly, investors (retail, predictably, but recently more institutional) have also increased their interest in digital assets. And lastly, regulators are actively participating and working with companies to issue tokenised equity and create a safe, efficient regulatory framework. This is demonstrated by the issuance of tokenised equity by 20/30 (a FinTech part of the FSA’s regulatory sandbox) on the LSE’s Turquoise platform in 2019, and the tokenisation of Mt Pelerin’s shares in accordance with the Swiss regulatory framework. All three of these factors will be vital to the near-term growth of the digital asset ecosystem.
The Digital Asset Marketplace Landscape
There are a number of current, established exchanges that are working on or have gone live with their own versions of digital asset marketplaces. The most prominent example is Intercontinental Exchange (ICE), the owner of the New York Stock Exchange (NYSE), whose cryptocurrency platform Bakkt is planning on going public (via a SPAC) at a valuation of $2 billion. Formed by ICE in 2018, Bakkt allows users to buy and sell cryptocurrencies and manage other digital assets such as loyalty points and gift cards. Another live project is by the Stock Exchange of Thailand (SET), which has initiated the creation of a DLT-based digital asset investment service with the aim of expanding investment channels and broadening fundraising opportunities. Other important initiatives are from established market players like Swisscom, Deutsche Börse, and SIX Digital Exchange (in Switzerland).
Bakkt’s ambition is to reach more than 30 million customers by 2025, from none last year, it says in its regulatory filing. The app, currently accessible only by invitation, had garnered interest from about 400,000 people seeking early access, Bakkt said.
The creation of marketplaces is further being aided by offerings like NASDAQ’s Digital Assets Suite, which is a ‘Marketplace-as-a-Service’ solution. Its technology stack facilitates the creation of marketplaces and includes functions for security, resiliency and transparency, alongside offerings throughout the security lifecycle like token issuance, custody and settlement. Accelerators like these can do a lot to drive the growth of digital asset infrastructure and pave the path for wider adoption by both retail and institutional investors.
Currently, there are more than 10 digital asset exchanges globally designed specifically for trading asset tokens. These are backed up by the more than 500 cryptocurrency exchanges, whose services can easily be expanded to include asset token trading. We see digital asset exchanges acting as a pre-Alternative Investment Market for immature and growing companies, offering a robust secondary market in the same vein as what Seedrs has done with its secondary market. Whilst tokenised equity is still in the early stages of its journey, the development of these marketplaces and the accompanying infrastructure bodes well for its increasing adoption when the market and regulations mature further.
Increased Investor Interest
Recently, institutional investors have begun to pay much, much more attention to digital assets. In a survey of 800 institutional investors across the US and Europe, 36% of respondents said they were currently invested in digital assets and 60% believed digital assets had a place in their portfolios. Moreover, 80% found the asset class appealing, with its uncorrelation to other asset classes, with its innovative technology play and high potential upside being the most attractive characteristics. This is reflected in the inflows into Grayscale Investments, the world’s largest digital asset manager.
In 2020, Grayscale raised more than $5.7 billion across its family of investment products, more than four times the $1.2 billion cumulative inflows the firm received from its inception in 2013 through the end of 2019.
Institutional investors represented a staggering 93% of capital inflows in 4Q2020, and in 2Q2020 $124.1 million of inflows came from new investors, comprising 57% of its investor base. Moreover, financial institutions like BBVA, Fidelity and ING are building trading and custody solutions for digital assets, indicating increased interest from their clients. This highlights how serious many investors are getting about digital asset investments.
The increased institutional interest has also been supplemented by large, influential companies buying Bitcoin as an investment. Two notable examples are Tesla (an obvious move when tweets by Elon Musk influence the market to such an extent) and Square. This is a bit of a self-reinforcing cycle: as large institutions get interested in and buy digital assets, the confidence granted by this combined with the ‘FOMO factor’ prompts other large institutions to buy digital assets, and so on. It nevertheless has had the effect of amplifying the prominence of the asset class.
When institutional investors are willing to invest more money into ‘unconventional’ assets like cryptocurrencies and are gaining the business and technical expertise of investing in digital assets, it is possible to see them adopt tokenised equity where regulations permit. Combined with the changing preferences of private companies in going public, investor confidence and adoption can serve to make the issuance of shares on digital asset marketplaces a prominent method of going public in the near future.
The Changing Nature of Going Public
As we’ve seen over the course of the past few weeks, market dynamics are shifting rapidly. The vast amounts of private capital flooding the market have distorted the incentives for companies to go public, and have brought about the growth in prominence of alternative ways of going public, such as SPACs and direct listings. The benefits of issuing shares on digital asset marketplaces combined with the evolving preferences of private companies promise to shake up the landscape yet again in the near future.
Related Reading
Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World by Don Tapscott and Alex Tapscott
Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money by Nathaniel Popper
Articles in this Series
Article 1: The Pull of Private Capital
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