Digital Securities: The Future of Investment
From humble beginnings with Bitcoin, digital assets have exploded into a bewildering range of increasingly popular financial assets that continue to captivate, confound, and redefine the world of investing, according to Amir Tabch, Senior Executive officer at Securrency Capital.
The ecosystem of blockchain-based digital assets has come a long way in a short space of time. Many experts believe that this is just the start.
Of all these digital assets, the securities industry has been the biggest beneficiary of blockchain-driven financial innovation. With many forecasting exponential growth that may eventually see a market valuation of $1,600 trillion (Sources: The Money Project; A.T. Kearney analysis), securities digitization has massive potential to stimulate genuine innovation that has, until now, remained elusive from the sector’s grasp.
It could well be the answer that a modern generation, demanding individual autonomy, transparency, and control over their financial decisions, has been looking for all along.
Overcoming the present paradigm’s costly, sluggish, and unsafe paper-based market, a digital security token, is a digital representation of financial asset classes like equities, ETFs, fixed income, funds, etc.
Welcome to DLT
It uses blockchain-based Distributed Ledger Technology (DLT) to record and verify investment contracts and ownership. How? In the blockchain, a group of computers or servers are linked together in a public or private chain using a cryptographic messaging protocol such that each computer or server has the same data. And since each protocol has its own unique security signature and is normally associated with a specific marketplace or smart contract process, it eliminates the need for any central authority to maintain records.
There will undoubtedly be obstacles to overcome to reach peak adoption, but the benefits of a digital security future, based as it is on blockchain, are undeniable.
Firstly, as blockchains are decentralized and have no physical presence, they do not have regulated hours and provide 1000x the mobility. Therefore, digital securities provide access to a 24/7 global market that enables round-the-clock trading with no boundaries.
So, whether they are in the biggest IT hotspots in the world or the remotest corners of Antarctica, investors and traders can now trade anytime, anywhere—including weekends and holidays—provided they have internet access. They can make payments, exchange ownership of digital assets, and receive their settlements in real-time, with no need for a bank, broker, or financial services store.
Not to mention the fact that shareholders get to connect with a global community—all through a single platform via an end-to-end transparent, secure process that makes fraud, misappropriation, and negligence nearly impossible by providing “any point in time” auditability. After all, who would dare attack a see-through labyrinth vault that the entire world has got its eyes on?
The elimination of centralized institutions and the relocation of the financial processes to the smartphones in our pockets and the computer in our homes also make the services accessible to a previously underserved population that had no access to traditional banking systems, credit cards, and other methods of payment. For developing countries and markets such as Africa and Latin America, this democratization is potentially as big a financial opportunity as the internet itself.
Given that digital assets are designed to address shortcomings in traditional capital markets, their widespread adoption is unavoidable — not just because they offer fundamental solutions to the big problems of mobility, accessibility, and transparency, but also because they address the more subtle issues of investment. For instance, with tokenization—which is representing the asset value in several tokens that are created (minted) on a specific smart contract protocol (e.g., Ethereum)—the asset value can be distributed as fractional claims.
Such fractionalization has direct consequences for investors who could not previously afford to invest in the bigger, highly expensive assets or asset classes. Tokenization offers them more options to diversify through new asset classes and a wider range of securities like real estate and private placements.
It also has the benefit of generating liquidity and viable markets for previously illiquid securities that had low or no trading volumes. Making it easier for the market to access previously unavailable assets means more potential investors. Simply put, it’s the embodiment of the idea that a shared meal tastes much better and is cheaper than dining alone, while also ensuring a greater assortment of dishes are brought to the table.
Another benefit of the blockchain is that messages passing between parties can be programmed to contain all the data needed to perform certain tests.
“Smart contracts” can instantaneously check rules embedded in message protocols without having to refer to a centralized system or ledger. Imagine all the hundreds of pages spent on ensuring compliance, regulations, and agreements compressed into a bite-sized block shared across computers. It’s hassle-free, paperless, and efficient down to a T.
These smart contracts remove the need for manual processes—no wait times and no long queues—as compliance is built directly into the code.
The rules of ownership, too, can now be embedded directly in smart contract tests. For example, a client must be a resident outside the USA to be eligible to own the stock, or that only KYC/AML-approved individuals can hold and trade-specific digital securities.
An endless number of smart contracts can be linked together to specify eligibility rules and enforce regulations.
This makes digital security easier to adapt to the different regulatory controls in various financial jurisdictions.
Smart contracts also mean lower transaction costs. As smart contacts allow investors to buy and sell directly with each other without the need for clearinghouses or third-party intermediaries, these cost reductions are directly translated into lower transaction fees for clients without compromising trust and reliability.
And finally, with the advent of a token to represent these asset classes, an investor can move value between various asset classes with much lower costs than they would have traditionally incurred. Traditionally, there have been significant costs associated with moving value across the asset spectrum, such as between asset classes like currency, commodities, fixed income, and equity. Now, an investor could move value between the US dollar, bitcoin, and Apple stock with just the cost of transferring between tokens as opposed to between the traditional asset classes.
Of course, each token would still be backed by the asset class and provide exposure to the risk-return profile of that asset class, but the transaction costs would be more affordable than most traditional models. This is the power and benefit of interoperability at work.
With such pioneering advantages in mind, the digital security sector is primed for new ideas. Starting in the very near future, we can expect more individuals to use digital security in various ways and by more individuals in the future. Traditional assets will seek to reinvent themselves as interest in digital asset trading grows among both private and institutional investors. First as a ripple, then a wave, and now a storm. Change is upon us, and it is happening right before our eyes.