Oct 14, 2018
In 2017, Bitcoin prices went up by nearly 1,700 percent in a single calendar year. It was a monster year for anyone who invested in cryptocurrency before 2017 and a satisfying validation of their early belief in cryptocurrency and blockchain technology. For those who missed it or arrived late to the party, they’re probably still playing the “could-have-should-have” game with the current value of their portfolio.
Blockchain technology and the applications that run on it are complicated global computer systems. Making them more difficult to understand is the fact that cryptocurrency requires people to think about things like money, business, and a global community in ways that are new and sometimes counter-intuitive. But the underlying technology is real, and it’s here to stay.
Regardless of Bitcoin’s price fluctuations, Blockchain technology is sound, transformative technology. Open source public blockchains (like Bitcoin and Ethereum) continue to evolve and innovate. As the technology gets better so do the applications that run on them, such as digital securities, which have emerged from the unregulated ICO ashes and are on the cusp of overtaking traditional means of selling, trading, and managing asset-backed securities. Digital securities are now in a position to digitize an available real-world assets class estimated to be worth over $7 trillion annually. It is a massive market, and digital securities are already beginning to transform it.
Digital securities are still new, however, and unfortunately linked (by association) to the over 4,000 altcoin ICOs that have eroded investor trust with an endless parade of plummeting valuations, broken promises, SEC subpoenas, and bad press.
As Alexander Pope once said, “A little knowledge is a dangerous thing,” so in an effort to help potential investors understand more about what digital securities are and how they’re unique in the cryptocurrency and blockchain world we present five basic things investors need to know about digital securities:
Digital securities are essentially digitized upgrades to traditional securities. If you already invest in securities in any form (stocks, bonds, real estate, CDs, etc.) then you are familiar with what it means to hold a security. For example, a digital security would simply replace your paper stock certificate with a digital version.
When you invest in a digital security, you are actually investing in the underlying asset. The fact that there is a “token” is somewhat irrelevant — it’s simply your digital proof of ownership in that security. Because digital securities are digital they are more efficient than traditional methods. They’re also tradable on global marketplaces, giving digital securities a level of liquidity that would be impossible with traditional securities.
Digital securities are comprised of a number of smart contracts. A smart contract is a simple program designed to automatically execute once a specified criterion is satisfied. Smart contracts dictate how digital securities can be bought, sold and traded in a compliant way, and because they are executed on the blockchain the transactions are transparent, traceable and immutable. A correctly coded digital security makes it virtually impossible for anyone to buy, sell, or trade the security in a non-compliant way. Regulators have so far have been complimentary of blockchain technology and its potential. US Securities Exchange Commission (SEC) Chairman, Jay Clayton, recently stated, “Blockchain technology has incredible promise for securities and other industries.” Many in the digital securities industry feel that it’s not too far of a leap to imagine regulatory bodies requiring all future securities to be sold using compliant digital securities.
In the US, most digital securities are offered under an SEC exemption — commonly a 506c Reg. D exemption, which allows for a maximum of 2,000 accredited investors in the offering. To comply with this regulatory requirement digital securities can be coded so that investors are only allowed to buy, sell, or trade digital securities if they have passed necessary KYC/AML accreditation and are considered accredited investors. At the same time, digital securities can monitor the entire offering to ensure that the 2,000 investor threshold limit is maintained. The equivalent confirmation for a traditional security could take weeks in order for the trade to happen. Digital securities allow for faster deal execution because compliance is verified virtually instantaneously.
The promise of global liquidity is perhaps digital securities’ most valuable trait. Digital securities have the ability to represent fractional ownership of an asset and to be traded on global digital securities marketplaces and exchanges — two things that are virtually impossible for privately held traditional securities.
For example, traditionally illiquid assets like real estate or fine-art can become liquid for stakeholders by issuing asset-backed digital securities that represent a stake in the underlying assets. And because digital securities can be listed on global markets, the security can be made available to global investors that are eligible to buy, sell, and trade the security in a compliant way.
Funds that offer digital securities enable investors a way to seamlessly exit without an otherwise onerous process via boards, lawyers, and accountants. For example, SPiCE VC, one of the world’s first digitized Venture Capital (VC) funds recently issued digital securities to its investors. In normal VC funds, investors must be ready to have their money locked up for ten years with no favorable exit before lockups expire. SPiCE VC investors are free to trade their digital securities on global markets as soon as regulations allow (typically a one-year lockup of funds in the US).
In the traditional securities industry, deal execution is often bogged down by the number of middlemen involved and trading is virtually impossible. Traditional securities are managed by a combination of excel spreadsheets, lawyers, paper certificates, custodians, transfer agents, and accountants which takes up a lot of time and money, not to mention the potential for human error. But because digital securities are automated, much of these manual processes are unnecessary, making digital securities more efficient and accurate.
Digital securities can also be coded to automatically manage a cap table and execute any events associated with holding the security, such as distributions, stock splits, voting, buy-backs, etc. The investor experience is improved because all these transactions are instantaneous. In theory, if you owned a digital security that gives you a percentage of sales revenue you could theoretically be paid your share the moment the business realized the revenue.
All transactions associated with digital securities (issuance, buying, selling, trading, etc.) are recorded on the blockchain, which is considered a “trustless” system due to the fact that blockchains are public and immutable in their record keeping. There is no need for any one party to trust the other when transacting via digital securities. Everyone just trusts the math.
Just as email supplanted the written letter, we anticipate digital securities will continue to replace traditional securities as the preferred method to issue, trade, and manage asset-backed securities. We’ve already seen the digitization of funds, companies, and real estate. With new digital securities exchanges and marketplaces coming online and a wide variety of digitized securities to be traded in a compliant way on a global scale, the opportunities for investors will be unlike anything is seen before in the asset-backed securities markets.
Investors won’t be investing in “digital securities”, they will be investing in a class of asset that was never before available to them, like hot early stage private businesses, exclusive real estate deals, and priceless fine-art. Digital securities just make it all possible in a compliant and efficient way.