Posted on

Tokenized Securities: Curb Your Enthusiasm

Noelle Acheson is a veteran of company analysis and member of CoinDesk’s product team.

The following article originally appeared in Institutional Crypto by CoinDesk, a newsletter for the institutional market, with news and views on crypto infrastructure delivered every Tuesday. Sign up here

With so much buzz around tokenized securities, compounded by strong progress from platforms and issuers, it’s worth looking at the hurdles still ahead, and what they mean for investors.

First, a brief recap: by “tokenized securities,” we mean a crypto asset that reflects an investment in things that do not typically trade on liquid exchanges. Obvious examples are real estate and private equity, but the concept can also apply to art, diamonds, ships and other coveted items that are difficult to exchange efficiently.

The technology for this is developing fast – platforms and specific token designs are emerging to make it easier for issuers, investors and regulators to get comfortable with the concept.

On a panel at CoinDesk’s Consensus: Invest conference in November, Harbor announced the launch of its platform with the first tokenized real estate investment trust (REIT), and an entire panel about crypto wealth management declared itself bullish on security tokens.

More recently, SharesPost, a broker-dealer and alternative trading system (ATS), said last week it had executed the first secondary trade of security token in which the assets were held in custody by the same ATS. This was a notable milestone because large investors are required in the U.S. to use a qualified custodian.

Why such enthusiasm? By wrapping a traditional asset in a tradeable piece of code, tokenized securities offer a way to broaden access to investments by lowering barriers such as illiquidity, high entry points and steep costs.

They also open up the possibility of more detailed configurations, making it possible to design return opportunities tailored to specific objectives, and they potentially offer greater transparency as to ownership and movement.

While the promise is great, the reality – as usual – is more complicated.

Liquid diet

One thing often overlooked in the excitement is that a new technology does not create liquidity. Markets create liquidity. Without supply and demand, the tokens will not trade. And demand does not necessarily spontaneously emerge.

And not just any supply and demand will do. Liquidity, in the traditional financial definition, requires sufficient volume of buy and sell orders around the current price so that a large order will not noticeably move the market. With new types of investment, that is not easy to come by.

Initially, this probably won’t matter much, since the initial tokens – assuming that they are compliant with U.S. securities registration exemptions – will only be available to accredited investors. Yet even these wealthy investors will want relatively narrow spreads, something that only happens when there is a certain level of trading activity on a platform.

Furthermore, for the market to fully realize its portfolio-management potential, derivative markets would need to emerge on top of the security tokens. This could bring further regulatory and transparency complications, as final ownership gets obfuscated through borrowing and hedging.

Settling down

Settlement is another issue. Immediate settlement is often touted as an advantage, citing a more efficient use of funds. Actually, it’s the opposite – to settle immediately, buyers will need to have the necessary amount already in the relevant account.

In traditional finance, the money gets moved when it is needed, not before. Until then, it “rests” in interest-bearing instruments. Middlemen provide assurance to seller and buyer that the trade will happen, giving them time to get the funds and assets ready for exchange. Sure, it may be faster and cheaper to do it on a blockchain with instant settlement – but that may not be in the best interests of the buyer.

Another hurdle is conceptual: are these a new asset class? Or are they just a reconfiguration of an existing one?

In other words, do they require a new framework for investing – new metrics, dashboards and knowledge base for a new investor? Or is the target market the same as the old target market, only a bit broader? If the latter, how long before it becomes comfortable with crypto assets? Is it really worth the while to do so, given the relative “clunkiness” and youth of the new platforms?

Gaining momentum

Solutions will most likely emerge to all of these obstacles. It’s not easy to spin up a market, but with perseverance, communication and investment, it can happen.

The settlement issue could be solved with further innovation in payment methods and types of programmable money. And the conceptual confusion will settle with time. The benefits are intriguing, and even traditional market participants tend to be open-minded when it comes to the possibility of enhanced returns.

Given the intensifying build-up of tokenized security technology and marketing, as well as increasing regulatory clarity, we are likely to see a flurry of activity in onboarding and launches over the coming months. And as the market gets comfortable with the concept, the creativity of the issuers and sophistication of the investors will generate new opportunities for wealth creation, hopefully broadening access to both returns and capital. This will encourage further development in the crypto space, opening up even greater potential.

But we need to keep our expectations realistic. Getting the technology working is just the first step. Markets are unpredictable, and reliable demand for these new assets may take time to emerge.

Early investors usually get access to greater profits than latecomers, which is fair given the higher risk. But no one knows how long they will have to wait.

Harbor CEO Josh Stein image via CoinDesk Consensus archives

Posted on

Japan’s Financial Regulator May Approve Crypto ETFs: Report

Japan’s Financial Services Agency (FSA) is apparently open to approving crypto exchange-traded funds (ETFs).

A Bloomberg report on Monday, citing a person “familiar with the matter,” said that the FSA is currently ascertaining institutional interest in ETFs that track cryptocurrencies and could ultimately give them the go ahead.

Japan’s ruling Liberal Democratic Party will reportedly submit draft legislation by March 2019, that could include such a move through amendments to existing financial rules. The bill, which would also bring in more self-regulatory oversight of the industry and class many ICO tokens as securities, could come into law by 2020, the report indicated.

However, Bloomberg added that the FSA has now dropped plans to include approval for trading crypto derivatives on financial exchanges due to concerns the products would mainly lead to speculation.

The increased scrutiny of the crypto space in Japan follows a major hack of the Coincheck exchange in January that saw around $533 million in cryptocurrencies stolen.

Crypto ETFs are seen by many market observers as a means to bring institutional capital into the sector, though not all are keen on the idea.

In the U.S., several participants are planning to launch such products, although the Securities and Exchange Commission (SEC) has not yet approved any. Back in August, the the agency rejected nine bitcoin ETF applications “to prevent fraudulent and manipulative acts and practices,” and in December postponed a decision on a product from VanEck/SolidX until February.

Further, SEC chairman Jay Clayton said at CoinDesk Consensus in November that he doesn’t see a pathway to a cryptocurrency ETF approval until concerns over market manipulation are addressed.

Tokyo image via Shutterstock 

Posted on

The End of the First Crypto Decade

Massimo Morini is a veteran in investment banks and financial institutions including the World Bank. Some of his research on blockchain was reported here and here.

The following is an exclusive contribution to CoinDesk’s 2018 Year in Review

2018 year in review

The end of 2018 is not the end of a year. It is the end of a decade, a decade that changed the world of money and finance.

I do not mean the decade since the release of the Satoshi paper that CoinDesk properly celebrated a couple of months ago. With the typical egotism of young, brilliant innovators, the crypto community loves to think that this is the end of the first decade of the crypto-era. But the rest of the world has been celebrating quite a gloomy anniversary this autumn: the 10th anniversary from the beginning of the Great Financial Crisis.

With Lehman’s default, the world woke up and found out that banks were not the safest industry in the world. They could not borrow enormous amounts of money from the public and invest them in very uncertain financial markets without running any material risk of default.

2008 taught us that banks could run out of the cash and capital necessary to manage their risks, and that they could default or require taxpayer money to be saved and avoid a default on their deposit liabilities.

What happened in the next 10 years? Did banks disappear? Was commercial bank money replaced by a new global cryptocurrency? Did financial markets, that were the spark that lit the crisis flame, get replaced by a network of trustless smart contracts? No, banks survived, and so did financial markets.

And now that banks and financial institutions seem to have discovered that blockchain is not a magic software giving easily safety and efficiency to existing processes (neither is it the weapon of a overwhelming digital gold crushing all existing world money), they tend to disregard that this was also the decade that saw concepts like distributed systems, financial cryptography and consensus algorithms become part of a public debate.

Yet, 2019 could be the year when banks really understand what these concepts mean for finance. Remember, finance had to pay a price for surviving, as a review of financial markets over these 10 years clearly reveals.

It became clear that the role of banks in money creation through deposits made them systemically too important and fragile for allowing them to play freely their other roles of moving liquidity and value in space (through helping efficient trading), in time (through safe intermediation between investment and credit) and across different states of the future (through advanced derivative contracts).

They became over-regulated entities, their operational costs grew, their funding costs became much higher due to a new perception of their risk. Additionally, their dependence on centralized entities increased. Not only central banks, but also other institutions like CCPs or CSDs (where the first ‘C’ always stands for “central”) now crucially manage financial markets such as bond, equity or derivative markets. Centralization was seen by regulators as the only way to increase standardization, transparency and to mutualize the resources of the individual banks toward market risk management.

The concurrent single-point-of failure effect was considered an acceptable collateral damage. In the same years, the financial industry stopped being the darling of investors, and was replaced by internet companies, which now total a much higher capitalization than banks.

Crypto in Context

What has the crypto and blockchain decade to say about such “old finance” topics?

We have to go back to the roots of blockchain and forget both the temptation of considering it “just a software” and the opposite temptation to consider it “heaven on earth.” The Satoshi paper was probably not the beginning. In the days when we celebrate Timothy May, we have to recognize that some ideas being realized today started to grow 30 years ago.

In this way, bitcoin is not a magic creation of perfection. Satoshi spotted that the internet lacks some of the fundamental features needed to store and transfer value. It lacks an enforceable form of native identity, an unanimous way to order messages in the absence of an official time-stamp and some alternative to the client-server architecture to avoid value to be stored by a single entity for all users of a service.

No matter how early or limited, Satoshi made a feasible proposal to overcome the above issues. It was a mutation of the web in the value management environment, and it is thanks to mutations that systems evolve.

In the past, while banks were expanding their balance sheets by creating more money and taking up more risks, some thinkers introduced the concept of Narrow Banking. This alternative idea of the role of banks could have spared us some of the big financial issues of the last decade. Narrow banking means banks with a narrower role, more similar to the role they had in some moments in the past. Banks without enormous balance sheets of deposit liabilities, used by everyone as money, matched by corresponding risky investments.

Narrow banking would require a way to free banks, at least in part, from the role of creating electronic money in the form of deposits.

The crypto decade shows that forms of electronic money that do not take the form of a commercial bank deposit are possible, and can be managed outside commercial banks balance-sheets.

The application of this principle could free banks from part of their money creation role and allow them to go back to a role of real intermediaries, helping those with money to take up well managed risks, and providing services to real and digital economy, without enormous books of assets and liabilities.

A Convergence Ahead

Yes, you read it correctly. I said that blockchain technology could help banks to resume their role as intermediaries. You read so much about blockchain tech disintermediating banks that this may sound strange.

Yet, today the systemic risk posed by banks does not come out of their strict intermediation activity, but from their “technical” role in money creation. Technology alone cannot avoid crises, but when used to make narrow banking possible it can stop a crisis from spreading systemically. No need to bail banks out if we have reduced the link between financial markets and our deposits of money.

If a form of digital money based on cryptography and managed on a distributed network was available for financial players, it could be the layer upon which further reduction of systemic risk in financial markets becomes possible.

Today, systemic risk in markets like derivatives or securities is often associated to the technological centralization that built up over the past decades. As we recalled above, recourse to centralized infrastructures increased after the crisis, in order to manage collectively the guarantees provided by individual banks, in order to provide more transparency to financial markets, and to help standardization and coordinated risk management.

At the end of 2008 regulators thought that such goals could only be obtained via centralization, even if this could make financial markets less resilient to systemic risk.

After the crypto decade, regulators know there are alternatives. Decentralized networks also allow for transparency, standardization and collective management of resources provided by the network nodes, through appropriate use of smart contracts. They can allow for forms of risk management and risk reduction that are unthinkable in the traditional world.

They may not have yet the required features in terms of scalability or privacy, but their technological evolution has come a long way since the original mutation.

So, the coming years may be the years of awareness.

No, early cryptos and tokens are not a fast and easy solution for the future of finance. No, a light splash of blockchain tech over old business models is not a solution either.

Some hard work is ahead if we want to use the lessons learnt over the past decade, and see these two world, the world of finance and the crypto world, to eventually converge into a new, safer financial system.

Have a strong take on 2018? Email news [at] to submit an opinion to our Year in Review.

Floppy disks via Shutterstock

Posted on

Asset-Backed Securities: Entering the Crypto Conversation in 2019

Charlie Moore is the CEO of Global Debt Registry, a fintech startup seeking to transform structured credit using blockchain technology.

The following is an exclusive contribution to CoinDesk’s 2018 Year in Review

2018 year in review

We are at the end of another busy autumn conference season, and I have had the opportunity to speak at half a dozen events to focus on the intersection of capital markets and distributed ledger technology.

As we wind down for the holidays and plan for 2019, I wanted to reflect on the key themes and current trends in structured credit based on my interactions with leaders and innovators in the market.

This year, ABS East saw an encouraging level of DLT specialists from larger industry participants attend for the first time. The underlying technology is now a few years old, and senior leaders in the securitization industry have become increasingly familiar with the end-value state of cheaper and faster transactions with greater asset integrity.

There is now a growing consensus that the decentralized nature of DLT supports our sector’s broader digital transformation goals, and that it can help us move away from a siloed ecosystem that has not been able to realize the same common protocol benefits seen in other asset classes.

The ABS opportunity

Harmonized data standards, shared infrastructure and immutable records have the ability to transform how asset-backed securities participants interact in the ecosystem.

Everybody, myself included, is on a journey of discovery here. That journey started over three years ago with a recognition of immutable, better record-keeping. This was followed by understanding of the value of a shared system of record to ensure that all permissioned parties in a transaction to have access the same underlying loan information.

These autumn conferences focused on the next phase of on-chain digital assets. In discussing these digital assets I’ve often been asked, “Don’t we already have digital loans?”

Even within the minority of the asset-backed securities market, where the application and origination process has been digitized, a PDF of a loan document is very different from a digital asset in the efficiency and sophistication with which it can be transacted in the credit markets.

A loan as a digital asset on-chain can be transacted with the ease, speed and certainty of other digital assets like cryptocurrencies (AML/KYC permitting), while the PDF document is still dependent on the legacy model taking weeks and significant cost to execute transactions, with limited contextual asset information attached or ability to run smart contracts.

We are seeing the emergence of two paths here: asset-backed tokens (or loan-backed) and loans native to the blockchain. In the token model, the original authoritative copy of the loan document is securely locked down with an associated token representing ownership interest and core asset characteristics.

This facilitates more efficient transactions and introduces a chain of title and verification not seen before in the market. In the native model, the loan lives solely on the blockchain, cannot be copied, printed, double spent or misrepresented.

Given the majority of lending is still paper-based, we expect to see a domination of asset-backed tokens for a while. The transaction and management of both asset types in the capital markets we call Digital Structured Credit.

Current stage of adoption

It is fair to say that capital markets is over the “hype” phase of Gartner’s adoption model with DLT.

As with any new technology, many overestimate the speed of adoption, but the market underestimates equally the long-term impact. The credit market is slightly behind most electronically traded asset classes that saw low risk in applying DLT to settlement & clearing inefficiencies.

We are hearing less about new proof-of-concept projects as the marketing value of DLT subsides and the business cases demonstrate clear benefits. Building the right social constructs, standards and incentives for value to be realized across the asset-backed securities ecosystem is arguably more important than building the underlying technology.

One of the core pillars for all digital asset classes has been custody. This had been a gap for institutional players to participate, particularly with cryptocurrencies, but still applicable to all digital assets.

In 2018, we have seen significant progress with established players like Fidelity introducing market offerings that will help drive adoption. In asset-backed securities, I continue to see commercial demand for private keys to digital structured credit being held by an established, independent custodian to deliver seamless integration to the existing securities custody and value-added services that investors demand.

Most professionals are now comfortable with the scalability, security and permissioned vs public implementation options for DLT. While asset-backed securities have relatively low volumes of data and transactions in comparison to other electronically traded asset classes, we foresee the benefits of these efforts to allow greater capabilities and on-chain development for the market.

The leading capital markets projects represented at these conferences were utilizing permissioned blockchains, with the expected controls and security, and not looking to change the industry access paradigm.

Some of the most common discussions among panelists this autumn included looking back at the credit crisis and a look forward at whom will benefit from the efficiency gains.

Could DLT have prevented the credit crisis? As with any technology, it is only as good as how humans have chosen to deploy it! (Ignoring the AI debate). There were obviously many well documented factors here, but few would argue that the immutability, enhanced data integrity and, shared system of record in keeping track of assets, diligence and all economic interests would have helped reduce impact.

Who will realize the efficiency gains created by DLT in the asset-backed securities market?

The parties who control blockchain nodes, the management of assets and the ability to author smart contracts will have significant influence on how future value is distributed.

Time will tell which constituents will drive this transition.

Have an opinionated take on 2018? CoinDesk is seeking submissions for our 2018 in Review. Email news [at] to learn how to get involved. 

Golden egg image via Shutterstock

Posted on

Singapore’s Stock Exchange Clarifies Rules for Listed Firms Issuing ICOs

Singapore Exchange (SGX) has clarified the rules for publicly listed companies planning to conduct initial coin offerings (ICOs).

In a column published Thursday, Tan Boon Gin, CEO of the stock exchange’s regulatory subsidiary, SGX RegCo, stressed that any tokens launched in an ICO are not listed on the SGX and that these rules are applicable only for the companies themselves.

As per the guidelines, any listed company planning to hold an ICO is required to consult with SGX RegCo in advance, as well as provide a legal opinion on the nature of tokens and an auditor’s opinion on how the ICO should be treated for accounting – both from “reputable” firms.

Companies are also required to make certain disclosures, including the rationale behind the ICO, the risks involved, how the raised funds would be used, planned know-your-customer (KYC) and anti-money laundering (AML) checks, and any impact on existing shareholders’ rights.

They also need to ensure that ICOs are “properly” accounted for in their financial statements and that associated risks have been addressed.

Further, if the tokens are considered securities under the country’s Securities and Futures Act (SFA), issuers are required to complete prospectus registration and licensing procedures. Firms may also be required to form a subsidiary to carry out the ICO.

Finally, SGX RegCo expects listed issuers of ICOs to “safeguard” their own interests and that of shareholders. “The issuer’s board is ultimately responsible for maintaining a robust system of risk management and internal controls,” Gin said.

Back in August, Y Ventures Group became Singapore’s first public firm to hold an ICO, which aimed to raise $50 million for creating a blockchain-based e-commerce system.

To date, however, no token considered a security has been approved in the country by the Monetary Authority of Singapore (MAS), as Damien Pang, head of the MAS technology infrastructure office for fintech and innovation, told CoinDesk at a Consensus conference in September.

SGX image via Shutterstock