The Rise of Digital Securities
In 2021 the modern economic landscape is already beginning to shift. The growth of cryptocurrencies and decentralized finance (DeFi) has been a part of the discussion for years, but the reality of how it will impact securities trading is finally being realized. An increasing number of securities are now digitized, underpinned by distributed ledger technology (DLT) that provides the necessary tools that allow for faster, cheaper and ultimately more secure markets, regardless of asset type.
Digital Securities Offer an Opportunity
DLT is poised to transform financial markets, by both introducing innovative new types of products, as well as changing how the underlying infrastructure works. The dematerialization of the public securities market has been going on for years, but still, the majority of the $6.5 trillion private securities market remains opaque, inefficient and illiquid. Digital securities offer the opportunity to digitize the ownership of trillions of dollars in assets and create a brand new global ecosystem.
This will then have a major impact on public markets by facilitating the introduction of many alternative assets that would otherwise not be listed, such as private equity or non-bankable assets. Furthermore, it stands to lower costs for both the issuing firms and their customers. Already, astute financial institutions are offering clients easier access to these products by way of digital securities. What really sweetens the deal is that using this technology reduces, on average, 40% of the cost of issuance, post-trade settlement and asset servicing.
Considering that digital securities can represent any traditional asset - equity, debt, real-estate, natural resources and infrastructure, it’s easy to see why this is such a promising trend. All accomplished through a process called “tokenization,” made possible thanks to blockchain technology. The recent interest in non-fungible tokens in the media and entertainment industry is a good example.
Tokenization and its Benefits
Traditionally, most private securities trades are performed using certificates of ownership. Thanks to blockchain technology as well as “smart contracts,” which are basically decentralized code, it isn’t very difficult to “tokenize” virtually any security. Using programs called “oracles,” the resulting token can then be pegged to the underlying asset's real-world value. Now, the same benefits that come with cryptocurrency trading can be applied to virtually any stock or even commodity.
This stands to offer a massive advantage to firms that embrace this new technology. Now, providing brokerage, trading and custodial services should be notably cheaper, as many of these processes will be handled by smart contracts. Settlements can happen virtually instantly and, again, with minimal oversight. Another benefit is that DLTs can enable a high degree of interoperability between different markets, as the underlying infrastructure should be largely the same. This increased access to, and easy transfer of, digitized assets has the potential to dramatically increase liquidity on once illiquid products.
Lastly, and perhaps most importantly, blockchain enables a level of security, authenticity and transparency that has previously been difficult if not impossible for these companies to provide. Blockchain transactions are immutable, meaning there’s almost no chance for fraud to occur, and the entire history of all activity is readily available for both counterparties and regulators alike. As long as assets are properly tokenized, then traders can have full faith in the veracity of their portfolio, at all times.
The Path to Offering Digital Securities
In order for this to become a practical solution, businesses need access to systems that can facilitate all of these steps, and easily. One option for a company would be to develop a tokenization platform in-house. But this could take years and would come with significant upfront costs, regulatory and compliance hurdles to be addressed, as well as identifying the most suitable technology to utilize for your needs now and in the future.
An alternative option would be for a business to utilize an existing, third-party platform. There are already some all-in-one tokenization suites available from companies like DASL, an out-of-the-box, production-ready, robust finance grade application designed with asset creation in mind. These types of systems come already built for the full range of functionalities needed for tokenization and trade, especially focussed on regulation compliance, which can be a real headache in this market.
Although there are a number of different security token platforms available, choosing to work with one underpinned by Corda, a distributed ledger designed specifically for the needs of highly regulated institutions will not only ensure the longevity of your offering, but you’ll have a secure, extensible, turnkey solution supported by industry experts.
The exponential pace of asset digitalization provides immense opportunities to reshape capital markets. Whichever way a company chooses to enter, digital securities stand to open the door to a whole new type of global market, one that resembles the efficiency of cryptocurrencies but still uses tangible assets as a basis. Ultimately, it is uncertain how fast this technology will be adopted, but it does look like the way of the future. As more companies realize the potential benefits and jump on board, any entity that doesn’t will possibly be left behind. Thankfully, the necessary tools are easily available and with a bit of education, there’s no reason any firm can’t begin getting involved immediately.
About The Author
Richard Crook is former Head of Emerging Technology at Royal Bank of Scotland, with a 20+ year career specializing in leading teams to shape and deliver maximum business benefits through technology solutions for the largest financial service institutions. He is now the founder of LAB577, a software company at the nexus of financial services and emerging technology, he and his team have been focused on Digital Asset Shared Ledger since September 2018.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.