Noelle Acheson is a veteran of company analysis and member of CoinDesk’s product team.
The following article originally appeared in Institutional Crypto by
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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.
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