Following up the Digital Securities Market Research, Jonas Sevel Karlberg, the Founder and Managing Partner of Amazix, has shared his thoughts on technology adoption. Jonas has shed the light on the potential market size that could be brought about by technology and the magnitude of DS opportunities in terms of the cost-savings.
According to Amazix, the most relevant of these are:
- Cost of IPOs is estimated to be between 5% and 10% of the total amount raised, for an average amount of $7M in the US.The costs of STO issuance, on the other hand, are expected to be about half of that.
- The total costs of trading equities on secondary markets and exchanges are between 0.5% and 3% per trade, totaling $250B in 2016. This is compared to 0.1-0.25% fees currently seen on crypto exchanges and expected to continue on security token exchanges.
- Studies have shown that corporate actions in traditional markets (i.e. dividend payments, voting, stock splits, etc.) cost ~$10B a year. Many expect most if not all of these could be automated through security tokens and built into the protocols.
- Finally, it’s worth noting that equities are a massive market at nearly $80T. For instance, in 2016 alone, companies with a combined year-end market cap of $800B IPO’d. It’s also a massive industry for service providers and middlemen, as equities generate $27.6B of annual revenue for the top 5 US investment banks. If we assume any penetration at all for security tokens in the traditional equities market, we’re talking potentially huge numbers.
All this being said, at Amazix we also feel it’s important to qualify these benefits as, while the cost savings are compelling, there’s also a large amount of mindless hype and lack of understanding among most industry pundits. This, combined with a certain naivety regarding the capabilities of banks and other traditional financial institutions, leads to a lot of mindless hype which, as industry insiders and experts like yourselves, we see it as our duty to dispel.
Firstly, it is important to remember that securities are first and foremost a legal category, not a technological one, and are therefore ultimately governed by the legal system, not the blockchain. Let us illustrate this with an example: Imagine for a second Coca Cola stock is tokenized and Warren Buffet’s 9.4% stake along with it. Now let’s say Warren Buffett gets hacked and his security tokens are stolen; does a 17-year-old Ukrainian hacker now own 9.4% of Coca Cola? Of course not, the transaction would either be rolled back or a new contract would be deployed with amended balances. In both cases, transactions are controlled by some kind of centralized entity; there is no censorship resistance, permissionlessness or decentralization; the three primary reasons for sacrificing efficiency to use a blockchain. This being the case, why is a blockchain needed? Isn’t it just acting as a glorified personal database, manipulatable by a central party?
Similar problems apply to many of the other purported benefits of security tokens. For instance, the oft-touted claim that security tokens “will be tradable 4/7 globally by anyone in the world”. This claim seems to implicitly assume that NASDAQ, NYSE, either out of ignorance or incompetence, choose to slash their own profits by a) shutting down their servers at 4:30 PM every day b) enforcing stringent KYC requirements and c) not accepting international Customers.
From our perspective, this is incredibly naive. These are not particularly challenging technical problems and the reality is there are strong legal and operational reasons for these decisions. Exchanges have opening hours as a way to concentrate liquidity because, as security token exchanges are now discovering, it turns out it’s incredibly difficult to bootstrap liquidity for securities. It’s also seen as a way to mitigate catastrophic losses as in many occasions (1987,2009) dramatic sell-offs were stopped only when they closed (in fact, in certain countries such as India proposals to extend stock market opening times have been shut down for this very reason). In the same vein, exchanges conduct KYC/AML checks (effectively limiting their potential client base) because they are mandated to do so by law and subject to huge fines and/or imprisonment if they do not.
Given this, what is the real benefit of security tokens? There are two primary benefits:
Firstly, security tokens will allow companies to effectively go public much earlier. In 1999, the average age for a company to go public was 4 years. In 2014, it was 11. There are many reasons for this such as higher availability of venture capital, but undoubtedly one of the primary catalysts was the massive cost and hassle of going public. Security tokens, by mitigating this, will make “going public” possible for less mature companies and lower the average age at which companies go public. This will have several benefits:
- A reduction in the liquidity premium private companies currently trade at, enabling the “consumer surplus” given to investors to be allocated to more companies;
- Allowing VC’s and angels more flexibility in their positions rather than being stuck with an investment for ~11 years until they decide to go public or exit. This will enable much more efficient capital allocation as investors are able to exit positions earlier and reinvest into more promising opportunities and;
- Enable many more investors to access the massive growth opportunities in earlier stage companies which have thus far been unavailable to them.
The second and often overlooked benefit is that security tokens, by “protocolizing” securities, will effectively create an open ecosystem of innovation – enabling programmability and composability. This is something Vitalik discusses at 26:04 of his talk at TechCrunch, but effectively security tokens will be usable as part of the open financial system that’s being built on the blockchain. For instance, we can imagine using security tokens as means of payment, as collateral for loans in smart contracts, as collateral for the creation of synthetic derivatives that can be traded by anyone; the options are endless. It’s almost like for 4 years (since the birth of Ethereum), we’ve been building decentralized financial infrastructure with MakerDAO, CompoundFinance, Augur, etc. but we’ve never had the financial assets to actually trade on this infrastructure. Security tokens could “fill that gap”, effectively acting as a trojan horse for the decentralized financial ecosystem.
Crucially, the ideas above only scratch the surface of what’s possible as security tokens can also be tailored to create new types of financial assets. For instance, we can imagine a security token for a local community center which also gives its holders discounts at the center; a mortgage security token in which the real estate register itself is embedded into the contract as an ERC721, allowing for instant redemption in case of non-payment, etc etc. At Amazix, we’re very excited to both witness and help facilitate all the innovative entrepreneurs and technologists will come up with using security tokens.