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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Explores how the financial industry will be affected by developments in blockchain and cryptocurrencies at the dawn of a new digital age in finance Our financial system is in the midst of a digital revolution. Blockchain, viewed by many experts as "the most important invention since the Internet," has changed the way we exchange value and information. Although most people are aware of Bitcoin and other cryptocurrencies, few understand how security tokens--digitized forms of traditional ownership certificates--can drive blockchain to reach its fullest potential by offering investors features and innovations that are simply not possible with paper certificates. Digital Finance: Security Tokens and Unlocking the Real Potential of Blockchain explains how the integration of blockchain and security token technology will transform the current financial infrastructure and radically improve efficiency, transparency, and security. Using clear language and an easy-to-follow framework, author Baxter Hines draws upon his decades' experience in the financial industry to address how the digitization of assets will drive cost reductions, enhance flexibility, and pave the way for new business models and revenue streams for years to come. Filled with real-world case studies and expert insights on the latest opportunities and trends, such as the COVID-19 pandemic's role in accelerating the adoption of blockchain, this must-have resource: * Shows how blockchain and distributed ledger technology are disrupting the financial industry * Explains what security tokens are and why they are the next major breakthrough for investing * Highlights how blockchain technology has created new and more efficient ways of fund raising and investing * Identifies the ways companies like IBM, Fidelity Investments, and AXA are deploying blockchain and tokenized solutions * Describes how assets only available to institutional investors could become marketed to the mainstream * Discusses the impact that security tokens will have on real assets such as stocks, real estate, bonds, and derivatives * Provides insight into how central banks around the world are embracing blockchain and beginning to issue digital currencies Digital Finance: Security Tokens and Unlocking the Real Potential of Blockchain is essential reading for financial professionals, general investors, finance and technology students, regulators, legal professionals, and users of cryptocurrency and blockchain technology.
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Seitenzahl: 346
Veröffentlichungsjahr: 2020
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Table of Contents
COVER
TITLE PAGE
COPYRIGHT
DEDICATION
DISCLAIMER NOTICE:
ACKNOWLEDGMENTS
PREFACE
INTRODUCTION
Opening Remarks – The Big Picture
Disruption of Investment Industry
Legacy Ways of Doing Business
Paper Securities & The New Alternative
Entering the Disruptive Phase for Digital Assets
Introduction Summary
Notes
PART I: THE MAGIC LEDGER
CHAPTER 1: BLOCKCHAIN BASICS
What Is Blockchain?
Foundational Elements of Blockchain
Distributed Ledger Technology
Building a Blockchain
Creating a Blockchain Transaction
Tampering with a Blockchain
Smart Contracts
Oracles
The Characteristics and Benefits of Blockchain
What Differentiates One Blockchain Platform from Another?
Chapter Summary
Notes
CHAPTER 2: FUNDAMENTALS OF A SECURITY TOKEN
Distinguishing the Types of Digital Assets
How Security Tokens Came Along
Tokenizing a Security
Code Is Law
Benefits of Tokenization
Chapter Summary
Notes
CHAPTER 3: WHAT TYPES OF ASSETS MAY BE TOKENIZED?
The Move Toward Tokens Backed by Assets
Stablecoins
Asset‐Backed Tokens
Fixed Income, Equity, and Funds Tokens
Industry Trends: Alternative Financing with Security Tokens
Industry Trends: Unlocking Private Equity Fund Liquidity
Employee Stock Options
Chapter Summary
Notes
CHAPTER 4: SECURITY TOKENS WILL MASSIVELY DISRUPT AND VASTLY IMPROVE MARKETS
Industry Trends: Lowering the Cost of Money Transfers
To Tokenize or Not to Tokenize?
Chapter Summary
Notes
PART II: CREATING THE DIGITAL WRAPPER
CHAPTER 5: KEY FEATURES OF A SECURITY TOKEN
Security Administration
Compliance
KYC & AML
Accounting and Reporting
Safety Mechanisms
Chapter Summary
CHAPTER 6: THE SECURITY TOKEN ECOSYSTEM
Fintech Companies
Protocols
Issuance Platforms
Advisory Services
The Token Stack: Putting It All Together
Chapter Summary
Note
PART III: REALIZING THE POTENTIAL OF SECURITY TOKENS
CHAPTER 7: REGULATION OF DIGITAL ASSETS
A Regulatory View From 50,000 Feet
How Regulators Might Respond
Jurisdictions
Countries at the Forefront of Adoption
Key Countries
Industry Trends: Central Bank Digital Currencies
Chapter Summary
Notes
CHAPTER 8: MARKETS FOR DIGITAL ASSETS & SECURITY TOKENS
Trading & Finding Liquidity
Developing the Primary Markets
Bringing the Token to Market
Developing Secondary Markets
What Is Needed for Tokenization to Thrive?
Jurisdictions
Alternative Trading Systems
Special Considerations Around Private Assets
Settlement and Clearing
Settlement Risk
Where These Markets Are Going
Industry Trends: Stock Exchanges & Distributed Ledger Technology
Chapter Summary
Notes
CHAPTER 9: “DeFi”: eLENDING AND THE FUTURE OF GETTING A LOAN
Crypto Lending & Borrowing
Earn Interest on Crypto
Making Loans with Blockchain
Mortgages
Chapter Summary
Notes
CHAPTER 10: DIGITAL ADOPTION
Where We Are Today
Cryptocurrency Adoption
Demographic Synopsis
Interest by Country
Historical Perspective: Internet Adoption
The Next Wave of Users
Millennials
Institutional Investors
Hurdles for Tokenization
Privacy
Quantum Computing
Chapter Summary
Notes
CONCLUDING THOUGHTS
Need for Education
Industry Trends – Creating a Cashless Society: The Rise of Mobile Payments in Asia
Ant Financial
Who Will Succeed in This Race for Blockchain Dominance – Notes of Caution
Big Fish, Little Fish, and the Mighty Whales
Historical Perspective: Titans of the Dot‐Com Boom, Where Are They Now?
Never Forget, It's All About the Investment Proposition
Conclusion Summary
Notes
ADDITIONAL RESOURCES
Sites for Digital Asset News:
Podcasts and YouTube Media:
Leading Organizations on Blockchain and Digital Finance:
Cryptocurrency Exchanges:
Decentralized Finance, or DeFi, Offerings:
ABOUT THE AUTHOR
INDEX
END USER LICENSE AGREEMENT
List of Illustrations
Chapter 1
FIGURE 1.1 A Simple Accounting Ledger
FIGURE 1.2 Sharing & Inspecting a Ledger
FIGURE 1.3 Examples of Hashed Data
FIGURE 1.4 Centralized vs. Distributed Ledgers
FIGURE 1.5 Data Fields Contained in a Block of Bitcoin
FIGURE 1.6 Example of a Linked Blockchain
FIGURE 1.7 Value Is Transferred from Alan to Beth Through the Blockchain
FIGURE 1.8 Benefits of Smart Contracts
Chapter 2
FIGURE 2.1 Token Categories & Characteristics
Chapter 3
FIGURE 3.1 Hypothetical Stablecoin Flow of Funds
FIGURE 3.2 Libra Association Network of Partners*This image is accurate ...
Chapter 4
FIGURE 4.1 Asset Tokenization
Chapter 6
FIGURE 6.1 Token Stack Illustration
Chapter 7
FIGURE 7.1 Aggregated Wealth by Country
Chapter 8
FIGURE 8.1 iSTOX Offerings
Chapter 9
FIGURE 9.1 Sample of a Digital Lending Framework
FIGURE 9.2 Steps in Creating a Blockchain Mortgage
Chapter 10
Figure 10.1 Graphic Depicting Results from the ING International Survey on M...
Figure 10.2 Graphic Depicting Results from the ING International Survey on M...
Figure 10.3 Comparing Growth of the Internet & Crypto Usage
Guide
Cover
Table of Contents
Begin Reading
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DIGITAL FINANCE
Security Tokens and Unlocking the Real Potential of Blockchain
Baxter Hines
Copyright © 2021 by Westmoreland Capital Management LLC. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per‐copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750–8400, fax (978) 646–8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748–6011, fax (201) 748–6008, or online at www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762–2974, outside the United States at (317) 572–3993, or fax (317) 572–4002.
Wiley publishes in a variety of print and electronic formats and by print‐on‐demand. Some material included with standard print versions of this book may not be included in e‐books or in print‐on‐demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging‐in‐Publication Data is available:
ISBN 9781119756309 (Hardcover)
ISBN 9781119756323 (ePDF)
ISBN 9781119756316 (ePub)
Interior illustrations created and rendered by Jade Myers
Cover Design: Wiley
Cover Image: © Shutter2U/Getty Images
For my parents, Anne and Bob Hines
DISCLAIMER NOTICE:
Please note that the information contained within this document can be relied on for educational and informational purposes only. The content, data, and analysis contained herein are provided as they are and without warranty of any kind, either expressed or implied.
This book is not intended as a substitute for the advice of a licensed legal or financial professionals. Readers acknowledge that the author is not engaged in the rendering of legal, financial, technical, or other professional advice. Consult a licensed professional before attempting any techniques or investment in any vehicle discussed in this book.
Past recommendations and investment results are not a guarantee of future results. Using any graph, chart, formula, or other device to assist in deciding which securities to trade or when to trade them presents many difficulties and their effectiveness has significant limitations, including that prior patterns may not repeat themselves continuously or on any particular occasion. In addition, market participants using such devices can impact the market in a way that changes the effectiveness of such device.
Although the author and publisher have made every effort to ensure that the information in this book was correct at press time, the author and publisher do not assume and hereby disclaim any liability to any party for any loss, damage, or disruption caused by errors or omissions, whether such errors or omissions result from negligence, accident, or any other cause. In reading this document, one agrees that under no circumstances are the author or anyone affiliated with the author to be held responsible for any losses, direct or indirect, that may be incurred as a result of the information contained in this book. This includes, and is not limited to, errors, omissions, or inaccuracies.
ACKNOWLEDGMENTS
The genesis of this book came from my deep belief that digital technologies and the blockchain will profoundly impact the financial industry. My experiences in financial technology, research, and investments led me to conclude that a truly revolutionary event was unfolding and its repercussions would have impacts lasting many years into the future. I knew the changes that would eventually come about were multifaceted, complex, and would require the participation of many outstanding people, organizations, and companies. As a result, I would have to draw not only from my own personal experience but also from the guidance and assistance of others to compile what was necessary to make this project a success. The entirety of this work has truly been a team effort.
Throughout my career, I have been very fortunate to have had numerous teachers and mentors who played an important role in my development and intellectual nurturing. The following people will always have a special place in my memory: Frederick Dixon (Portland, Oregon), who gave me my first job in the industry; Leighton Huske (Richmond, Virginia), who took me under his wing during my time with Branch Cabell; Sanford Leeds (Austin, Texas) and Britt Harris (Austin, Texas), who both helped guide me through business school; and Paul Magnuson (Dallas, Texas), whose passion for value investing made a lasting impression on both me and my career.
From my earliest days, family has been my foundation. My sister, Hedley, and brother, Whitfield, have provided love and support throughout the many years. Shirley was always there to lend a helping hand. My wife, Michele, is still with me through all the ups and downs while simultaneously serving as a wonderful mother and friend. My children, Christian and Thomas, have kept me feeling young as I have just crossed over my 40th birthday. My beloved dogs, Brogan and Sydney, in their own magical way never failed to provide comfort and companionship whenever I needed the encouragement to just keep on keeping on.
To my dear friends, Dave Beran and Paul Bullock, thank you for your continued support and faith in me. Your encouragement, advice, and contributions were pivotal in making this book a success. The two stood by me during every struggle and success along this journey. That is true friendship.
Thanks to all my colleagues at Honeycomb Digital Investments for all your manifold contributions. I am grateful too to the organizations that accepted my requests for permissions to use their works and to those persons who had the faith and commitment to endorse this book. I would also like to thank Bill Heyn and Brian Bares for providing guidance on key issues along the way.
All of the folks at John Wiley & Sons have been a joy to work with! I want to especially give my regards to Bill Falloon for trusting me to write a book on such a new, complex, and ever‐changing topic. From Day 1, I knew deep down that Wiley was the publisher for this work. I was incredibly excited when I learned of Bill's support and his commitment to getting this project off the ground. I am also appreciative for Bill's referral of Jade Myers. The illustrations, graphics, and charts Jade put together were first class and really helped to bring across key points. A special thanks should also go out to editors, Purvi Patel and Samantha Enders, for all of their hard work and efforts in keeping everything moving along.
One last note of appreciation to anyone who has said “You have to read this book!” to a friend or colleague. Those small words make a huge difference in making the time spent writing this book well worth it!
PREFACE
This is an incredibly exciting moment to be involved in finance. There are more and more signs that digitization will transform the traditional investment business model that exists today into a more modern, fair, transparent, and distributed marketplace. This new paradigm will connect investors directly with opportunities via blockchain‐based platforms. Just recently, the first regulated security tokens have gone to market. Regulatory certainty has begun to arrive and technology is matching what is needed for this digital future.
Given the significance of this moment, I took a step back to take stock in how I personally got to where I am. My investment background comes from a deeply conservative point of view. During the first portion of my career, I worked in analyst positions at a conventional brokerage house and then at a retirement system for public school teachers. Afterwards, I spent over a decade as a portfolio manager at a firm whose discipline was always to buy blue‐chip dividend‐paying stocks. So at first, the idea of “crypto” assets and blockchain tokens seemed foreign and frankly, outright crazy. After first hearing about Bitcoin in early 2011, I cannot recall whether I thought it was a scam or a fad – but I likely thought it was both! Like so many others, I was not on the ground floor of Ethereum or any of the Alt‐coins. Despite all this, I found myself fascinated with the technology underlying these new manias and how innovative people continued to take it to another level.
After adopting a much deeper understanding of how the technology works and what it could do, I came to realize the blockchain was so much more than simply Bitcoin – and that blockchain technology was not simply going away. It was clear to me that this technological revolution was only going to get bigger and eventually play a major role in the future of the economy, and finance in particular.
Since its origins in 2009, blockchain technology has been somewhat of a rollercoaster. It is important to recognize, though, that this next step of tokenization is not scary, but rather a process with enormous benefits.
In writing this book, I have kept three major points in mind that I feel will help others come to that realization:
First, we tend not to see the forest for the trees when it comes to this emerging space. Everyone has heard about some problem that has come about since the advent of blockchain: the hacking of Mt. Gox and the subsequent theft of millions of dollars of Bitcoins, the role of cryptocurrency in the drug trade that functioned over the website Silk Road, or the use of cryptocurrencies to prop up dictators in North Korea or Venezuela, to name a few. It would be unwise, however, to allow these headline‐grabbing occurrences to warp our view of the broader picture.
Throughout history, mishaps and unfortunate events tend to happen when new frontiers open up in the world of finance. We're all familiar with the stories of how Willie Sutton, Bonnie and Clyde, or “Public Enemy #1” John Dillinger terrified the country, targeting insecure banks with their robbing sprees. It actually wasn't too long ago when no one in his or her right mind would have given out a credit card number over the internet to make a purchase. I could go on and on listing similar examples from the past.
Many issues affecting blockchain are getting sorted out as the technology matures, just as would be the case in any emerging technology or advancement. As higher standards are applied and as the market embraces regulatory compliance, so too will the public begin to embrace and trust blockchain. There is no doubt that our current financial system is anything but perfect. Name‐brand banks are constantly in the news due to involvement in money‐laundering scandals. Financial services firms are frequently bested by cybercriminals who hack user information. The last time I checked, the paper dollars and euros in our system are used in the trade of all kinds of illicit activities! In other words, let's not lose perspective, focus on a few bad apples, and forget all the positive attributes and additions to the financial infrastructure which blockchain technology will provide.
Second, blockchain's complexities cause many to give up in trying to wrap their minds around its many facets. They throw the whole concept into the same category as “rocket science” and are waiting for a more concise explanation of how it works. Albert Einstein said, “Everything should be made as simple as possible, but not simpler” and that “If you can't explain something simply, you don't understand it well enough.” My goal in writing this book is to help boil the key concepts down to the essentials and not get bogged down in the details.
Third, people become discouraged when they hear that the once‐promised “next big thing” in blockchain gets leap frogged by the “new, next big thing.” The pace of development is incredible with almost daily stories of exciting, breakthrough improvements. Some of the best minds from both Wall Street and Silicon Valley are now focused on making the most out of this new technology and the opportunities it presents. That is one thing that won't change.
I'll be the first to tell you I don't have a crystal ball. It is difficult to keep up with the ever‐changing environment of technology, cost, and regulation in this market. If I had tried to write out a game‐plan predicting how this industry would unfold, then this book would be out of date before its publication.
Instead, my objective is to provide a framework for the potential of what blockchain and security tokens can do within the financial industry. It also will give the reader an understanding of what factors and attributes to look for in determining which projects are most likely to thrive in this new environment.
It seems inevitable that one day all investable assets will be tokenized and that we will see an unbelievable amount of wealth transferred onto the blockchain. There will likely be a time when security tokens are globally traded, and in theory, anyone who has an internet connection and is within the regulatory limits will be able to access and exchange them. This will result in capital market access being democratized, not only for large institutions or the wealthiest classes, but for any investor around the world. One of the most exciting parts about all of this is that everyone can get involved!
Baxter HinesApril 2020
INTRODUCTION
Blockchain will spearhead the next generation of financial market infrastructure.
Security tokens are a digitized form of traditional ownership certificates.
Blockchain and security tokens will disrupt the investment industry by providing cheaper and faster financial market solutions.
Opening Remarks – The Big Picture
Our financial system is on the verge of a massive transformation. The current infrastructure involves complex webs of services, exchanges, and institutions intended to provide an efficient, steady linkage between market participants. Under today's regime, centralization has been the most effective way to trust that all transactions – and the system as a whole – will function reliably and properly. Large organizations, whether they be central banks, multinational brokerage houses, or other financial intermediaries, control the gateways through which money flows around the world; society allows this because these firms have the size, brands, products, and personnel we deem trustworthy. But there is a heavy toll exacted in exchange for a thin veil of confidence afforded by these old‐school methods of accounting and verification. This approach is bloated and bogged down by antiquated designs, inadequate integration, bureaucratic stall, and the human tendency to stick with the familiar. The architecture is inadequate for today's needs and inhibits the optimal functioning of a modern globalized economy. A major overhaul to improve efficiencies and drive down costs is long overdue.
Blockchain technology is the solution to spearhead the next generation of financial market infrastructure. Blockchain solves the problem of how to transfer value and information without having to rely on a single thirdparty. Blockchain uses mathematical laws, accounting principles, and governance mechanisms to ensure trust and transparency unparalleled to what our current systems provide today. Cryptocurrencies like Bitcoin introduced the world to blockchain technology and showed how it has the potential to create a reliable, immutable, and auditable system of payments that do not require intermediaries. Cryptocurrency was just the first step and paved the way for the upcoming digital transformation.
Security tokens are the next milestone for the financial markets. In simple terms, security tokens offer investors a digitized form of a traditional ownership certificate, providing title of a regulated financial instrument combined with the agility and speed of blockchain. But there is so much more that security tokens can provide other than just proving ownership of title. The “digital wrapper” creates huge excitement because it will power a new era with widespread ramifications and possibilities for both investors and issuers globally. Not only will security tokens allow both old and new players to offer creative and original products and services but they will also bring about the cost savings and efficiencies made possible by digitization. Through process integration and superior design, security tokens will facilitate greater and wider access to new investor bases and new geographies that would otherwise be difficult to achieve.
The tokenization of securities is still in its early years of both development and adoption – mainly due to the complexities and uncertainties around regulatory compliance. Indeed, the transition to tokenization will not be easy. Security tokens are far more complicated than that of the cryptocurrencies on the market today. As a result, they will require more sophisticated applications for their creation, trading, and maintaining. Leading‐edge technology companies are racing to build a new interconnected financial infrastructure on top of the blockchain to ensure tokens are safe, compliant, and more cost effective than the paper alternatives we deal in today. Regulatory bodies are watching closely and will move cautiously on what they allow – and the speed at which they move – so as to safeguard the public's interests.
The digitization of finance and security tokens is showing an incredible amount of promise. There are conceivably hundreds of trillions of dollars of assets worldwide whose value could be transformed and unlocked by the blockchain. The financial industry now has the products, the leadership, the systems, and the vision needed to make this potential a reality. Many stakeholders realize that there is something very big starting to unfold. Thought leaders and financial entrepreneurs are coming to accept that most assets can be digitized. Soon, the trading and ownership of digital assets will explode, and adoption will take hold. The ability to alter the liquidity, integrity, and cost effectiveness of a security will be the driving forces of this trend. The future and its potential are massive, and the growth will take place over many, many years.
The world is moving in a direction where blockchain will have a significant impact on how the markets interact. Players in the industry will need to have a broad comprehension of how the technology works, what it can affect, and what consequences it may have on business. The purpose of this book is to explain these concepts in a way for everyone to understand. Given that blockchain and security tokens have so much to offer, one of the biggest ironies is that education of the general public may very well be the greatest hurdle to going mainstream. Hopefully by the time you finish this book, you can safely say you have made it past that obstacle.
Disruption of Investment Industry
“The biggest opportunity set we can think of over the next decade.”
Bob Grifeld, former CEO NASDAQ, discussing blockchain's potential1
So if blockchain and security tokens are so much better, cheaper, and faster than what we deal with today, does this mean “out with the old and in with the new?” Not exactly. This new way of doing things may not immediately replace lines of business currently seen in the financial space but will more likely provide powerful tools to help the overall industry grow and become more efficient. In short, the new technology will force change so that current systems must evolve.
Today, technology companies are rebuilding the financial infrastructure on top of here the blockchain, thereby creating a more efficient and interconnected financial fabric. This has led to the removal of many financial institutions from investment transactions in a way that is generally advantageous to investors and issuers. In the near future, there will likely be widespread attempts at disintermediation in which new companies and offerings will seek to disrupt the status quo by replacing the facilitators involved in many traditional business transactions with blockchain applications and services. These new ways of doing things are likely to usurp, disrupt and overtake the legacy competition.
Very much like the way the internet changed the financial services industry in the late 1990s, digital solutions will create new sales opportunities, new capabilities and new markets to tap. This innovative method of doing things will likely lead to cheaper, faster, and likely safer outcomes. Many of the services provided today will be very similar in their outcomes but will just be made better. Take the example of how the internet changed the way we buy an airplane ticket. Back in the day, if you wanted to travel from Washington, D.C to Berlin, you would contact your local travel agent and she would contact the appropriate airlines, search prices and get back to you with options. The tickets you bought would eventually be mailed to you. Today of course, you simply visit the website of an airline or go to an online travel booking site to do this. The internet merely made improvements – albeit significant improvements – to the old system. It created a faster and cheaper way of conducting business as usual. Likewise, as the internet opened up whole new realms of possibility, so too will blockchain.
Through the use of blockchain, security tokens are creating huge excitement because they can combine the best of the latest technologies with all of the investor protections and regulations that we find in traditional securities today. To cite just a few things that will be enhanced:
Soon you may be able to move digital securities around the world 24 hours a day, seven days a week.
Compliance systems will be embedded into securities and automated such that people can trade from jurisdiction to jurisdiction, without fear of running afoul of local regulators.
Companies will be able to communicate with their investors all at once with just a click of a button. Corporate actions such as dividend payments, proxy voting, and rights offerings will be sent from the issuer directly to the investor.
Investors will be able to trade in lucrative, often established, opportunities that lack liquidity today. For example, venture capital and private equity investments are often unavailable because of their lack of tradability and need for large ticket size. Security tokens offer avenues to alter that investor profile.
While the removal of intermediaries and the automation of processes will generally be seen as advantageous to the economy and society as a whole, those who control the financial markets and their gateways will not go away quietly. Anyone who has been in business long enough knows the difficulty of disrupting the status quo. There are many entrenched constituencies who have strong incentives to resist change. Big businesses will scramble to keep things going their way. Regulators and legislators will look to ensure proper measures are in place to reduce risks and disruptions as the groundwork for blockchain is being implemented. As I discuss later in this book, it is essential to have guidance from both lawmakers and the large, most respected entities in the industry. Yet changes are coming and the technology isn't going away. As a result, initial resistance will be more of a speedbump than a barrier in seeing these possibilities unfold.
Case Study: Carlsberg
Based in Copenhagen, Denmark, Carlsberg A/S is the world's fourth largest brewer. In addition to its flagship namesake beer, the company brews world renown brand beverages Tuborg, Kronenbourg, Baltika, Grimbergen, Somersby Cider and more than 500 other beers. Carlsberg products are enjoyed all over the globe.
During my time as a portfolio manager of an international mutual fund based in the United States, I was an investor in Carlsberg on behalf of my clients. In order to build a position and hold Carlsberg stock, the following are just a few of the many steps that had to be taken:
Set‐Up phase:
A relationship had to be set up with a local Danish bank to act as a custodian for the shares
A relationship had to be developed with a broker that had expertise in trading Danish securities
A relationship had to be established with a broker specializing in foreign exchange with a particular niche to the Danish krone
Trading Stage:
The fund's US dollars had to be converted into Danish krone
Shares of Carlsberg had to be purchased on the Copenhagen stock exchange
Holding Stage:
Carlsberg pays an annual dividend in Danish krone. Those dividends had to be converted back into US dollars before they were distributed to American clients.
A few other things to note. First, as I was based in Dallas and the stock was being traded in Copenhagen: the market hours were a factor of contention as trading of Carlsberg would be occurring late into the night for me. Second, American holidays and Danish holidays don't always coincide. If I were on holiday or the Danes were on holiday, there was little to no chance that we could've conducted trades during those times.
One could argue that we simply could have purchased Carlsberg in the United States as it has an ADR, or American Depository Receipt. Indeed, Carlsberg does have an Over‐The‐Counter ADR available. Unfortunately, issues arise in that scenario as well. At the time of this writing, Carlsberg stock in Copenhagen saw over $30 million a day of stock traded on average; yet, the ADR traded less than $1 million some days. That is a significantly lower level of liquidity in the ADR and purchasing in the OTC market could result in a less favorable price than what could be obtained in Carlsberg's primary market of Copenhagen. Also, trading in the ADR market can be somewhat tricky especially around the dates when a dividend gets paid. Often times, the dates in which an ADR pays out a dividend is different from when the underlying stock does. Market makers in ADRs might be reluctant to exchange stock when there could be any question as to who gets the dividend. On top of that, the custodian banks who issue the ADRs can charge a handling fee that can be as high as 2% per annum.
This example illustrates how difficult and expensive cross‐border trading and investing can be. While the fund I was investing for had billions of dollars under management and was able to bear cost, many smaller investors cannot. When making these investments, I often would scratch my head and ask “Isn't there a better way to do this?”.
Legacy Ways of Doing Business
The financial systems used today are the summation of all things cobbled together in yesteryears. What does that mean? It means that when these systems were designed, the financial industry for which they were built looked different. The technology, service offerings and client demands were also different. It is not uncommon to hear of firms still using centralized mainframe computers or software systems from the 1970s for important processes. Thus, the designs of the systems used today are not running with what is available in today's markets for today's business climate.
Financial firms often have computer architectures that are multi‐layered – there are different systems for the front, middle, and back offices. On top of that, you may have additional applications for handling financial, client or regulatory reporting. Manual inputs and manual corrections are standard in successfully completing many tasks. Financial entities will have entire departments dedicated to creating customized solutions to help these different systems talk to one another. As a result, information is not stored or handled in its most efficient way. These techniques lead to siloed workforces and unnecessary risk resulting in inefficient, costly, and sub‐optimal business practices.
Paper Securities & The New Alternative
Paper certificates have long been the easiest and most economical method for recording and transferring ownership of securities. But this practice has led to issues including lost certificates, re‐issued certificates, doubled up certificates and other problems. Numerous invalid or improperly handled security transfers have resulted in headaches for regulators, owners and issuers.
Digital forms of certificates will clarify the chain of custody and ownership. The financial industry will be shocked to realize how simple and superior the digital method is compared to what is used today.
In the late 1990s as the internet was first blossoming, regulators in the United States were in desperate need of a new way to collect and store the mandatory filings that were required of securities issuers. Instead of having to regularly process stacks and stacks of paper copies of filings, the regulators determined that electronic submission of all documentation was the better route. This led to the formation of the EDGAR database. Soon thereafter, all filings were required to be in digital form.
A similar type of reckoning may happen with security tokens. Regulators have much to gain by seeing an immutable, transparent record of the trade histories of securities and their holders. This digitization would lead to faster auditing, better monitoring and superior record keeping.
Historical Perspective: The London Whale
In 2012, a single trader lost almost $6.2 billion for JP Morgan. Nicknamed the “London Whale”, the trader accumulated a position larger than what the bank would have ever allowed. When the market went against the trader, it was too late to correct the situation and losses mounted quickly.
Regulators investigated JPMorgan's internal controls and risk management systems. In the end, the bank was forced to pay nearly $1 billion in regulatory fines and a number of high‐level executives took massive pay cuts.
A key reason that “The London Whale” was able to take such outsized positions was because some of the bank's risk measures were manually calculated on Excel spreadsheets.2 While this practice is common in the industry, it is clearly inappropriate for such a mission‐critical purpose.
A lot is riding on these financial systems. Undue risk is taken by not having integrated, reliable and trustworthy systems. Without proper communication protocols and processing capabilities, there is a significant risk that something important will fall through the cracks.
Financial institutions are led by some of society's smartest and most innovative professionals. These firms commit huge amounts of capital every year to ensuring they are competitive and up‐to‐date on compliance and regulatory standards. But revamping legacy IT systems can be a daunting task and problems associated with efficiency can get swept aside. There comes a time though when every business has to face the facts. The question of “Are we doing things right?” turns into “Are we doing the right things?”. Financial institutions will have to come up with a new game plan and a new foundation on which to build their infrastructure. Blockchain, digital assets and security tokens can provide this definitive path for long run sustainability.
Entering the Disruptive Phase for Digital Assets
In the book “Bold: How to Go Big, Create Wealth and Impact the World”, authors Peter Diamandis and Steven Kotler outline how advancements in information technology take hold in the marketplace. Diamandis and Kotler lay a framework for how these adoptions tend to unfold over the course of six very distinct stages they term “The Six Ds of Tech Disruptive Technology”. The underlying thesis is that traditional industries will be shaken up as the world becomes more digitized, and that this will happen at an exponential rate. The authors' way of looking at how digital technologies become immersed into society help give us an idea of where digital securities are in their evolution.
“The Six Ds are a chain reaction of technological progression, a road map of rapid development that always leads to enormous upheaval and opportunity.”
Peter Diamandis and Steven Kotler3
As illustrated in bold, the six stages of exponential growth are as follows:
Digitization
– Once boiled down into a series of ones and zeros, processes become an “information technology.” This transformation enables new business models, products, services, or processes that can be supported by digital innovation. This turn of events marks a significant milestone for a line of business and sets about a chain reaction of incidents that challenge the traditional elements of that industry.
Deception
– As things are digitized, time is needed before the innovation gets to a point where it can truly match its promised potential. During this stage, the growth is exponential but still seems relatively small to the public (think of the process of a penny doubling – after a few rounds, it has grown from 1 cent to 2 cents, to 4 cents, to 8 cents and so forth. More time is needed before an impact is really made). As a result, hype and interest around digitization can falter. Incumbent players in the industry will downplay the threat to their business. Society becomes impatient and begins to distrust what they once hoped for.
Disruption
– Digitization increases the options for disruption. Entrepreneurs innovate new products and create new markets that will disrupt existing businesses. As more begin to realize the power the new way of doing things has to improve or optimize lives, the established customs and practices become obsolete – or at a minimum, less relevant. Unfortunately for those entrenched in the old ways of doing business, disruption always follows the deception period. At this stage, either you disrupt or you will be disrupted by someone else – there is no avoiding the inevitable!
Demonetization
– Here, money is removed from the equation and new offerings are free or offered at a fraction of their historical price. Costs of products and services fall dramatically. Two decades ago, a set of encyclopedias cost thousands of dollars; today Wikipedia is free, providing a more extensive, accurate, and update‐to‐date online alternative. Video editing software packages once sold for millions; now, people use Instagram apps.
Dematerialization
– As digitization takes further hold, entire product lines disappear. Smart phone apps are the perfect examples – one phone can now replace the calculator, the camera, GPS, the alarm clock, the portable media player, and so many other devices.
Democratization
