Security Tokens & Shipping Containers
How standardized shipping containers changed the world and why security tokens are poised to do the same thing for financial markets.
The standardized shipping container is an invention that doesn’t get nearly enough credit for changing the world. It is, however, responsible for dramatically accelerating global trade. As explained in an article in the Economist, standardized shipping containers were responsible for a 320% increase in global trade during the first five years that they were in use, and an astounding 790% over the first 20 years. This occurred because products of all shapes and sizes could be put into these standard containers that could be used across every step of the supply chain process from container ships to trucks used for transport. Regardless of the actual products that went into the containers, there was now a standard way to move them around the world.
Security tokens have the potential to play the exact same role for OTC (over-the-counter) products and fractionalized asset ownership. Despite the world’s obsession with measuring how our economy is doing by looking at the stock market, a much better measure may be the OTC financial markets as they are an order of magnitude larger. They are not as easy to access today, however, as each financial product is bespoke and requires a dealer to be involved in every transaction to ensure that each trade complies with the relevant rules and regulations. Security tokens may change this model in the same way that standardized shipping containers changed global trade.
Security Token Benefits
There are three transformative benefits that security tokens bring to financial markets: Regulatory controls, Liquidity, and Transparency. Let’s break each of these down a little bit further.
Regulatory Controls: Today, every OTC product needs to have dealers review any transaction to confirm that it adheres to the regulations in place given the jurisdiction and the counterparties involved. Security tokens offer an alternative to this manual process in that the rules can either be coded directly into the token to prevent non-compliant trades, or even require a call to an external service to validate a trade is compliant before it is allowed. This way there is no risk of a rogue dealer allowing trades that should not occur and the cost of an intermediary is removed. The net result of this is that trades can happen without manual intervention, be fully compliant, and adapt to changing regulations over time. They will be safer, faster, and cheaper.
Liquidity: Just as standardized shipping containers made it easy to transport products around the globe, security tokens make it easy to build exchanges for a wide range of financial products. The exchange merely needs to support ERC20 tokens and perform the same KYC activities for market participants that any equity exchange requires today. Multiple exchanges are launching to provide trading venues for security tokens such as Templum, tZero, and Open Finance. The ability to take a wide range of financial rights such as revenue sharing, profit sharing, equity ownership, or any other OTC product and put them in a standard package (ie. a security token) means that you can now have exchange traded products that historically would have required OTC treatment. The impact of this is that assets that historically have been illiquid, such as equity in a startup, will now be available to trade on an open exchange and be converted to cash at any point in time.
Transparency: The ability to view all security tokens on blockchain and see their history provides a level of transparency that doesn’t exist today — even with equity trades. If a large investor is trading in or out of a given security token it will be evident to anybody that is paying attention in real time. Recent announcements such as Templum’s partnership with Cusip Global Services (CGS) to provide industry standard CUSIP identifiers to the tokenized securities marketplace will make it even easier to search and find security tokens via all of the standard financial portals available today such as Bloomberg.
Who Will Use Them?
Given these benefits, it is easy to understand why a number of different types of companies are looking at security tokens as the best financial vehicle for them to leverage. Here are just a few examples of why various types of companies are excited about security tokens:
Early stage companies: Rather than rely on venture capital or angel investors, early stage companies are starting to look at security tokens as the preferred model of capital raising. The benefits to both the entrepreneurs and the investors are substantial. Perhaps the most important difference between raising via security tokens and venture capital is that the investments are liquid from the outset. This means that the firm has a balance sheet asset that they can sell if they need more capital and investors can move in and out of their position based on their perception of how the firm is doing and how it fits with their current investment strategy.
Expanding firms: Growing firms with existing revenue lines are beginning to view security tokens as a way to raise growth capital in a way that gives them more control alongside the ability to take some profit off the table without having to either sell the company or go through a full IPO process. This interim step that allows successful companies to create liquid instruments tied to the company hold the promise of turning extremely large sums of corporate value that is currently illiquid into something that can be monetized by investors and employees that have created successful organizations.
Private equity transactions: Traditional private equity transactions have relied upon seasoned management teams raising large amounts of capital to acquire firms and improve their performance. Recently, Special Purpose Acquisition Vehicles (SPACs) have become popular as a way to raise capital for PE transactions via an IPO for a management team to acquire assets. Security tokens offer an option to perform something that could be the next generation of SPACs — that of taking an identified company or collection of companies and raising capital for a known management team to acquire them based on a security token that provides financial rights to the acquired companies. In this model, investors can review assets that are being purchased and assess the management team’s ability to improve their performance. It provides the investor with greater visibility prior to their investment and a liquid asset that they can sell if and when they choose to. Effectively, it is the best of traditional private equity and SPACs combined into an integrated model.
Real Assets: Assets such as real estate, precious metals, fine art, and machinery represent a significant portion of assets around the world but have been notoriously difficult to own at a fractionalized level. Security tokens make that possible — it is extremely easy to create a security token for a physical building where each token represents 0.001% ownership. Those tokens can then be sold on an exchange and people that wish to own a part of the given building have the ability to purchase it or sell it based on their belief about the value of the complete asset. This concept of fractionalized ownership has been around for quite some time, but security tokens are the construct that might finally bring it into the mainstream for everyday investors.
In summary, just as something as simple as a standardized shipping container was critical to enabling the rapid acceleration of global trade, security tokens hold the potential to do the same thing for global trading of OTC financial products. While they aren’t the front page news item such as currencies like Bitcoin, these deceptively simple digital tokens could very well be the most important invention to come from blockchain technology yet…