Digital Securities some lessons to date
Let’s start with 3 points to frame our ideas below:
1. Email is better than paper, digital shares are better than paper shares
2. The value of any share, digital or paper, is derived from the quality of the underlying asset
3. Digitalize = the process of converting information into a digital form to change a business model and provide new value producing opportunities
DSO = Digital Security Offering or STO = Security Token Offering as they are also known, are traditional investments where the shares to investors are issued digitally versus on a traditional paper contract. We prefer the term DSO as it is more friendly to traditional investors and easier to understand.
Why do this?
The benefits begin at the administration level bringing greater transparency to the setup and issuance of a new company, including cap table management, distributions, disbursements, company information management etc. The DSO also offers new ways to form capital for sponsors/issuers and as the contracts are now “programmable”, we will start to see the creation of new and improved offerings apart from traditional debt or equity.
We believe that digital securities are the future of all securities issuance for private and public companies. And in the not too distant future, we think you will see this offering coming at the government level too, so the issuance of a new investment vehicle i.e a new LLC or Cayman Fund will be issued 100% digitally by the government, as its simply a better system and easier for them to manage too.
We have now gone past the theory stage and have real use cases where traditional investments like a venture capital funds have issued shares to investors digitally and these shares are now trading on a regulated and licensed exchange, meaning that instead of the typical 7–10 year lock up for investors, there are now liquidity options available after just 12 months. This is a critical change and a pivotal moment. Those claiming this is not a 0–1 episode and more of a 9–10 are obviously flushed with cash and have never wanted to free up capital or had funds tied up in illiquid holdings before.e
One of the current issues in the market is that most DSO/STO posts are written by the blockchain/crypto/ICO groups, not traditional investors or issuers, who are the first ones actually needed for any issuance to occur. The only thing DSO has in common with BTC/ICO is components of the underlying technology, but most other characteristics of each are simply worlds apart.
You need a team of experts (legal, tax, due diligence, accounting, investment, fundraising etc) to run any security offering and with a DSO, you also need to add the technology specialists. This is why so many comments and DSO projects from the blockchain community do not tell the whole story as they are missing many pieces of the puzzle and not seeing the true opportunity here.
Also what this means is that most DSO to date have been startups looking to raise capital, and startups are not the ideal underlying for a DSO. Why? because ultimately the goal of investing into a DSO is so that you can get your shares and trade them on an exchange. For a DSO to be trading on an exchange you must be able to calculate its value, which means DSO on exchanges lean toward underlying securities that are asset-backed and paying dividends or income to the holders where it is easy to value them on a frequent basis like real estate.
As we look out to the future we see the true value of DSO in a completely different product than what we have discussed so far (i.e new projects raising money). The real opportunity is that you can start to take portions of existing assets/funds and sell them down to investors, so there is no “fundraising” risk, you have existing proven assets with audited financials (not just projections) and a much bigger product universe of offerings where issuers will pay strong returns for the ability to free up some liquidity from their assets. This hugely important point is currently almost never mentioned.
The initial wave of DSO were start-ups and ICO projects that pivoted to try to raise capital but with teams lacking any understanding of capital markets and process flow, damaging the success of most of these projects. The other issue with startup DSO is that they typically pay no dividends and are difficult to value at any point in time. Unsuccessful fundraising campaigns for the wrong types of DSO projects, should not be used as the barometer of success for the future and promise of the “DSO industry.
There will be options for P2P or OTC trading of DSO even as many will never get a listing on an exchange, but ultimately the best DSO will be trading on DSO exchanges whereby there will be liquidity if the exchanges choose the right quality DSO to list.
If you could invest in a DSO issuance or a traditional issuance with the exact same underlying asset, 99.9% of investors are going to prefer to invest through the DSO structure, as there are liquidity options now available
Another major issue today is that DSO is being pushed out in the wrong places. The “DSO industry” needs to be “born” at private equity and traditional investor events and conferences, as it is simply digital shares of securities, it is not a “better ICO” or a cryptocurrency, it is completely different.
We will still be suffering some growing pains as this all gets shaken out in 2019 but it is going to be massive and those that say DSO is a 9–10 and not a 0–1, firstly, are not Peter Thiel, and secondly, do not own enough illiquid assets or have not spoken to enough private equity issuers to see the clear value proposition being created here and we are only just beginning…