ICO: a threat for banks or a new financial instrument to be regulated?

During 2017, an increasing number of entrepreneurs tried to raise funds by launching this kind of operation, similar to traditional crowdfunding but involving the presence of a token, a cryptographic asset which is supposed to provide the buyer with the right to access to some sort of network or to receive a return on the investment.

To be more specific with the term ICO we refer to two main categories of Coin Offers:

- UTO, which stands for Utility Token Offering: they are used by Blockchain entrepreneur to launch their own project. Specifically, the token represents the right to receive either discounts or other advantages in terms of network accessibility. In most of the cases, they are supposed to be related to disruptive business models which require customers to be represented by a distributed network (e.g. Gnosis for sharing computing power…)

- STO which are nothing else than a pure tokenization of traditional securities (stocks, debts, etc…)

Concerning the second category, I would like to picture two different scenarios. Banks and Financial Intermediaries exist also because of their activity in looking for capital and financial resources on behalf of their clients. For this very reason, banks may be radically transformed by the rise of this new fundraising technique:

1) Assuming there are not intermediaries, clearing houses nor settlement bodies, banks may be potentially disrupted, especially if companies interested in launching an ICO are MNE and big corporations. They are able to find the necessary technical expertise to easily conduct such a sophisticated operation without asking help to banks

2) A more realistic scenario can refer to banks leveraging ICOs and taking advantage of this new instrument. To be more specific, retail and investment banks not only provide people and companies with the money they might need or ask. They also offer a specific type of consulting activities and settlement of sophisticated operations and ICOs can be seen as a new revenue opportunity as well as an efficient way to leverage Blockchain and Distributed Ledger technologies.

By default, some kind of blockchain like Ethereum allow a sort of automation by securing the execution of the so-called smart contracts when some hypotheses happen or are verified. Now let’s just imagine what might happen if we apply this logic to short-term and long-term bonds as well as on equities. In this second scenario, Banks will still be able to perform their advisory activities by putting in place the required standards and by verifying all necessary requirements. But when it comes the time for the company either to pay interests or distribute dividends, a smart contract is triggered, and the investor receives directly the payment through an atomic transaction, recorded on a distributed private ledger in an immutable way.

The purpose of this very short article is not to dive deep into details and possible regulatory disruption coming from the rise of this brand-new class of financial tools. Without any doubt, blockchain can potentially disintermediate financial markets and force institutions to rethink the roles of regulators, depositories, and CSD. Conversely, my intent is to make the reader think about what might happen if we apply the smart contract logic to derivatives. Recently Barclays launched a Hackathon, a 48 hours challenge during which banks developers tried to prototype financial derivatives on some of the main blockchain technologies currently available in the market (https://medium.com/corda/derivhack-2018-on-corda-943cc3695c43). As a result, major international Corporate and Institutional Banks were able to test and iterate the first financial derivatives products built on automatized lines of code.

When we think about an “Initial Coin Offer” we definitely can refer to all sort of sophisticated financial operations such as credit pooling, loan syndication, crowd-lending among the others. Let’s consider a Syndicated Loan. The company interested in asking for funds can launch a special type of token on a private blockchain. The token will represent a fixed amount of fiat money and banks can directly finance the company by buying tokenized parts of the company’s debt. This type of operation can be imagined on a financing pool dimension or with a single bank running the whole operation. The crucial part is the use of DLT which implies a dramatic reduction of reconciliation costs as well as an increased level of transparency, requirement which is more and more needed in order to be compliant with some regulations like Solvability II and MiFID II. Traditional finance is transforming, and an increasing parallelism can be identified between big tech and financial institutions activity scope.

Instead of fearing the change, financial players have to embrace this transformation and take all possible advantages. As of now, a huge number of early adopters is already trying to deploy first internal and external blockchain solutions. Main obstacles, indeed, are represented by the lack of regulation and the necessity to create a “network” dimension. It is especially the network dimension which makes the transformation process much slower as completely opposite to the traditional siloed banking model. What if illiquid assets are suddenly tokenized? In the next few years, Blockchain and Tokenomics are going to bring to the Alternative Investments category more liquidity and operational efficiency.

Another time, as it happened during the advent of the internet and the second industrial revolution, there is a bunch of market players which is forced to change.

Thanks to the consortium dimension, banks are now forced by blockchain and DLT to sit around the same table and discuss in an open and constructive way. This doesn’t mean blockchain or ICO represent a threat for banks. Today we still have physical mail services, even after the rise of e-mails. However, a radical transformation will be a vital step to resist in a fast-paced world and we have to get ready to see an enormous (r)evolution affecting all traditional financial players.