Why digitize debt ?
The purpose of this post is to bring awareness to the alternative of physical certificates/notes currently used to represent the issuance of debt securities (ex. bonds) in the capital markets industry. The alternative is a digital representation in a public ledger leveraging blockchain technology.
Why do we need an alternative?
- The current process is highly manual and paper intensive.
Today’s security issuance process is manual and multiple-step. These steps are error prone leading to inefficiencies in the issuance process.
- Redundant record keeping leads to costly reconciliations.
Blockchain technology would improve the efficiency of security issuance by
- Replacing manual process with smart contract automation
- Removal of intermediaries
- Automated asset servicing
Blockchain tech could reduce financial transaction processing cost model and increase transaction security.
The physical notes of the traditional issuance process are replaced with blockchain based digital assets. The transactions involving these digital assets are immutable and transparent.
Smart contracts can be programmed with legal conditions and terms, facilitating auto-execution of terms without intervention. Smart contracts are programmed with the contents of these terms and conditions. Smart contracts also automate corporate actions such as processing of interest payments on a debt agreement.
Let’s look at traditional capital markets
Companies raise capital by selling securities either privately or publically. The securities could be debt or equity-related, based on the company’s capital needs and or strategy. These securities (stock or bonds) are issued to investors in public and/or private markets.
Let’s look at traditional debt
A debt issuance is a fixed corporate or government obligation such as a bond(secured loan) or debenture(unsecured loan). The issuing company can sell bonds publicly or privately, and is obliged to pay interest and to repay the principal at a later date.
According to research done by Capgemini shows average fees paid are 0.9% − 1.5% for a bond issuance. This cost could be reduced by eliminating the intermediaries involved.
When a company decides to issue bonds to attract investments, its owners need to partner with an investment bank. The bank appraises company assets, then negotiates the terms with said company. Both sides turn to their legal team, who is responsible for due diligence check of the assets and deal agreements. This process could take up to 1–6 months. A massive amount of paperwork is involved in the process.
Let’s look at digitized debt
The digitization of debt using blockchain technology would bring efficiency to the laborious process above. Unlocking enormous potential for the multi-trillion asset class.
At Birch Global Services we’re developing out a suite of solutions that explore these opportunities. Our first offering is a crowdfunding platform designed to give accredited retail investors exposure to digital assets backed by debt.
To conclude here’s how the digitalization of securities benefits participants in the security issuance process.
• Real time settlement eliminates counterparty risk
• Lowers cost of issuance by removing intermediaries
• Mitigates administrative and operational risks
• Transactions are transparent and easily auditable
• Available 24/7