Exchanging shares P2P on the blockchain
Many small companies are incorporated as shareholder owned corporation. Most of those companies are not listed on an exchange (too expensive) or on OTC markets. The share of those companies are not traded at all.
Share can be used to raise new capital or as collateral for a loan or many other things. But today it is overly cumbersome to exchange shares of unlisted companies.
What if there was a simpler solution?
OTC market on the blockchain
Today’s OTC markets are managed by brokers. These brokers act as gate keepers to their markets and could be replaced by a peer to peer (P2P) platform on the blockchain very easily. Reducing fees and hopefully improving liquidity for the exchange of shares of unlisted companies.
Barriers to entry
When the OTC trade is performed through a broker, the broker takes on some responsibility. In a P2P world, the middleman being removed, there is no one to take on any responsibility. The transaction has to become trust-less.
The second barrier is that each trade is unique. Again, the broker has an agreement with both seller and buyer, removing the need for them to enter a direct agreement between them.
This can, of course, all be solved with the blockchain.
Analog Flow of events
In Switzerland and France (the two countries I’ve checked) the flow of events needs to be the following:
- the buyer and the seller agree on a price and amount of shares and write a contract
- both parties sign the contract and tell the company whose shares they have exchanged, that there is a new owner
- the company then modifies the shareholder registry to reflect the trade
Assuming that there are no issues with the bylaws and that both parties can be identified, the shares have now changed hands.
In Switzerland, changes to laws to make it possible to automate this process came into force in 2016. France recognised a Blockchain transaction to be legally binding in 2017. Fairly new ground but it is possible.
Digital flow of events
The information stays the same but the way it is produced changes. We will use dual-linked or Ricardian contracts (available on the Contract Vault platform) and a dedicated client.
This is the simplest form:
- The buyer and the seller agree on a price and amount of shares
- The seller enters the information into their client app and generates a PDF of the sale contract, signs it with their private key (and/or officially recognised digital signature) and sends the PDF along with the signature to the buyer
- The buyer verifies the signature and the PDF, signs the document with their private key and sends the signature back to the seller
- The seller directs the client app to transfer the shares to the buyer. The app calls a smart contract function and provides the parameters: number of shares to transfer, the address of the recipient as well as the PDF and the two signatures
- The smart contract verifies that both parties signed the same contract and that the signatures are valid and proceeds to make the transfer if the verification passes
Again both parties must provide proof of identity before being able to make this transaction, and the bylaws must be adapted. But this time, everything was automated, and the shares could be transferred without the company maintaining an infrastructure of any kind.
Note that the payment for the shares is not included in the process. This is to keep things simple but could be included as well. We could create an escrow that is only released with the transfer.
The system is composed of only two technical components:
- A client application which allows to send the shares and sign the PDF contract
- A smart contract which acts as the share registry
The internet and the Ethereum blockchain provide the necessary infrastructure.
By providing investors with a simple app and using a smart-contract as their shareholder registry, companies can make sure that their shares can be exchanged with minimal friction and without the need for a broker.
This approach does not solve any issues with scams, but it might give legitimate businesses a boost which they struggle to get now as the barriers to being listed or included in OTC markets are too high for most SMEs.