#Digital Bytes a weekly analysis of a selection of developments in the Blockchain and Digital Assets sectorsblockchain
Will regulators and compliance drive tokenisation of assets?
There are a number of organisations trying to convince investors of the merits of Tokenising different assets classes, on the basis that once it is possible to buy a fraction/share in a property or piece of art or a car etc, it will enable smaller investors to participate and create a pool of liquidity. While this sounds very plausible in practice, illiquid assets such as art, property and classic cars tend to be the preserve of the very wealthy or institutional investors. These asset classes usually have little day to day liquidity, as these more sophisticated investors tend to buy and hold for the longer term. However, the jury is still out since by tokenising these illiquid assets, it will instead lead to other people actively buying and selling on a daily basis!!!
The Real Estate Investment Trusts (REITs) market started in the USA in September 1960, as a way of encouraging investors to participate in buying property in the USA. This REITs model has been subsequently copied by many other countries around the world.
The statistics below show it is estimated that 80 million people are exposed to USA REITs, which is valued to be over $3 trillion in size, with the majority REITs being quoted on a regulated stock exchange.
It is possible to buy a USA REIT at a discount of its asset value and, indeed, at the end of 2018, the discount of the median RIET was as large as 18%.Therefore, one has to question if there are potentially 80 million investors exposed to over $3 trillion of assets, which one can buy at a potential discount of 18% — how will tokenisation help?
The other popular mis-nomer has been how Initial Coin Offerings (ICOs) and the tokens they created will democratise capital. To put this a different way, ICOs offered the promise to enable smaller investors to have access to smaller exciting tech start-ups. These have historically been the preserve of wealthy-sophisticated investors and institutions, like Venture Capital and Private Equity Funds. In 2017 Naga, a German publicly quoted company, epitomised this by raising over $50 million from 63,000 people. Unfortunately, apart from a handful of tokens, there is relatively little liquidity in the secondary markets and exchanges for many of the organisations that have issued a token.
According to Coinmarketcap.com, there are less than 100 tokens that had a volume of more than $1million, after which the volumes fall dramatically to a few thousand over most 24-hour periods. But this really ought not to be a surprise, as there are relatively few investors who buy even quoted smaller companies. In the UK, there are 481 companies on the Alternative Investment Market (AiM), that have a capitalisation of between £2+ million, but less than £100 million, and another 272 companies listed on the main London market valued under £100 million. So, just in the UK, we can see there is plenty of choice for investors but unfortunately it is almost impossible for even these publicly-quoted companies to raise fresh capital. There are multiple reasons for this — lack of information about these smaller companies, difficulty in valuing the company, few tangible assets being owned and lack of institutional interest etc. Often there is no liquidity to buy and sell these quoted smaller company shares. How familiar are these reasons cited as to why there are a lack of investors for tokens in the secondary market?
UK smaller companies have out-performed the FTSE 100 index — in the 10 years to 6 November 2018, the FTSE Small Cap ex IT index has risen 266%, compared to a 140% increase for the FTSE 100. So, surely investors would be flocking to this asset class? Therefore, why will tokenising equities mean that these investments do any better??
This backdrop has not stopped The London Stock Exchange (LSE) from embracing tokenisation of equities and, in April 2019, it actually allowed a company called 20/30 to list its “tokens”on the LSE exchange- why? Strangely, this could be due to regulation and compliance pressure as, by tokenising/digitising a share/bond etc, it is possible to build-in greater controls from a compliance standpoint. For example, an international mutual fund will have a maximum it is allowed to invest in the USA, say 10%, but the fund manager may go to buy another share and not realise that this will take the fund over the 10% limit. This results in a compliance breach which ought to be reported internally, and then potentially to the FCA. Alternatively, let us assume you are a high-risk investor and your portfolio manager decides to buy a low-risk investment, again causing a potential deviation from your portfolio strategy and the need for more compliance reporting. These types of breaches are common, costly and time-consuming and totally avoidable if pre-trade checks have been automatically carried out prior to, not after, a trade is executed. These checks are not easy to carry out in today’s largely analogue manual systems, but eminently possible using automatic machine-run checks if a security is digitised.
Also, the amount of income payable to an investor can be calculated, based on the number of minutes the investor has held a share, bond or property. This is opposed to being paid the distribution, based on the investor owning the asset on the day that the share, bond or property makes its dividend, coupon or rent payment!
As compliance pays an increasingly important role in the financial services sector, and the constant need to be seen to be “treating customers fairly”, will we see quoted companies like Apple, Facebook, Microsoft, Shell, BMW Tesco being asked to create a digital/tokenised version of their shares?
This rather ironic state of affairs, where regulation drives the adoption of Crypto, is juxtaposed to the current situation where institutions shy away from tokens as they are seen to be akin to investing in the “wild west”, and concerns about the wrath of compliance officers abounds…….
Crypto ATM- cash point machine goes berserk and “dishes out” cash…..
At Bond Street underground station recently, what the Americans call an Automatic Teller Machine (ATM) or a cash point machine in the UK, someone tried to convert their Bitcoin in to pound notes and it began issuing so much cash the withdrawer could not cope……..
As you can see a security guard tried to keep shoppers and commuters at bay, who looked on in amazement, as used bank notes littered the floor.
The ATM turned into what looked like a Las Vegas one-arm bandit machine that had hit the jackpot, and bank notes were soon flying out of the machine all over the floor… If nothing else I am sure it cheered up the commuters and certainly distracted the shoppers on Oxford Street!
Tokens helping to make beaches cleaner!
The images below highlight the dramatic results earlier this year in the Philippines, when over 45 tonnes of plastic and rubbish were collected off a beach in Manila Bay.
Plastic Bank and Bounties Network have been encouraging people to collect rubbish and plastic, and rewarding the collectors by paying them in Ethereum (a Cryptocurrency). These two companies then partnered with a local Philippine cryptocurrency firm, which itself took the Ethereum and converted it in to the Philippine peso.
SC Johnson, the makers of Raid, Pledge, Kiwi, Glade etc, has been involved in a number of projects in Indonesia, where it has been giving away Digital currencies in exchange for local villages to collect plastic waste. According to a press release, SC Johnson teamed up with Plastic Bank to establish eight plastic recycling centres and is giving Digital tokens as an incentive to pick up rubbish off their local beaches, as “people can then use the tokens to buy needed goods and services — reducing the risk of loss or theft”.
These are great examples of how Digital Assets are being used to encourage positive behaviour and help reduce the amount of rubbish in our communities.This could not be further from how some people few Crypto currencies being the preserve of drug lords, terrorists and generally unsavoury characters.
A little closer to home, in 2017, the Hull Coin was launched. Whilst it cannot be bought, it can be earned by doing “good work” for Hull’s local community and then spent in local shops to receive a discount. Other towns in the UK have also looked at issuing local currencies, but as yet we have not seen wide spread adoption.
Take two — Kodak is back!
In January 2018, KodakOne announced that it was going to launch the Kodak coin and, as a result, Kodak Inc share price went up 120%.The basic idea behind KodakCoin is to use Blockchain technology to help photographers manage their photos by creating permanent, immutable records of ownership. It was believed that KodakOne would make it significantly cheaper and faster to register and sell digital images. The Platform was said to offer a simple, transparent Blockchain-powered worldwide royalty accounting, licensing and payment system. The KodakCoin was never a part of Kodak Inc, but was a separate company that licensed its name from Kodak Inc. While KodakCoin’s Initial Coin Offering (ICO) never proceeded, a year on, KodakCoin has generated over $1million in revenue in its beta-test trials.
Kodak Inc is back in the press and this time it is Kodak, the company that invented the digital camera, and then decided not to commercialise it. This time it is looking to create a Blockchain-powered platform to store and manage documents, all held in the cloud. Kodak claims that its new platform could generate as much as 40% in terms of cost savings, using Blockchain technology.
So second time around, no ICO, no huge increase in Kodak’s share price, but just another example of a global brand using a Blockchain to offer its customers a service to help make business processes hopefully more efficient and cheaper. All rather dull one could argue, but business is not always “sexy”!
Blockchain is helping retails with supply chains and factoring
Target, who is the eighth largest retailer in the USA, has been working with Hyperledger, IBM and Bitwise to use Blockchain technology, initially to help it improve its supply chain logistics for a number of its paper products. Target is also looking at using Hyperledger as it is used by Cargill, who is one of Target’s main food suppliers. In a recent blog, Joel Crabb, at Target said“Working directly with one of our largest food suppliers will allow Target and all other participants to learn from one another as blockchain technologies mature. This also gives us an instant use case in determining which data to share and how to govern a multi-enterprise, blockchain-backed distributed ledger.”
Once again, as we have seen in the luxury goods sector with LVMH and the shipping sector with Tradelens, Target is looking to collaborate with suppliers and other parties enabling them to all share their experience and knowledge. This style of “collaborative capitalism”, where independent organisations are actively engaging with each other and sharing information and knowledge, is intended to create a stronger, more robust and transparent solution which will help the market and not just the interests of one organisation. This collaborative style is well summarised by Crabb: “Maturity in this space will take time, but we’ll only get there when enterprise partners like Target and Cargill dive in together.”
Meanwhile, the third largest retail store in Russia, Dixy, is using Blockchain technology to help it develop an open-trade finance platform, called Factorin. This platform is designed to enable it to engage with factoring firms and help Dixy’s cash-flow management. The Factorin platform has been under trial for a few months and has already processed over 10,000 transactions. It has been developed to help improve efficiency, cut out human errors and speed up payments due to small and medium sized business — which are estimated in Russia to be valued at $45 billion.
Custody services for Digital Assets is becoming a reality!
In order for institutions to be fully engaged with Digital Assets, they are going to need a third party to look after their assets — a role which has historically been provided by custodians.The regulators in most jurisdictions insist that the organisations that manage your funds have to be independent from the entity that physically looks after the assets. The good news is that the options and choices for those looking for custody solutions for their Digital Assets continues to evolve. Metaco has announced that it is using Aon(the world’s second largest insurance broker) and a group of Lloyds of London underwriters, as they are now able to offer “crime-protection” insurance for Digital Assets held in Metaco’s Crypto-wallet. This means that clients’ Digital Assets will be protected, both when their assets are stored “hot” — on-line, and “cold — off-line.
This is not the first time Aon has been involved in supplying insurance for Digital Asset custody providers, as it announced earlier this year it was working with Anchor labs in the USA.
However, while AON claims to have 50% of the current insurance market for Digital Assets, other firms, as the chart above illustrates, are also active in offering insurance solutions for the custody of Digital Assets.
Another potential new custody provider for Digital Assets is 20/30. Robert Gaskill, from 20/30 ( the first company to issue a Security Token, to be listed on the London Stock Exchange), recently told me 20/30 is looking at an acquisition in the custody sector. 20/30 is considering buying a firm that integrates its current custody solution and so will offer full insurance for custody of Digital Assets provided by Lloyd’s of London.
Interestingly, we are seeing companies relocating from the Channel Islands (where being a trustee is a regulated function) to the UK, where currently trustee services are not regulated.
The reason, no doubt, is that it will save these companies compliance costs. This means they ought to have lower professional indemnity insurance premiums and less capital tied up in the business, as not being regulated the capital adequacy rules are totally different. But why is this relevant?
Well, there are a number of people who believe there is no reason why a trustee could not, in effect, offer a very similar service as a custodian and, because the compliance cost-base is potentially less, trustees will be able to offer this service at a lower price. Assuming that the FCA do not insist that you need to be regulated to “look after” assets for regulated firms, could we see traditional custodians like BNY Mellon, State Street, Northern Trust, JP Morgan or Citigroup, to name a few, offering themselves as trustees as opposed to being custodians?
Given JP Morgan’s foray into the Digital Asset sector by launching the JP Coin, will this give it an advantage over its competitors, as it has potentially a deeper understanding of some of the challenges and opportunities being presented by Digital Assets?
Visa’s “flexible friend” embraces Digital Assets
Visa, who last year handled over $11.2 trillion of payments (according to Forbes) in 200+ countries, is now looking to attack the international money transfer market — which is said to be valued at over $125 trillion. Since 1973, Society for Worldwide Interbank Financial Telecommunications (SWIFT) and headquartered in Belgium, has dominated the market for international payments. However, SWIFT uses old technology, making it relatively slow and expensive to move money around the world, which is why Ripple is arguing that it is able to replace SWIFT, as Ripple’s Blockchain-powered solution is so much faster and cheaper. If indeed Ripple is successful, it would make the business extremely valuable. This may explain why Ripple rose in value by over 35,000% in 2017and caught the imagination of many Crypto-enthusiasts, as well as sparking a wave of “Fear of Missing Out” (FOMO) across dinner tables around the world and people searched for the next token that could offer them the hope of early retirement….
Visa has also announced that it is going to expand the number of countries from not just the UK, but to six more countries — Spain, Germany, France, Italy, Ireland, and Holland — by now enabling Coinbase to expand its Crypto to fiat debit card for clients. The card allows users to spend in Euros and Sterling, then their Cryptocurrency holdings will automatically be sold to meet the fiat equivalent cost of the purchase. The Coinbase card is attractive for those that travel overseas, as it will reduce the normal expensive foreign exchange fees that many other cards levy. Unfortunately, so far the reaction has not been that positive, with the card scoring only 2.4 on the Google App store. However, new upgrades are promised, which hopefully will improve the customer experience.
Initiatives, like the above from Visa, have to be welcome as they are driving down the costs of sending and spending money globally, while making it much easier for holders of Digital Assets to access their investments in easy and convenient ways. It ought make it easier to redeem digital loyalty rewards, which are being touted as an important market for Digital Assets. Companies are looking to use Digital Assets to attract new customers, while incentivising existing clients to do more business. We are seeing companies offering to pay for clients’ data, as opposed to just collecting it and then reselling it to advertisers — Google and Facebook have been doing this for years!
IOTA have been giving tokens to drivers of Jaguars and Land Rover vehicles during tests in Ireland, it collects information about road conditions and traffic congestion. Facebook has just announced a project called Study, where it will be paying clients for their data (possibly using the soon-to-be-launched Facebook Digital currency, Globalcoin).
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