At the end of October, tZero, the leading alternative trading system for security tokens, announced it had been chosen as the trading venue for a $300 million data infrastructure technology fund from Tynton Capital, a venture capital and private equity fund manager.
Once this offering is complete, it will be a sizeable addition to a still small and rather self-enclosed market in security tokens.
Securities token offerings (STOs) have replaced initial coin offerings (ICOs), which burst onto the technology investment landscape in 2017 and 2018 when blockchain-based businesses raised large sums by selling to investors utility tokens to use on their platforms.
At one point, subsidiaries of messaging app Telegram were on course to raise up to $1.7 billion from an ICO, until the SEC clamped down and ruled that these coins or tokens were in fact securities and should be subject to full securities laws.
Even before the Telegram deal, ICOs had raised more than $4 billion.
For the last two years, market participants have struggled to adapt their blockchain-based business models to legacy security market regulations. The SEC has allowed certain disclosure and other exemptions for STOs, but they have failed to attract the large sums that were briefly being thrown at ICOs.
Investors may have been put off by a number of ICO scams.
Just being a technology provider doesn’t get you very far
Carlos Domingo, Securitize
According to data aggregated by Security Token Market, the total market capitalization of the securities token market was $540 million at the end of October, with that dominated by just two tokens, tZero’s own tZrop, with a market cap of $144 million, and Overstock’s Ostko, valued at $275 million.
Overstock is a US-listed internet retailer of home products that competes in that segment against Amazon. It boosted the securities token market by airdropping tokens as a dividend to conventional stock investors in May. Overstock also owns tZero.
Daily trading volume in tZrop and Ostko might be around $40,000 each. That is tiny.
However, the potential for blockchain technology to bring new liquidity to the vast market in private assets, in particular real estate, private equity and venture capital, means that it is not going away.
At the end of September, the European Commission published a draft proposal for a regulation on markets in crypto-assets (MiCA) that are not covered by existing EU financial services legislation.
Lawyers at Clifford Chance say this makes clear the European Commission’s (EC) intention to create an EU framework that both enables markets in crypto-assets as well as the tokenization of traditional financial assets and the wider use of distributed ledger technology (DLT) in financial services.
Could the dream merely have been delayed, not dashed?
Carlos Domingo, chief executive and co-founder of Securitize, the first SEC-registered transfer agent for digital securities – it records changes in ownership, maintains corporate security holder records and manages distributions to investors – tells Euromoney: “Private capital markets have been growing faster than public capital markets, but they are much less actively traded.
“Public equity markets might turn over 30 times their market cap each year, while private equity markets, which are twice as big, turn over barely 10%.”
He adds: “Buying and selling private equity is a cumbersome, manual process with limited price discovery.”
That is now becoming an issue for companies, investors and policymakers alike.
Domingo says: “Companies like Airbnb are staying private much longer than Amazon did, for example, and delivering much more value to private investors. There is a sense that many investors are missing out on a big opportunity.
“Some private companies want a degree of liquidity in their shares, but getting it is a problem if they don’t want to go through the expense of a time-consuming IPO, or are not suitable for direct listing. The recent popularity of Spacs [special purpose acquisition companies] is another sign of that search for liquidity.”
Opportunity
Domingo sees another opportunity: “There are a lot of companies between $100 million and $1 billion in value that are not suitable for IPO, direct listing or acquisition by a Spac that might benefit from greater liquidity of shares in digital form. That could be a $1 trillion market.”
In mid October, Securitize signed a definitive agreement to acquire Distributed Technology Markets (DTM), an SEC and Finra-registered broker-dealer and alternative trading system (ATS).
The acquisition requires regulatory approval, but assuming that arrives, the two groups will then be putting the pieces of a puzzle together.
“Regulators are a little more inclined to support this space, but some firms have still underestimated the regulatory complexity of dealing in digital securities,” says Domingo. “Just being a technology provider doesn’t get you very far. You also need all the securities licences.”
There may eventually be some kind of consolidated price quotation system for private securities trading
Chris Wittenborn, Distributed Technology Markets
Securitize serves more than 130 corporate clients on its platform, including as a transfer agent for dealing with digital securities holders. These tend to be private equity and venture capital funds, real-estate businesses and operating businesses mostly in blockchain technology and fintech sectors.
It could not previously raise money for these as it was not a regulated broker-dealer. Domingo suggests maybe 20% of those clients might be suitable for trading on an ATS.
“There only around 50 ATSs in the US, and we scanned the whole market,” he says. “Only a handful are active in digital securities. We came across Velocity Markets just before its DTM subsidiary was approved as an ATS for digital assets.”
The firm is also a broker-dealer that can match issuers and investors.
“We will face competition from a handful of other licensed transfer agents and from other ATSs, but I don’t know of anyone else that combines both capabilities,” says Domingo.
Even as a proponent of greater liquidity in private equity and real-estate markets through digital securities, Domingo does not think it will come quickly. “This is at least a two- to three-year journey,” he says.
When and if greater secondary turnover comes to private equity, the evolution of electronic public equity markets since the 1990s may offer some clues as to how that develops.
Chris Wittenborn, chief executive of DTM, spent much of his career as an equities market maker.
He tells Euromoney: “In public markets, there are many venues, but there is a national best bid and best offer that go into the consolidated tape.
“When you look at your E*Trade or Schwab account, you see just one price for Apple stock, though you may have bought it directly from Nasdaq’s pipes or from Citadel Securities or any variety of destinations integrated with Nasdaq, including bulge-bracket market makers.”
Could private equity go the same way?
Wittenborn says: “I’m hopeful that there may eventually be some kind of consolidated price quotation system for private securities trading. Otherwise, you may end up seeing the same private security trading at different prices on different venues, which could be confusing, but on the plus side could attract arbitrageurs who would then close that gap.
“However, this only happens once previously static private assets start changing hands. Once they start to move, you will see different types of buyers: long-term holders, short-term traders, arbitrageurs.
“Liquidity begets liquidity.”
