The digital securities industry continues to grow year after year, with experts predicting it will become a $1,600 trillion market in the future. As technology continues to mature, traditional markets are continuously explored to be disrupted and the digital securities market is of key interest. Digital securities offer corporates as well as individuals substantial benefits and the adoption process is accelerating.
- What are Digital Securities / Digital Assets?
- Digital vs. Traditional Securities
- Types of Digital Securities
- Benefits of Digital Securities
- Removing Friction When Issuing Securities
- Quick Distributions and Payments
- Higher Liquidity Potential
- Greater Transparency
- Better Management of Shareholder Lists
- Compliance is Improved
- The Legal and Regulatory Perspective on Digital Securities
- Digital Securities Currently and Where They are Heading
What are Digital Securities / Digital Assets?
Digital securities are financial securities that are represented digitally using a blockchain. They are also referred to as security tokens or tokenized securities, and while they reside on a decentralized network, they still fall under traditional securities regulations. Securities, in general, refer to the tradable financial instruments & the corresponding underlying assets and how they are used to raise and transact funds in both private and public markets. The securities market has shown ongoing growth and data suggests the global market capitalization exceeded $90 trillion by the end of last year in 2020.
Digital vs. Traditional Securities
The legal status of digital securities is the same as traditional securities. However, digital securities offer the benefits of pace & traceability. It is the same as automating any type of process, as this is generally much more flexible while streamlined than dealing with paper. The traditional processes associated with issuing securities are rather opaque while still vulnerable to fraud. The time and resources required for these processes are what inspired digital securities, which are able to efficiently bundle & simplify these very processes while providing an immutable audit trail at lower transaction cost. With the development of blockchain, digital security is now a flexible and accessible solution that many industries will benefit from as it shows in the different types of digital securities or tokenized assets found in various fields of application.
Types of Digital Securities
As with traditional securities, there are various different types of digital securities. Some of the most common digital securities are as followed:
- Real Estate – Real estate refers in general more to the asset class itself and its equity- or debt-related investment products rather than the physical property. Blockchain is used to monetize either the underlying land & buildings or the respective fractions of it and offers digital tokens to represent that very ownership. This type of digital security can also be used for debt-linked structures such as rent owed or paid.
- Venture Capital – This is one of the most popular areas of digital securities seeing great adoption. Many businesses worldwide use security token offerings to attract venture capital firms and investors globally to their business taking advantage of extended reach through digital channels to these specific investors and newly acquired efficiencies of executing the transaction.
- Private Equity – Digital securities can also represent private equity, which can include a traditional company share digitally represented or alternatively structured transactions around revenue or other collaterals. The private equity industry benefits from the flexibility that security tokens offer in design.
- Real Assets – Real assets are often used for portfolio diversification and are more stable but less liquid than other financial assets. Even here digital representations of precious metals, natural resources or other commodities are seeing digitalisation of their representation of ownership.
- Hedge Funds – These pooled investment funds that trade with reliable liquid assets are also making use of the advantages that digital securities bring to this industry segment; that mainly being fractionalisation, wider accessibility of target clientele and lowered transaction cost.
Benefits of Digital Securities
There are many benefits of digital securities for almost everyone involved in this process. This summarises the benefits already touched on prior.
Removing Friction When Issuing Securities
When it comes to traditional securities issuance, the major pain points are time and effort involved in the process and the cost associated with either. As with many similar processes, there are many manual procedures involved historically. Digital securities are still issued using the same process, but thanks to blockchain technology friction are removed, and the process is much quicker and easier for every party involved. This makes investing more accessible than ever before, and companies also benefit from the reduction of effort.
Quick Distributions and Payments
If you were to receive a dividend from traditional securities, this would generally still be mailed to you. This is a slow and frustrating process by modern standards, as it involves paper handling and potentially cashing the dividend cheque. Blockchain technology – with just the click of one button – lets shareholders instantly receive their dividends after the transfer agent has approved the transfer.
Higher Liquidity Potential
Blockchain technology allows investors to trade around the world 24/7. At the same time, it adds transparency to the processes and there is higher liquidity potential. This increased liquidity potential shows already with the market shifting to shortened lock-up periods: investors are now often offered a one-year lockup period, as opposed to the five to ten years that were and are common within traditional securities.
Public blockchain technology offers a more transparent process for investors. Everything is recorded on the immutable blockchain, hence providing a much more secure process from start to finish. Investors can be assured that their data was secure at any point, and anonymized public records protect everyone involved at every stage in the overall process. Issuers can conveniently receive reporting for internal checks and external auditing at the same time.
Better Management of Shareholder Lists
Fraud has been surrounding paper stocks and securities ever since and thus represents a severe risk for every party involved. Hence this is an area of substantial concern for investors, but these records remain tamper-proof with the underlying blockchain technology. Transactions are checked & verified and trades are time-stamped so there are fewer risks involved in this process while shareholder cap tables are automatically updated at the same time.
Compliance is Improved
Smart contracts and the use of the blockchain help to improve this area are of utmost critical importance. Rules and regulations can be embedded into the technologies, allowing for greater compliance throughout the processes. This increases security and reassures market participants.
The Legal and Regulatory Perspective on Digital Securities
As with any new technology and advancements within the financial industry, there are many concerns surrounding the legality and regulations of digital securities. When it comes to digital tokens, our legal systems are still in the early stage of trying to understand what regulations would work best to rule over this innovation entering the traditional set-up. However, as digital securities, they are still qualified as securities so investors have the same protection as they would with traditional options. While more laws are likely to appear in future years as technology expands and innovation is regarded as the future of our world. Companies may be reluctant to expand their operations in this area just yet due to this reason. Regulation eventually follows technical innovation and the global legal community & governments are in the process of synchronizing the legal frameworks along with the innovation that blockchain is dawning.
Digital Securities Currently and Where They are Heading
Digital securities are only looking to increase in both use and popularity in the upcoming years. While they are already very popular today, the increasing regulation in the area will only accelerate adoption. Digital securities can be used to represent any traditional asset across the traditional asset classes of infrastructure, natural resources, debt instruments, etc. Blockchain and digital security are perforating the traditional status quos and non-fungible tokens are a great example within the arts & entertainment industries. There has been a constant wave of artists, entertainment, and sports stars using these NFTs to create art, trading cards and offer digital assets to their collectors & fans around the world. This is just one simple example of the technology and how adoption is happening on every front.
The many obvious benefits of digital securities will keep driving this adoption across jurisdictions and asset classes. Smart contracts help to tokenize any security and these programs still attach these tokens to their real-world value. In order for digital securities to become more accessible, systems are needed that can quickly and easily facilitate all of the steps involved. These system & technology providers are emerging and further investment is being allocated to the digital securities infrastructure.