Can Security Tokens Fail And Never Fulfil The Potential?

The big dream or the end goal would be to have a truly global capital market where investors could invest in companies from different continents without the current regulatory boundaries. This would be a true free movement of capital. Blockchain and tokenisation can empower us to achieve this result. This would require harmonisation of securities laws of different continents, which, due to current differences of the regulations, sounds and IS a pipe dream. We have to take a step back and start with one continent first which (desperately) needs this – Europe. For readers based in the US or Asia, this perhaps has little importance. For us, Europeans, it should be a priority. European capital markets are fragmented. German companies are doing IPOs in Germany, no Swedes (or any other nationality) are investing in German IPOs. Similarly, German investors aren’t investing in Polish IPOs, and so forth. US capital markets are almost three times bigger than the European capital markets. Meaning, there’s more capital and investments in the US, and if there’s more money, there are more companies. With more companies, there’s more talent. If you think about the biggest tech companies at this moment, then you think about Amazon, Google, Facebook, Apple. All from the US. Then you have Alibaba, Tencent, Samsung and Baidu from Asia. All the biggest tech companies are either from the US or Asia. This isn’t something trivial. These companies employ tens of thousands of employees, if not hundreds of thousands. They create a vibrant real estate market, restaurants, shops, everything – these giants really have the power to carry economies. Think Nokia in Finland and the effect it had on the Finnish economy. Nokia is long gone. Europe has big companies as well, tech unicorns like TransferWise, lately valued at 3,5 billion USD, but at least today, it’s not even remotely comparable to the biggest boys of the industry when it comes to scale and influence.

I firmly believe that blockchain empowered solutions, especially tokenisation of securities and equity, could help to improve the situation – even if these are just small improvements at first. Small progress, and building an infrastructure for more profound progress, is way better than the stagnation of the capital markets. The gap with Asia and the US isn’t getting smaller, it’s getting wider. While we’re ready and capable of building the necessary technology, everything starts with the state and the political will.

Here are the main obstacles we see in Europe, in no particular order:

  1. Is there political will?
  2. Are the policymakers ready to change the outdated laws so we could actually utilize the technological advancements?
  3. Can we make the required changes within key organizations which are suffocating the financial innovation, because the current incentive program makes it easier to say “no” than to take any risks with new technologies?

Let’s take Estonia as an example, as we are the most familiar with Estonian regulations and environment, although the situation isn’t only such in Estonia. The problems I’m going to highlight are like that almost everywhere in Europe. As a concept, because of the existing infrastructure and digitalisation of the economy, Estonia could become one of the best places for raising capital for companies, if Estonia would have a state-supported tokenisation and funding platform for European companies. And by state-supported, I am referring to supporting regulatory environment, not the financial support. This requires political will and vision for the country. This requires calculated risk-based approach. This requires politicians and officials who understand that in order to compete in this new world, country or a state has to be an attractive jurisdiction for the companies. Until the political discussion is based on “who said what” and “how to make us look better than the other guy”, there will be no progress. Estonian politicians understand half of the equation, meaning, starting a business is super simple in Estonia, and e-Residency program has been a runaway success in many ways. Yet, it can’t stop there if we really want to be part of and be a leader of the new era of tokenisation. The laws related to capital markets that need to be changed aren’t that far-reaching. Few countries that are doing something, are already considered as stand-out jurisdictions. A good example is Malta, which has passed legislation for distributed ledger technologies, thus, is considered to be one of the best jurisdictions out there. In reality, the laws they’ve passed are very complex and difficult to make use of.

Let’s look at some concrete samples about how blockchain could be used to make capital markets better. Blockchain offers the opportunity to simplify the structure, reduce the number of parties and quantity of required documentation, and automate many of the processes; reducing complexity, saving time and cost for companies raising capital.

Here are some more concrete examples:

a) EFSA recognises the blockchain as an independent third party. There would be no need for a registrar to keep a register of holders, the register is the blockchain. The issuer wouldn’t need to pay the registrar the fees. It means there are less contractual relationships and therefore fewer costs. A legal and beneficial title can be united.

b) Payments could be done on a peer to peer basis using smart contracts. No need for the middlemen. Securities would be delivered directly to the investor against the payment. Same applies to the payment of interest and principal. On some occasions, all dividend/interest payments have to be done via CSD (central securities depositary). In a blockchain age, where payments can be done via smart contracts directly, that’s an unnecessary function and cost to use the CSD. There’s also no need for a paying agent, removing another layer of costs. These functions are generally carried out by the banks. If the interests of the banks and other big institutions are part of the solution, one can already imagine how difficult it will be to get the regulators to make the necessary changes.

c) On the investor side, it’s super easy to access the blockchain wallet and keep your tokenised assets, meaning, there’s no need for a custodian if you don’t want to use one. Again, lessening the need for third parties and reducing costs, and simplifying the whole process.

Sure, there are a lot of vulnerabilities and other tech-related risks that we’d need to map out, but that’s not the hard part. It’s the people and decision makers. My third point of the obstacles is making changes within key institutions.

The governing bodies like Financial Supervision Authorities in any European countries are generally the ones doing the registration of the prospectuses in a given jurisdiction, or issuing activity licenses for companies operating in the financial sector. They’re also the watchdogs of any financial misconducts. They’re also the ones who get blamed for any money laundering activities happening in the country. Less there are problems, easier their job and more pats on the back they get from their European colleagues. Meaning, they’re incentivised to say “no” to the financial innovation if the innovation presents possible risks to the image of the institution, and more precisely, can shed a bad light on the leading figures within the institution. Hence, if you want to have a good career on a personal level, it’s way smarter to not take these risks. If the country falls behind because of the conservative approach to new technologies and innovation, it’s very unlikely someone will blame them personally. There has to be a political will to change that, and an initiative on a state level to push for innovation. For example, Lithuania has the vision to be the FinTech hub of Europe. Today, they have given out almost (or even more than, can’t remember) 100 E-money institution (EMI) licenses. Each e-money institution has to deposit 350 000€ as a required capital, have local employees and an office. These companies also need law firms, accountants and auditors, among other services to function. Lithuania has built a platform for EMI’s and built an online application system to process applications. Last year Lithuanian Central Bank processed more than 62 billion euros of transactions done by EMIs. Even a small fee of this is a huge amount of money. I am not saying there aren’t any risks, because there are, but doing anything worthwhile has risks.

To overcome these obstacles, we need to keep on presenting these ideas and use cases to the policymakers. We have to keep on pushing the FSA, politicians, and other relevant parties until we get the door open. It’s tough for the first movers in this complicated market, as they will spend time, money and effort to make it happen.

However, the reward may just be worth it.

PS! I did not directly answer the question of whether the security tokens can fail and never fulfil the potential. The answer is no – the success of the security tokens is inevitable.