The financial industry is beginning to embrace the benefits of blockchain for securities trading. Nasdaq first used the Nasdaq Linq blockchain to conduct a private market securities sale in 2015. More recently, the Australian Securities Exchange (ASX) announced plans to move the entire exchange to a blockchain based clearing and settlement system.
As the world adopts blockchain technology, it becomes more important to investigate the advantages of tokenized securities. Brokerage firms can use the code base of Ethereum and the underlying blockchain technology to reduce internal costs, develop new products, enter new markets, and increase value for existing shareholders.
Faster, Cheaper, Safer Transactions: Ethereum Inside
Global fund transaction network Calastone estimates that the mutual fund industry could save more than 1.9 billion British pounds by switching to blockchain technology. The original promise of cryptocurrency was a faster, cheaper, more divisible currency. These benefits have yet to be realized by most firms and consumers.
Performance comes first. Despite the focus on day traders in the popular press, the majority of financial transactions still take hours or even days to clear. The average public Ethereum blockchain transaction takes just a few seconds, and the average fee is only about half a euro. Users trying to trade Bitcoin and Ethereum had to wait several hours during volatile trading last December, but Enterprise Ethereum is being built to withstand similar temporary increases in volume.
Privacy and permissions are also crucial to the adoption of Ethereum. Enterprise Ethereum will be able to restrict access and information to the parties involved in transactions, much as SSL encryption protects websites today. However, hardware wallets and multi-signature wallets will enable a much higher level of security than SSL could ever provide. If a customer wants to spend 50 euros, that can be as easy as pressing a button. If a customer wants to sell stocks or withdraw 500 euros, he would be able to authorize it by typing in a pin on a hardware wallet that offers ATM level security. If a customer wants to close his retirement account and transfer 500,000 euros to another country, that could require multi-signature confirmation from his wife and his broker.
Creating New Products: Smart Token ETFs
Tokenization also dramatically expands the ability to create new financial products. A Bancor Smart Token can be backed by multiple other Ethereum tokens, just as ETFs are backed by stocks, bonds, and commodities. It would be relatively easy to create and deploy a Bancor protocol “Smart Token ETF” backed by tokenized securities.
A Smart Token ETF would have several advantages over the ETFs that are traded today. A significant advantage is that all users could exchange component tokens for the Smart Token ETF, a privilege currently reserved for authorized participants in the ETF market. Another notable improvement is that the Smart Token ETFs would always be available to do instant conversions, which would substantially increase the liquidity of the underlying tokenized securities. Finally, Smart Token ETFs would automatically trade with each other, which would resolve most of the liquidity issues that impair ETFs with lower market capitalizations.
Opening New Markets: Everyone Wins
Blockchain technology has already enticed new investors into financial markets with lower minimums and less bureaucracy. Cryptocurrency exchange Coinbase reached 11.7 million users in October of 2017, surpassing the 10.6 million active brokerage accounts at Charles Schwab. Financial firms that tokenize securities should be able to attract the customers of the rapidly growing cryptocurrency exchanges with the ability to purchase arbitrarily small amounts of high priced stocks. RegTech also promises to give token investors faster ways to comply with know your customer laws.
The other side of opening new markets is even more interesting. Small-cap stocks have historically outperformed larger companies in the long run, and tokenized securities could provide investors with more of these high return small-cap investment opportunities. The more scarce capital is, the higher the return on capital becomes. Access to capital is even more limited in the emerging markets, so tokenized securities from the developing world could provide investors with even higher returns and help lift millions out of poverty.
Increasing Liquidity Increases Value
The net effect of tokenized securities is to increase the liquidity of the underlying assets. It has long been known that investors must be compensated for lower liquidity with higher returns outside of the stock market. However, research by Roger Ibbotson indicates that liquidity plays a similar role within the stock market. Tokenization raises the value of securities to investors through increased liquidity, so the value of tokenized securities should also rise in the market.