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Dec 09, 2021

The great tokenization of the capital markets

Linda Montgomery investigates what digitization means for IROs

We are currently witnessing the next-level digitization of Wall Street as securities are ‘tokenized’ into virtual representations of value. If you think this is all about Bitcoin, you would be wrong. Dawn Fitzpatrick, CEO of Soros Fund Management, recently told a Bloomberg audience that her $6 bn fund owns some Bitcoin, but this is far less interesting than the use-cases she sees for distributed finance (DeFI).

DeFi refers to the shadow financial system being built on smart contracts on blockchain, replicating a wide range of existing financial products, with significantly less process friction and cost. A recent study by the Frankfurt School of Finance & Management predicts annual security token offering (STO) growth in Europe of 81 percent, surpassing the market volume of cryptocurrencies by 2026.

The day-to-day job of the IRO will no doubt change with the advent of tokenization, along with the make-up of investor bases, but the net effect may be a wash. IROs may free up time as administration and the number of intermediaries is reduced, but investor community management and marketing may pose new challenges.

A security token is a digital representation of a real-world asset – like shares in a company, a bond or a bar of gold. Being tokenized means it is issued on blockchain and represents ownership, a share in the profits, legal protection and shareholder rights. While physical asset ownership is managed by a transfer agent or issuance platform, the digital asset shares can be traded freely by eligible investors anywhere in the world, offering far easier and more streamlined ownership.

Security tokens can offer automated inter-jurisdictional compliance, optimized clearing and settlement processes, compliant registration and other parts of a regulated transaction, all on an immutable, transparent and secure global blockchain ledger. Cap table management, shareholder notifications, voting, dividend distribution and auditing could all be made easier, according to the evangelists.

As of August 2021, more than 100 issuers representing the financial services, technology and real estate sectors have a combined market cap of $1.1 bn, with average daily trading volume of $7 mn, according to Companies want to stay private longer and want an easier way to attract a new, wider body of investors and liquidity. Private markets were worth $2.9 tn in 2019 and are expected to grow to a whopping $14 tn by 2023, according to the World Federation of Exchanges.

Some firms like the simplified accounting, tax and investor communications offered by blockchain. Some like the increased inclusivity, which enables retail investors to benefit from higher private market returns as well as fractional purchases, and faster deal execution. This points to more public offerings, larger investor bases and more need for IROs.

In the US, Blockstack raised $23 mn through the first Regulation A+ STO in 2019. This set a precedent enabling the sale of tokens that are immediately tradable by non-accredited investors, which could trade on secondary markets that now also offer more regulatory clarity.

In 2020, Arca Labs began trading its digital security ArCoin, representing shares in its US Treasury Fund. Also last year, INX, a Gibraltar-based crypto-trading exchange, launched its token, becoming the first ever security token IPO with a full prospectus qualified by the SEC. It currently has 7,542 investors and a market cap of $371 mn. 

In April 2021, the SEC qualified a Regulation A+ offering for Exodus, marking the first US-based issuing company. It raised $75 mn from 6,800 individual investors. Entoro Capital recently announced the first non-fungible token of artwork offered as a security.

According to analyst Quinlan & Associates, we are at the ‘market testing’ stage and larger-scale institutional adoption will follow. It predicts growth of global listed security token trading volumes to $162.7 tn, with $4 tn in global issuance, or 27.4 percent market share of all securities, by 2030.

Future IR practices might be borrowed from the blockchain world. The proliferation of Ask me Anything sessions and new tools like Telegram, Reddit and Discord have all proved to be popular places where Gen Z retail investors can gather information about the coins and tokens they buy.

Regardless, IROs will have to become experts on token economics because a savvy crowd of retail investors wants to dig deep to understand how this impacts an investment. Will influencer programs with key opinion leaders and investor community building dominate their outreach activities? Will arbitrage take place between the token price and the company’s value on a traditional exchange?

If your current IR job is a bit quiet and predictable, the tokenization of securities might make your future job quite the opposite.

Linda Montgomery is a Toronto-based fintech and digital assets marketing executive and an IR professional

This is an article from the Winter 2021 issue of IR Magazine. Click here to access the digital magazine.

Linda Montgomery

Linda Montgomery is a Toronto-based tech industry marketing executive and IR professional. She holds two business degrees and a CPIR (Certified Professional in Investor Relations) designation from the Canadian Investor Relations Institute.