This is the second of a two-part article series on security token offerings. In part one of the series, we looked at the advantages and disadvantages of STOs with the backdrop of the disappointment with ICOs. The second part elaborates what these tokenized securities mean for the capital markets. What will be its impact and what are the hurdles in its way?

Global capital markets are still recovering from the 2008 crisis: with it, the regulatory demands have added more lines of defense. In this challenging environment, capital markets still fund 65% of the US economy¹, therefore the dependency on capital markets cannot be ignored.

A typical trade lifecycle is besieged with numerous issues and challenges in today’s world, some of them are related to checks and balances at various stages, for instance:

• Investment compliance checks at the pre-trade, at trade and post trade stage. This check is time consuming and requires huge investments in building and maintaining the rules.
• Reconciliation and confirmations to validate the trades consumes more time.
• Transfer of securities and funds requires validations and settles in T+3 or T+2 which locks the valuable capital and huge opportunity costs attached to it.
• Since the trade record copies are recorded in their books, there is a need to update the books and system of records on an ongoing basis. There is a trust issue which is compelling the organizations to maintain their own set of records that is validated.
• Due to trust issues explained in #4, there is some regulatory requirements that all financial institutions are required to comply and this leads to increase in costs. As per Globescape’s Poneman Report, the cost of compliance grew from $16 mn in 2011 to $30.9 mn in 2017, almost double the cost².

Some of the issues highlighted above are mitigated with the advent of blockchain technology and others will be addressed through STOs.

Advantage STO

STOs offer two blanket advantages: i. Timing ii. Speed.

a. Timing

The Clearing and Settlement of Trades now conforms to T+3 standard. With STOs and smart contract technology, this will occur in real time basis. The need for clearing and settlement systems will go away.

b. Speed

All the supplementary support services like reconciliation will be a thing of the past.The reporting aspect maybe built in smart contracts to generate client/transaction reports on a real time basis.

Due to regulatory requirements still in flux, there is a deep reluctance in the role of market players like custodians, broker dealers. However, the basic tenets of holding and protecting customer’s assets (in this case STOs) is not going to be lost. Recent alliance between Coinbase Custody and TokenSoft Global Markets³(acting as a Broker – dealer) has led to a strong foundation institutional grade security, financial controls and auditability.

Transfer Agents will have a limited role to play as the need to store dividend or corporate actions items and other reporting needs could easily be embedded in smart contracts.

Recordkeeping will be a challenge as the fund accounting aspect will remain significant in STO environment. The integration with fund accounting systems is to be explored and how that will impact global updates on real time/batch basis.

Due to efficiency in clearing and settlement operations, the depository services and maintaining counterparty risk will go away. This will reduce investments in resources increasing efficiency and profitability many folds.

Key Bottlenecks

• The US regulatory authorities are yet to come out with a full-fledged version of regulatory requirements on security token offerings including the specific role players like custodians. For instance, in case of STOs, the underlying physical assets could also be exchanged by consumptive assets, which will change the exchange dynamics including valuations.
• The institutional investors will require massive trust factor to start trading in STOs and this could only be achieved if a custodian platform is established on the lines of Bloomberg Terminal. This will provide 100% protection of assets and confidence to the institutional investors. Unless that is seen as valid in near future, the STOs market will function within a limited scope.

Conclusion

It is significant to note that South Korea’s leading Blockchain research centers – Coinone Research Center and Chain Partners CP Research have determined that STOs will be a huge success in crypto industry with STO market estimated to grow to $2 trillion dollars by 2030⁴. However, one needs to bear in mind that too much regulation would hamper the progress and create hurdles, and too less regulations will give away trust in digital coins with no return in future. Therefore, SEC needs to work on a robust guideline that will promote STO business with minimal risk for the investors at large.

From an IT transformation standpoint, the opportunity is infinite. Banks’ technology landscape will require a relook with focus on more automation and digitizing of data management. There will be a need to build interfaces to pull data using STO protocols. This will require niche skillsets.

2019 and beyond looks more exciting for STOs as banks and other ancillary firms study the impact on its business and technology.

Here are the immediate opinion on trends for the next 3 years:

• Assets worth trillions of dollars will shift from traditional markets and trading platforms and will move into the security tokens market by 2023⁵.
• Many trading avenues for security tokens will be established⁵.
• Asset managers will save $ 2.7 billion on switching to a blockchain infrastructure including STOs⁵.

The best is yet to come!

References

1. www.sifma.org – SIFMA 2018 Outlook: Trends in the Capital Markets
2. https://www.financemagnates.com/cryptocurrency/news/tokensoft-broker-dealer-taps-coinbase-custody-service/
3. www.financemagnates.com
4. http://www.altnews.nu/latest-research-from-south-korea-suggests-that-2019-could-be-the-year-of-stos/
5. https://cryptonews.com/news/what-could-save-asset-managers-usd-2-7bn-a-year-blockchain-1263.htm