Some Ideas About the Present and Near Future of Security Tokens
At a recent conference someone asked me why I had stopped writing about security tokens. I was a bit surprised by the question and answered that I was merely taking a few weeks to reflect about the validity of some of my previous ideas in the current context of the digital securities market. After all, it’s hard to keep producing content when all your ideas are either wrong or impractical 😉. While I am still bullish and invested in the security tokens space, it is unquestionable that the market is facing several existential challenges that need to be addressed if we want digital securities to become a relevant chapter of the crypto movement. Today, I would like to outline an analytical framework around some of those challenges and discuss a handful of ideas related to security tokens that I am excited about.
If you are an outsider looking at the security tokens market, it would be easier to enumerate all sorts of challenges that are preventing the growth of the space. However, I believe most of those challenges can be boiled down to a handful of root causes that we have already seen in previous technology and financial markets. That doesn’t make them easier to solve but at least brings some historical references to the analysis. Here are some of my favorites.
Infrastructure vs. Applications Stalemate
One of the existential frictions in the security tokens space is related to the dynamics between application and infrastructure. Will the issuance of new digital securities lead to the implementation of the required infrastructure building blocks or the other way around? Some technology markets like mobile apps are lead by applications while others like cloud computing are lead by infrastructure. In the case of digital securities, we seem to have a stalemate.
The current security tokens market is lacking world class projects that can push the infrastructure of the space but, at the same time, it’s hard to attract great project without basic building blocks like disclosures or liquidity. Even some of the most advanced infrastructure building blocks in the space like exchanges are experiences major challenges from both the technical and market-adoption standpoint.
Liquidity Remains the Main Obstacle
Building on the previous point, liquidity remains the main challenge to solve in order to unlock the potential of security tokens. Unfortunately, a segment of the digital securities market keeps thinking about liquidity as a side effect of tokenizing great projects. Build it and they will come type of philosophy. I think that thesis has proven to be wrong thus far. In financial markets, liquidity is something you engineer for not something that happens organically.
Enabling liquidity in security tokens is going to require a combination of crafty foundational blocks like liquidity pools or the tokenization of more liquid assets. Liquidity is certainly a market infrastructure challenge and its hard to build it one project at a time.
The Market can Stay Illiquid Longer than Companies can Stay Solvent
One of the major challenges facing the security token ecosystem has been the lack of venture funding flowing into the space. To this day, only a handful of companies have managed to attract enough funding to remain competitive and navigate this bearish phase of the market. Paraphrasing the great Jahn Maynard Keynes, the security tokens market can stay irrational(illiquid) longer than most companies can stay solvent. From that perspective, we are likely to see an even larger number of startups capitulate and abandon the digital securities space.
A Few Companies Will be Forced to Build the Market
A side effect of the previous point is that the security token space is being built on the shoulders of a handful of companies. The thing about operating in a market with minimum or no competition is that you don’t only need to build products or acquire customers but also build the market as you go along. The current state of affairs in security tokens indicate that a very small number of companies is likely to have a disproportional level of influence in the future of the market.
In the early days of the security tokens markets, I often used the analogy of Drexel Burnham Lambert and the junk bond industry as an example of a financial market that takes a lot of time to develop. Junk bonds were originally created in the 1970s but remained highly irrelevant until financier Michael Milken and his team at Drexel figured out how to used them to finance leveraged buyouts. It’s fair to say that Milken and Drexel legitimized the junk bond industry by finding the killer use case. However, a key point to understand is that Milken and Drexel benefited from policies from the Ronald Reagan administration that unlock a frensy in mergers and acquisitions.
Extrapolating the lessons from the junk bond movement to the security token space, legitimizing the digital securities market is going to take more than one killer app. Instead, we need a systematic movement backed by the right regulatory climate that foments the issuance and trading of security tokens. From that perspective, security tokens definitely need a Milken moment to legitimize the space. It can’t be done one token at a time.
Despite the numerous challenges, there are several new ideas that in the context of digital securities that I am intrigued about. Specifically, I am referring to ideas that can yield benefits in a short to medium term and provide more clarity about the future of the security tokens market.
Multi-Asset Collateralized Digital Securities
In the absence liquidity, it might be smart to attach security tokens to more liquid vehicles. The recently launched multi-asset collateralized Dai protocol(MCD) offers a mechanism to issued Dai backed by other digital tokens. You can imagine adapting that model and provide Dai that is collateralized by pools of digital securities. In the short term, I think MCD could be an effective vehicle to engineer a bit of liquidity into security token models.
Tokenized Semi-Liquid Assets
An alternative to overcome of the lack of liquidity in security token markets is to create digital securities backed by assets with certain levels of liquidity. This is what I like to call an “expanding the pie” strategy. While many forms of securities such as stocks are widely available, others like REITs, ETFs or certain derivatives remain highly unavailable to investors outside top financial markets. Tokenization might be a way to expand the reach of those securities while leveraging part of its liquidity infrastructure.
Permissioned Security Token Networks
Given the challenges of digital securities in public blockchains, it is likely that the market will start experimenting with consortium networks specialized on a specific type of assets. Companies like Ripple have proven that this approach is a viable business model although it certainly comes with serious concessions in terms of the principles of digital securities. I believe in the next few months, we will see some interesting ideas in terms of permissioned networks focused on digital securities.
These are some of my concerns and new hopes for the security token markets. While much of the massive optimism of the last year has lost momentum, the companies that remain committed are showing the levels of rigor and conviction necessary to push this space forward. Technology markets are highly unpredictable and there is only so much you can engineer for success. Sometimes, you just need to stay in the game long enough to take the shot at the right time.
Published at Tue, 19 Nov 2019 13:25:43 +0000
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