What is a digital security?
A digital security is a digital representation of an asset that happens to be a security, an investment contract or ownership tied to an asset, for which ownership is verified and recorded on a distributed ledger. A distributed ledger is a consensus of replicated, shared, and synchronised digital data geographically spread across multiple sites or institutions.
The benefits of digital securities over traditional paper-based securities include greater transparency, new investment products and enhanced liquidity for illiquid assets.
1.0 of digital securities is simply better ways to hold your shares in traditional investment products like real estate, private equity and venture capital, which are typically highly illiquid investments which tie up investors capital for extended periods of time with limited to no ability to trade or exit a position.
2.0 of digital securities is the development of new financial instruments and offerings as we now have “smart” securities which are actually programmable agreements (instead of paper agreements), opening up a new world of debt/equity offerings that we have not seen before.
We are now officially into the 3rd year of digital security offerings (DSO) or security tokens as they are also known. If we consider the first launch to be in 2017 by blockchain capital (we believe) a tokenized venture capital fund. Since then, there have been many launches with some success in funding and listing on secondary trading exchanges. This list from 2018 highlights many early projects were startups that were difficult for traditional investors to understand and unappealing to their target audience at the time (mainly crypto investors). Incorrectly, the “DSO” market was seen by many to be weak or lacking growth due to the poor quality of the “S” in the offerings.
But ultimately we have the entire capital markets being digitized and it is not going to happen overnight. The industry is being built at the same time, issuance, custody, secondary trading etc. so it has been fragmented and hard to piece together for most issuers and investors alike. The fact is that it is the issuers and the product that is the most important components of the industry, without good investable projects there is nothing to invest in for all investors.
Positively, 2019 has seen a huge improvement in the quality and size of offerings. Listed companies, revenue generating companies, established private equity groups and private banks are just some of the groups working on their own DSO.
Quality issuers (not investors) are needed first to ensure the market can grow.
3rd party suppliers/key stakeholders needed in a traditional security offering are still needed in a DSO, and they need to get their business development units to work out how and what has to change within their service offerings to adapt to the digital era of securities issuance.
We have now gone past the theory stage and have real use cases where traditional investments like private equity real estate funds have issued shares to investors digitally and these shares are now trading on a regulated and licensed exchange, meaning that instead of the typical 7–10 year lock up for investors, there are now liquidity options available after just 12 months. This is a critical change and a pivotal moment. The 2.0 moment has arrived and we are just scratching the surface of new investment structures that are better for investors and issuers.
What if we could show the market that the typical real estate fund is structurally flawed, why?:
- We have a fixed life investment vehicle for a cyclical asset class
- Many funds will be forced to liquidate at the fund expiration date in the next downturn losing investors capital
- 20% profit share may result in managers taking dangerous levels of debt and selling the best assets first to get over the minimum return hurdle rate to get to their “profit/bonus”
A real estate fund issued in a DSO can now offer:
- Evergreen vehicle as investors can now trade their shares after a short lock-up period offering enhanced liquidity and value
- The fund manager takes staged and scaled equity in the fund, truly aligning compensation (instead of a % of “profit”)
- The fund can now obtain the true benefits of compounding returns without a forced liquidation at a specific timeline
Here is a model of what this looks like for investors returns:
As we look out to the future we see the true value of DSO in a completely different product than what the market has seen to date (i.e new projects raising money). We believe the real opportunity for DSO is not just for raising funds for new projects but using the structures to take portions of existing assets/funds and sell them down to new investors, so there is no “fundraising” risk, and you have existing proven assets with audited financials (not just projections) and a much bigger product universe of offerings where issuers will pay strong returns for the ability to free up some liquidity from their assets. This hugely important point is currently almost never mentioned.
We believe that digital securities are the future of all securities issuance for all assets. And in the not too distant future, we think you will see this offering coming at the government level too, so the issuance of a new investment vehicle i.e a new LLC or Cayman Fund will be issued 100% digitally by the government, as its simply a better system and easier for them to manage too.
InvestaX has built the leading consortium of key stakeholders to provide the full end to end solutions for a digital securities issuance including fundraising on a licensed compliant technology-enabled platform. Join us on our mission to build out the new financial eco-system of digital securities for private equity investing sign up www.investaX.io