While the future path is still very uncertain, investors should consider building a reliable information channel to monitor the creation of new tokenized assets. Investors might also want to debate whether blockchain technology itself presents an investment opportunity and whether they can build successful investment strategies via those companies that look to monetize it.
There are reasons to believe, at least in principle, the reduction of market friction can expand investors’ opportunity sets, extending their reach to assets that they don’t currently own. And technology, in this case blockchain, has always been and will always be an important driver of reducing market friction.
- Costs related to securitization come down
- A reduced need for intermediaries results in a reduced cost of creation of securities (tokens)
- Raising equity or debt, as opposed to solely relying on loans, becomes economically feasible for small and medium-sized businesses
- With smart contracts, execution of various administrative processes also becomes more efficient such as profit sharing, voting rights distribution, buy-backs, and so on. Trading of these tokenized securities becomes cheaper, faster, less risky, more transparent
- As opposed to the current practice of T+2, the settlement of trades can be completed in a matter of minutes
- Trading becomes 24×7, facilitated by smart contracts triggered by predefined parameters instantaneously completing transactions
- Faster deal execution reduces counterparty risk (delay of settlement increases the risk of either side failing to fulfil its trade commitment)
- Transparency will also improve as the tokenholder’s ownership rights are embedded directly onto the token with an immutable historical record of ownership.
- When the market accepts the immutable nature of trading data, the need for reconciliation – therefore the cost related to it – might be completely removed.
- Tokenized economy promises to further reduce market friction
- Programmable securities facilitate bespoke design of rights, more precise risk-taking and automated compliance
Programmable securities open the door to amazing innovation. Say a company wants to reward long-term investors – more dividend, more voting rights etc. This can be easily programmed into the security token that can distinguish between you, who have been holding the stock for five years, and Joe, who just bought the stock two weeks ago. A company can also issue stocks that are linked to a particular revenue stream as opposed to the whole balance sheet. This gives freedom to investors to choose more precisely the risk / return profiles they would like to include in their portfolios (eg you are only interested in three drugs that GSK propose to develop).
Another benefit is in the area of automated compliance. One of the most difficult aspects of trading securities is related to regulations, which vary by asset type, investor type and buyer/seller/issuer jurisdictions. Because security tokens are programmable, compliance can be baked right into the token, operating automatically.
More precise risk-taking and hedging are made possible by programmable securities. New types of securities could emerge as risk / return characteristics can be more precisely defined. ETF markets may see further innovations and become more cost-efficient due to disintermediation. When we add programmable securities with machine learning and artificial intelligence, we are really just limited by our own imagination as to what the future capital market might look like. Theoretically investors could hold the precise combination of risks they wish to.
This document has been written by members of the Thinking Ahead Group and is part of a series that explores how the investment opportunity set of institutional investors might evolve in the years and decades to come. The members of this working group include representatives from Wellington Management, BlueBay Asset Management, Willis Towers Watson, Amundi Asset Management, and Epoch Investment Partners.