Capital issuance via a digital ledger offers not only greater liquidity, but some significant efficiency savings. Sam Chadwick considers the future of blockchain in capital markets, including the potential impact of cryptocurrency regulation.
- Cryptocurrencies and the rise of blockchain was the subject of our recent investment banking digitalization webinar, which was hosted alongside our partners from OddUp.
- Capital issuance via a digital ledger such as blockchain significantly cuts costs and can reduce the time-to-market from three months to as little as a day.
- The big questions that remain regarding blockchain in capital markets are not so much about the process, technology or investor appetite, but regulatory treatment.
Bitcoin and other cryptocurrencies are all over the news currently, given their precipitous decline in value since the beginning of 2018. While sceptics point to the perfect example of an asset bubble, enthusiasts are quick to remind them that bitcoin has already died five times before.
What gets less coverage is the continued investigation and development in blockchain. If you want the assets you HODL to gain in value, then it is even more important to BUIDL. And that has been happening, to a large extent outside the media spotlight.
Refinitiv and blockchain
Refinitiv has been developing blockchain-based services since early 2016. At first, our cryptocurrency services, including bitcoin pricing, were not getting much customer interest. That is until October 2017, when the pricing of various cryptocurrencies, in particular bitcoin, went off the charts.
We now offer price discovery across our flagship Eikon and Elektron data platforms, and indicators such as sentiment analytics have proven popular, given the opacity of such markets and the lack of traditional content sets such as financials and estimates.
Meanwhile, our oracle framework for distributed ledgers, called BlockOne IQ, has been used to provide off-chain market data such as foreign exchange data and interest rates, as was the case in the floating rate debt issuance by JP Morgan Chase & Co on behalf of the National Bank of Canada.
Capital issuance via a digital ledger such as blockchain offers not only greater liquidity, but some significant efficiency savings. For instance, the cost of issuing a £20 million bond falls from around £400,000 to £100,000. The time-to-market falls from three months to a day, while settlement falls from weeks to seconds.
Start-up company funding
But it is fair to say the volume experiment has been taking place elsewhere — in the market for early stage and start-up company funding, where issuers have exploited the appetite for initial coin offerings (ICO) and, increasingly, security token offerings, to crowd fund new ventures.
Just as with traditional venture funding mechanisms, the medium-term failure rate of such enterprises is likely to be high, but the wealth managers I speak to tend to be very positive about the mechanism itself — that is to say: the tokenization of assets.
For value-add intermediaries it offers the opportunity to get insights and price discovery on otherwise opaque and illiquid assets that would normally be off-the-table for all but the most well-resourced institutional venture capital funds.
However, such tokenization does present something of a conundrum, particularly for the investment banking community, since an ICO or STO is the liquidity event and precludes any initial public offering down the line, therefore forcing them to get involved in earlier capital raises than they would have normally.
For example, the Swiss bank SwissQuote is supporting Lake Diamond’s ICO currently underway. It also means companies that have offered such tokens are locked into that form of ownership for good. I have had numerous discussions with exchanges around the world, who are highly cognizant of the disruptive effect of this to their business model.
In response to this, I suspect it is just a matter of time before a leading stock market launches a specific exchange for trading security tokens. In fact, we are already seeing some early moves in this direction. The SIX Exchange in Switzerland is listing the first Multi-Crypto Exchange-Traded Product.
Cryptocurrencies and regulation
The big questions that remain are not so much about the process, technology or investor appetite, but regulatory treatment. Regulators like to classify and pigeon-hole products and that is not always easy for crypto assets that can be promethean and transition between states.
Our approach is to think in terms of whether an asset is backed and whether it is fungible. For instance, cryptocurrencies tend to be relatively fungible (in fact, freshly minted bitcoins tend to command a premium, given the risk that older coins may have been used to facilitate criminal activity) and unbacked.
Fungible and backed would be where people represent traditional financial securities, such as debt or equity, as crypto assets. Non-fungible, non-backed is anything from race horses to real estate. Non-backed, fungible, would apply to things such as Cryptopunks or the more famous Cryptokitties (if you don’t know, don’t ask).
Regulatory uncertainty and growing competition
Such regulatory uncertainty is opening up global competition to capture the industry. The center of gravity seems to be growing in Asia, with China, Singapore and Hong Kong all receptive to the opportunity, while Switzerland, Malta and Liechtenstein are attracting interest in Europe.
The rationale is not to seek regulatory laxity but regulatory certainty, and safeguard against any retrospective criminalization. Good regulation is likely to help adoption, rather than hinder it.
In terms of medium-term outlook, I currently see four plausible scenarios for the way ahead.
- A low-probability scenario is that not much happens. In this instance, we are likely to see new financial challengers in the form of technology companies that are able to make most efficient use of the new mechanisms.
- We may see banks adopt the technology and shift the way their organization creates value away from transactional services of payments and capital issuance and into other value-add services. In order to remain competitive, they will likely have to pass at least some of those efficiency gains on to clients, in an even more secure and safe way by not using a public blockchain.
- Governments step up and create digital currencies. In that case, some of the optimization of crypto assets gets taken up by that. There is some market-leading investigation happening in Scandinavian countries on this point.
- A scenario where crypto assets further accelerate as individuals, communities and corporations see merit in a digital, immutable store of value and means of exchange that goes beyond the traditional currency structure and allows those participants to benefit directly from engaging in that value system.
This final scenario comes close to the utopian dream of bitcoin evangelists, and where we would expect to see much more activity and the truly game-changing opportunities.
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Investment Banking Digitalization Webinar Series
In our upcoming #IBDigitalization webinar, Raja, CEO and co-founder of Origin Markets, will join Leon Saunders Calvert, Head of M&A & Capital Raising, Refinitiv, for a discussion on the key themes regarding what digitization might hold for capital raising innovation.