Openfinance Insights

Don’t Believe These 4 Myths About Digital Securities

Posted by Juan Hernandez on Jul 12, 2019 10:33:56 AM
Juan Hernandez
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4 Myths About Digital Securities “Are digital securities another questionable crypto investment?” “Can I invest if I’m not accredited?” “What do these assets have to do with blockchain, anyway?”

As one of the most significant innovations in financial services, digitally formatted securities are poised to transform the $8.8 trillion alternative asset market. By replacing the inefficient, outdated processes that have defined this market for decades, digitization can help investors diversify like never before, find liquidity when they need it and potentially improve overall valuations. With the market for digital securities growing, however, confusion about these assets is just as widespread. Here, we set the record straight on four common myths.

Myth: Digital security is the new term for ICO and cryptocurrency.

In light of the Securities and Exchange Commission’s crackdown on crypto assets and the market’s 2018 crash, many investors are rightfully cautious of new investment formats. Unlike many crypto investments that have attempted to sidestep regulation, however, digital securities are regulated by FINRA and the SEC regulations. These securities are not a new asset class, but simply an updated, more efficient format for traditional private and non-listed securities like venture capital, real estate, and private equity — assets people have invested in for generations. Digitization makes it easier for investors to access a wide range of investments, while regulation ensures they’re protected as they do.

Since some of the ecosystem for digital securities is currently powered by blockchain, many people automatically associate the market with bitcoin and other crypto assets. Blockchain is just one underlying technology enabling this new form of digitization, however. In practice, the shift from traditional to digitally formatted private securities is more similar to the public equity market’s move from paper certificates to electronic trading decades ago. While the ease with which investors bought and sold these securities changed, the underlying securities didn’t. Just like with public securities, interest in the back-office technology will likely dissipate over time.

Myth: Digital securities won’t be successful because adoption has been limited so far.

Using the 2017 ICO era as a yardstick to measure the success of digital securities isn’t an apples-to-apples comparison. ICOs gained popularity and success largely because of a lack of regulation, with many governmental agencies declaring most of these investments to have been non-compliant security offerings.

Because digital securities are subject to regulation, many intermediaries play important roles in building a sustainable, compliant infrastructure. Like any new market, this process will take time and result in slower, more methodical uptake in the coming years. While the market for digital private securities will reach an estimated $19 billion by 2022, it’s still a relatively small corner of the industry compared with the massive $30 trillion U.S. stock market. The historical success of thoughtfully regulated capital markets, the large alternative asset market and the advantages of digitally formatting these securities all suggest that initial market volume is likely just the beginning of what’s to come, however.

Myth: I’m not an accredited investor, so I can’t access these securities.

Eligibility to buy any security is determined by a combination of the offering type and an investor’s specific characteristics, not the format. In fact, non-accredited investors can invest in Regulation A+ and Regulation CF offerings today and can actually buy Regulation D securities 12 months after their initial offering. The same holds true for digital securities, because the format doesn’t determine who is qualified to invest. The difference is digitization makes accessing these investments much easier for accredited and non-accredited investors alike.

In the traditional private securities market, only people with an immediate connection to the issuer are typically able to invest in a deal. Without a secondary trading market, exchanging these assets after the initial offering is equally difficult. The ecosystem for digital securities allows non-accredited and accredited investors to explore a broad range of investments, while smart contracts help to streamline compliance for issuers by automatically enforcing investor qualifications and shareholder limits. It’s important to note, however, that individual issuers and platforms may set different qualification criteria when deciding which investors can trade certain assets.

Myth: Digitizing securities guarantees liquidity for investors.

While digitization allows for a more efficient secondary market, there is no guarantee of liquidity. The quality of the offering and an orderly marketplace with both buyers and sellers are still the cornerstone for liquidity. Digitizing securities simply provides a path to liquidity where little to none has existed in the past.

Still, the promise of liquidity can work to the advantage of both investors and issuers. Since investors know they can potentially buy and sell an asset if they need to, more of them may consider investing in these securities, ultimately helping to boost both liquidity and potential valuations.

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