Blockchain Technology in Equity Capital Markets
Imagine yourself running a business, intending to raise capital with equity but your business is not big enough to issue an initial public offering (IPO), yet not small enough to secure angel investor’s funding. In three to five years, it may no longer be a problem because your business will be conducting Initial-Coin Offerings (“Syngum” 2019) — to have a mini exchange with cryptocurrency representing your share in the company. For private companies, equity investing has predominantly been occupied by venture capitalists and private equity investors. The rise of financial technology will extend options for private companies to issue an Initial Coin Offering (ICO) which allows general investors to have access to invest in these fast-growing private companies. Although the default risk for these private companies is serious, it will be a meaningful alternative for high-yield investors.
With Blockchain technology, authorized digital banks can underwrite equity issuances in a much safer settings than listing them directly to public.direct listing. Blockchain is able to record the transactions of each share(coin) with an identification number and maintains a precise ledger of shareholder ownership and trading history. Traders would register with a digital bank to be qualified as a broker and use an alphanumeric identification code to identify themselves to other traders.
Trends in Equity Investing
Since the Great Recession, investors have been diversifying their portfolios across asset classes and in new investment vehicles. Particularly, ETFs have become popular for their low fees and diverse portfolio constructions. Additionally, private equity has been a popular means of diversification for HNW individuals as the industry has generated high returns and experienced explosive growth due to the amount of dry power in the financial system. Recently, there have even been talk about lifting the wealth restrictions of PE and allowing the average person to invest. Moreover, the tech booms have nurtured numerous unicorns who have had great social impact but lack healthy financials. the discouragement public pressure have on companies like Tesla, Uber, Snapchat, etc. As a result, start-up unicorns have turned towards alternative equity sourcing options. Like how Spotify and Airbnb have decided to raise capital through direct-listing options. (“TechCrunch” 2019)
IPO vs Direct Listing
The cost structure of getting listed on a stock exchange is ridiculously high because the middle person charges 2–8% of the market capitalization of the company at the intended selling price and it takes over 12–16 months from readiness planning to IPO. Nonetheless, obligating to regulation like quarterly fillings and public accounting practices have cost company a sizable amount of cash. According to PwC IPO Report in 2018, 64% of the US Public Companies have spent overall a billion-dollar at IPO fiscal year at private auditing, financial reporting, and legal services(“2019 US Capital Markets” 2019).
In contrast, direct listing has also carried a really bad reputation for years because there are not intermediaries that are credible enough to hold transactions and regulate companies. Bulge-bracket banks will have a conflict with interest because they provide debt financing options and equity insurance advisory service. While there is not any financial institution that is reputable to run a direct listing platform for private companies due to the costly operating system and low profitability.
The 2010 decade has seen a great recovery from the financial recession and nonetheless somehow technological-driven as the biggest companies are now all technology and media companies. We have never been in an environment that is so innovative that even tech startups are ubiquitous and helpless(“Mckinsey” 2019). Imagine if we can invest in a private company without a huge budget or if the company would be able to raise funds without getting pressure from investors while being regulated. Then public investors would be able to access to these small-mid-enterprise (SME) just like institutional investors and venture capitalists.
What’d Investors/Management Have to Say About ICOs?
How are we going to adapt to this changing landscape? And who? Digital banks are able to, digital banks stand as the perfect financial institutions to execute and be the middleman between SMEs and investors. Through issuing Initial Coin Offering (ICO), by hard-coding shares with blockchain technology, shares can be distributed in a form like coins with a specific identification number that is traceable and transferable — just like shares. They are backed with fiat currency just like dollars and prices are set by bid/ask volumes. Essentially works the exact same as most crowdfunding platform but the return of investment has just changed from a physical product/monetary vouches to a share of the company.
To investors, ICO would be phenomenal as the credibility and trust digital bank injects into the company will mitigate the high default risks, because the digital bank will shortlist companies by requiring them to have a adequate financials and proofs of prosperity. Furthermore, it adds a new sector of investment options to fund managers and investors to look into, especially towards the mid-market emerging companies.
To management, ICO stands as an attractive option because it is safer than listing their shares directly to consumers or being traded on the public stock market. Most importantly, these coins are hard-coded and activities such as buybacks can occur internally, even if the company intends to file an IPO as they have grown bigger, these coins are still representable and can be converted into common stock through the digital bank.
In addition, the downside of Initial Coin Offering can also be dangerous as the digital bank would have to create an environment for companies be eligible for the underwriting services. First, how big the companies need to be or how much revenue do they need to achieve in order to be eligible for the underwriting services. Secondly, how often and how much information would they need to disclose? It will certainty be difficult for digital bank to adjust these bars and regulation for the sake of reduced default risk and greater consumer protection
On August 31, Syngum, the world’s first digital asset bank was established in Singapore and the financial landscape is started transforming in the capital markets industry. Its capability to operate a mid-market high volume trading platform is mainly due to the advanced blockchain technology. The faster real-time gross settlement process and traceable records helped developing consumer trust and eventually creates a more investor and corporate-friendly investing circumstance.
In North America, there aren’t any banks that do have similar functionality as Sygnum, mainly due to strict regulation from the legislative councils as well as opposing voices against blockchain and cryptocurrency resulted from the Bitcoin crash in 2018. Majority of the banks in Canada have worked towards digitalizing their consumer banking operation, however there has not been anything special in the capital market industry yet.
Future trends to look outfor
A few years from now, we might be able to witness sales & trading jobs are getting automated growing mergers & acquisition activities. These are the catalysts of an emerging shares exchange platform for cryptocurrency to take place with advanced blockchain technology. We shall take a minute to think about what is the implication behind giving general investors access to private companies towards different stakeholders. Private equity/venture capitalist might have to complete with general public for company’s shares, startups will be able to raise capital at a much cheaper and safer way, management might get less pressure from shareholders due to loosen regulation etc.
2019. Mckinsey.Com. https://www.mckinsey.com/~/media/McKinsey/Industries/Private%20Equity%20and%20Principal%20Investors/Our%20Insights/Private%20markets%20come%20of%20age/Private-markets-come-of-age-McKinsey-Global-Private-Markets-Review-2019-vF.ashx.
“2019 Annual US Capital Markets Watch”. 2019. Pwc. https://www.pwc.com/us/en/services/deals/library/us-capital-markets-watch.html.
“Empowering Digital Asset Banking”. 2019. Sygnum. https://www.sygnum.com/.
“NYSE Exchange Proprietary Market Data | Real-Time”. 2019. Nyse.Com. https://www.nyse.com/market-data/real-time.
“NYSE Proposes Big Change To Direct Listings — Techcrunch”. 2019. Techcrunch. https://techcrunch.com/2019/11/26/nyse-proposes-big-change-to-direct-listings/.