2020 Year in Review: the Year Digital Securities Became Mainstream
Predicting when a trend moves from a niche or hobby to the mainstream is fraught with risk at the best of times. While it is easy to point to the PC, Internet, iPhone, and Facebook in retrospect as industry game changers, one should also remember that the Apple Newton, Pets.com, Webvan, and most recently — Quibi, were also supposed to be the next great thing. Financial services trends are even harder to predict as the industry is heavily regulated and such a cornerstone of the economy and people’s lives that big changes are infrequent and even actively discouraged.
However, even in this conservative sphere, our belief is that 2020 was the year that digital securities and digital securities offerings (DSOs) moved into the mainstream. If one looks at the classic adoption S-curve, DSOs have spent that last 2–3 years in the innovators phase (see chart below). But 2020 saw the industry push through into early adopters and poised to rise sharply up the S-curve of adoption.
Digital Securities Activity Surged in 2020
The digital securities market grew substantially in 2020, from about $585 million in market capitalization at the end of 2019 to over $950 million by December 2020 (representing 62% year-over-year growth). About $407 million worth of digital securities were issued in 2020, compared to $125 million in 2019 (225% growth).
Secondary trading also saw a significant growth throughout 2020 with $10.9 million in average monthly trading volume, compared to $0.5 million in 2019 (roughly a 22X increase). Over 80% of this new trading volume comes from TZero’s secondary exchange, Dinosaur. These trading volumes still pale in comparison to the $50 Billion in daily volume seen late 2020 in cryptocurrencies.
This substantial increase in 2020 activity was driven by a combination of attractive investment offerings, mainstream institutional activity increasing in DSOs, and expanded DSO eco-system.
1. Attractive Investment Offerings
One of the main reasons for the surge in 2020 was that issuers finally brought attractive opportunities to investors. This seems like an obvious need for the market to develop, but following some of the disasters during the Initial Coin Offering (ICO) boom of 2017–18, where 92% of deals were estimated to have failed, quality offerings were not a guaranteed outcome for DSOs. Early DSOs that mainly focused on blockchain companies and exchanges did not expand the attractiveness of the asset class.
Market participants appeared to collectively agree on what the market needed to grow — regulated, high quality issues following clearly stated securities laws. There were several landmark deals that showed the improving quality of issues:
Aspencoin — $22.5M Raised in 2020.
- DSO backed by the St. Regis Aspen Resort, Colorado
- Reg D 506 © on Tezos blockchain
RealT — 21 DSOs raising $3.1m in 2020
- 21 individual property deals valued at $50K to $600K each
- ERC-20 Tokens trading via Uniswap
Overstock — Issued $66 million via a digital dividend in May 2020.
- The largest listing and market capitalization (now $222m) of a DSO by this innovative digital retailer
- ERC-20 Tokens listed on TZero (Dinosaur) regularly generating highest trading volumes
Notable amongst this list and activity in 2020 were real estate offerings. They represented about 75% of new offerings in 2020 and reflect both the complementary use case real estate provides to digital securities, and the appetite for high quality deals. As the largest asset class in the world and one understood by a broad spectrum of private market investors, real estate’s emergence in DSO issuance is a key driver of adoption.
2. Mainstream Institutional Activity Increasing
After the ICO boom collapsed, many cryptocurrency players repurposed their business model towards digital securities. While that brought technology and energy to the business, it did not enhance credibility. In contrast to cryptocurrencies, digital securities are part of a heavily regulated business — regulation that forms the foundation of trust needed to accelerate adoption — and many of the repurposed players initially tried their best to avoid this burden.
However, 2020 saw increased traditional institutional adoption, bringing digital securities into the regulated mainstream. According to Security Token Advisors, 39 of the top 100 global banks have active blockchain programs. Some of these are no doubt hobby projects by the innovation departments of banks trying to show they are keeping up with trends. But some major banks have taken significant steps. DBS Bank, a fintech-pioneering Singapore bank announced that it would create a digital asset exchange that provides a full eco-system of issuance, trading and custody. HSBC followed on work that Deutsche Bank and Societe Generale did in 2019 by issuing bonds using blockchain.
Blockchain focused neo-banks also began to make a difference. Syngum, a Swiss-licensed entity describing itself as the first regulated Digital Asset Bank, launched an end-to-end tokenization solution. Blockchain-friendly Wyoming State licensed two Special Purpose Depository Institutions, one of which — Avanti Financial, plans to offer digital securities services.
While it is tempting to see all these moves by the mainstream financial sector in isolation, the overall picture is one of strong momentum towards mainstreaming and, therefore, adoption. These institutions have millions of clients and a great deal of credibility they can bring to the industry and will be a powerful force in pushing adoption.
3. Expanded DSO Ecosystem
While far from complete, the digital securities eco-system also expanded substantially in 2020. Unlike cryptocurrencies, the regulated securities market relies on a broad ecosystem of specialized players — broker-dealers, exchanges, Alternative Trading Systems (ATS), transfer and escrow agents, corporate secretaries, trust companies, custodians, etc. — in addition to a variety of specialized technology providers. Partnerships and even acquisitions mushroomed in 2020 to begin bringing together the many ecosystem players needed to drive adoption of digital securities.
Securitize.io, a digital securities technology provider, emerged as a major player through its acquisition of Distributed Technology Markets, allowing it to string together issuance technology, transfer agency along with a registered broker-dealer and ATS. INX, a digital securities exchange, helped consolidate the market through the acquisition of OpenFinance. In Canada, the Canadian Securities Exchange (CSE) teamed up with Odyssey Trust and technology firm CurrencyWorks to provide integrated token issuance, transfer agency and settlement services.
Even in custody — traditionally the lagging link of the ecosystem, regulators issued new licenses to specialized blockchain custodians in Hong Kong, Singapore, UK, and the U.S.
The partnerships, integrations, and new licensed players will reduce the friction of accessing the digital securities market place and help drive its growth.
Key Trends to Look for in 2021
Past trends are not always an indication of the future, but we are feeling confident that digital securities are now on a sustainably upward trend as adoption continues. Estimates in 2019 predicted tokenized securities capitalization will be $2 Trillion by 2030. While that is still a far distance off, we see a potential pipeline of several billion dollars of issuance across the market, which combined valuation growth and conversion of traditional securities, could see market capitalization could achieve $4–5 billion by year end 2021.
However, a number of trends need to move favorably to ensure the industry keeps rising up the steep part of the S-curve:
- The custody bottleneck needs to unlock: In many markets there are zero or just one licensed digital asset custodian. Even where custodians exist, they are often mostly focused on crypto-assets, which results in expensive solutions not fit-for-purpose for digital securities. In addition, institutional investors will have an inherent caution in entrusting the custody of their digital assets with new startups — creating a barrier to adoption. Watch for an increasing number of credible licensed banks to enter the market that will drive institutional interest. HSBC and DBS have already announced these services, while other banks are creating units focused on digital assets (including crypto-currencies) which provides the vehicle to provide DSO services in the future.
- Central Bank Digital Currencies (CBDC) introduction: Most primary and secondary DSO transactions still involve a lengthy and cumbersome cash settlement process. This adds inconvenience, time, and risk into the purchase of digital securities by investors — compounded by the fact that many digital securities players still find it difficult to even get banking relationships. Digital currencies are the unique solution by enabling simultaneous settlement of digital assets versus value on blockchain. The existence of USDT and USDC stablecoins, which approximate US dollars, is one reason cryptocurrencies regularly have more than $50 Billion of daily digital asset to digital asset settlement volume. However, using stablecoins like USDT is not an option for many regulated firms. Watch for CBDCs to be introduced, solving many of the settlement challenges and creating a truly modern market with real-time DSO/CBDC settlement.
- Further integrating the DSO ecosystem: While the efforts of Securitize, INX, CSE and others have started to string together a more end-to-end solution, clients and broker-dealers still need to solve too much of the ecosystem themselves. Reducing the friction of accessing the market is key to accelerating growth, particularly in the settlement and custody parts of the end-to-end chains. Watch for more partnership, acquisitions, and true end-to-end solutions provided by new industry players.
- Increased Investor interest: Our view is that DSO issuance potential greatly exceeds demand. However, despite the improved attractiveness of offerings, investors have yet to see the compelling case for DSOs versus other investment opportunities, even though investors are flush with cash and in search of new yielding opportunities. They may be intimidated by the blockchain technology and required digital wallets, or annoyed that they need to set up multiple accounts in order to get access to deals. Broker-dealers and exchanges need to reduce the onboarding burden and distribute offerings more widely amongst each other to increase choice for investors. The biggest trend to watch is a step-function increase by individual and institutional investors participation, indicating the industry has dramatically improved its attractiveness.
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2020 saw the take-off of adoption in the digital securities market. The trends are in place for 2021 to see further growth and opportunities to see digital securities become a major force in financial markets.
Co-Founder & C.E.O.
Atlas One Digital Securities Inc.