By Vlad Estoup, Investment Representative at Atlas One Digital Securities
For in-depth research on digital securities, visit research.atlasone.ca
Crypto bull runs expose the need for regulation
2017 brought the cryptocurrency space to light, with Bitcoin rising 2000%+ in a matter of months and several other cryptocurrencies following suit, only to crash substantially afterwards.
This bull run was saturated with ICO’s (initial coin offerings), many of which were deemed unregistered security offerings afterwards — a label that caused problems for issuers of the tokens, as it entailed the requirement to follow traditional securities laws. As such, some projects were fined millions of dollars, and some were able to escape the “securities” label by convincing regulatory bodies that their token had a “utility” in a platform and did not constitute an investment into their enterprise with the expectation of profit.
Several projects have used this tactic to launch ICO’s, and a lot of them were legitimately not securities. But many were frauds, and investors lost millions discerning between the two.
Fast forward to 2021, and the need for regulatory oversight for blockchain technology for financial markets has become even more evident. With more robust cryptocurrency on-ramps and decentralized exchanges allowing anyone to issue a token and create a liquid market through liquidity pools, the access to this unregulated market is larger than ever, and institutional investors are being scared away from this side of blockchain technology.
Digital securities are the start of compliant blockchain use
Digital securities are the solution that sophisticated investors have been waiting for, offering the transactional benefits of blockchain technology with the safeguards of securities regulations. In essence, it is a look into the future of how tokens can enable more transparent and liquid capital markets, and it is all starting with private securities.
Asset classes that were difficult to access are now becoming increasingly available to all investors, regardless of geographical location or access to personal connections. By following KYC procedures and adhering to regulatory requirements such as selling to accredited investors, digital securities issuers can benefit from ground-breaking technology while safely providing access to investment opportunities.
This process is being fueled by registered broker-dealers (such as Atlas One Digital Securities), who can tokenize private shares and distribute them to a large number of investors. In the future, it is likely that there will be several on-chain and off-chain networks across broker-dealers worldwide, creating more liquidity for investors and facilitating market access.
As of today, the majority of the liquidity is in the form of ATS’s, or alternative-trading-systems. These are regulated exchanges that allow retail investors to trade digital securities in a regulatory-compliant manner.
The current leaders in this space are INX Digital Securities (who recently made history by issuing the world’s first on-chain IPO on Ethereum), as well as tZERO (who are listing various digital securities to their exchange, from equity in startups to real estate-backed tokens).
There is also a decentralized side to this growing market. Singapore-based IXSwap (which is being launched by the InvestaX team) is creating a decentralized platform for investors to trade between whitelisted wallets. R3, the technology provider of the Corda blockchain has also announced interest in creating a decentralized solution for finance.
Wallet whitelisting is nothing more than smart contracts determining which wallets are allowed by law to hold certain securities. When a wallet is whitelisted, it can hold the contract’s tokens.
This is laying the foundation for a worldwide repertoire of whitelisted wallets, which can then be verified by decentralized (and centralized) trading systems, and allow for more liquidity in digital securities.
Regulation is at the heart of blockchain success
The core component of long-term success and growth for blockchain-based financial markets (including cryptocurrencies, defi and NFTs) is regulation. Digital securities are the first step in proving that as long as there is a robust regulatory framework in place, blockchain technology can be of tremendous value to global financial markets and institutions.
Broker-dealers like Atlas One ensure that only eligible (and KYC’d) investors hold securities, on top of conducting due diligence on deals. Furthermore, investors can benefit from a layer of protection from broker-dealers’ suitability checks, who will assess if the investment is appropriate for the investor’s needs and risk tolerance.
Several cryptocurrency-related companies are seeing increased pressure from regulators to label their products as securities. Most notably, Coinbase’s “Lending Program” was deemed to be offering securities (i.e. bonds) to investors, which triggered the publicly traded cryptocurrency app to shut down the feature. Although this was a significant hurdle for the company, in the long-run it will cause defi players to assess their need to engage with regulated players in the space, such as digital securities broker-dealers capable of issuing compliant fixed-income securities on-chain.
Some may argue that regulated entities such as broker-dealers acting as gatekeepers to whitelists are not a decentralized model. While that is true, this model is far more decentralized than the current centralized finance model of a small number of exchanges. A network of thousands of regulated broker-dealers, exchanges, and other regulated entities will create a compliant marketplace for private securities supported by blockchain technology. When market participants adhere to securities laws, investors benefit from greater transparency and protection.