Technology has had a profound impact on financial services in the US. New payment methods enabled the growth of e-commerce, peer-to-peer lending redefined personal loan markets, and Robo-advisors changed the face of wealth management.
Technology has had a massive impact on the publicly listed securities markets, OTC derivatives markets, and other financial markets by improving information flow, execution speed, security, and access.
However, a large segment of the financial services industry has not benefited from technology innovation yet – private securities and placements. The flow of capital into private markets plays an important role in economic growth. Private investments support early-stage entrepreneurs in developing their innovative ideas, enable established businesses to grow and reach their potential, and it provides crucial fuel to many sectors of the economy. Private investment capital is also a key ingredient in long-term macro wealth creation and it is crucial to enable the efficient allocation of this capital across the economy.
Despite its size in terms of the notional amount of securities issued, the valuation of these securities, and the number of market participants, private securities are characterized by fragmented “marketplaces” and costly paper-based processes. These limitations are cumbersome for capital-seekers and investors alike.
The current lack of efficient markets for private investments create major drawbacks for its participants:
- Limited Price Discovery – fragmented markets do not allow for efficient price discovery, often resulting in inflated valuations and inefficient capital allocation.
- Fragmentation – unlike other financial markets, private securities issuance markets are fragmented. Access to capital is often limited to an immediate network of recurring contacts and key players. This creates an investment bias and the type of investor exuberance we witnessed recently with inflated valuations in private companies, which eventually were deflated when faced with the scrutiny of public markets.
- Illiquidity – private securities, once issued, tend to be highly illiquid. While this may seem to be an advantage since these types of investments should be seen as “long term patient capital,” there are significant disadvantages associated with illiquidity:
- Concentration Risk – as investors evaluate investment opportunities, non-existent liquidity forces them to concentrate their investments to only a few investments, creating an impression of security. However, investors are unable to diversify their risk by spreading their investment capital across more offerings.
- Diversification Risk – As successful investments grow, investors are unable to decrease their portfolio risk due to the high cost and complexities of selling their shares in these companies. This creates inflated paper-based wealth and increased risk to the investor.
- Limits on Investment Size – investors, constrained by limited liquidity options, tend to limit their investment size, leaving potential capital allocation on the table.
Recent regulatory changes in the US created a more favorable environment for private securities markets. Regulators and legislators seek to modernize private capital markets to address these well-understood shortcomings, broaden access, and improve market efficiencies.
Despite this, change has been rather anemic because regulations and existing market participants failed to grasp the underlying infrastructure challenges of private securities markets. In addition, the economic slowdown caused by the COVID 19 pandemic slowed down the flow of capital. The lack of infrastructure, the burden of legacy technology, coupled with complex record-keeping requirements make it unnecessarily costly to transact in private securities. Developing a new capital market infrastructure for private securities requires a commitment and understanding of modern technologies.
Blockchain creates a unique opportunity to create a new capital market infrastructure suitable for private securities that is accessible, based on mutual trust, and that has a materially lower cost to use. This is possible today. Blockchain allows the issuance of digital ownership certificates, free peer-to-peer trading, capital event processing (dividends, royalties, buy-backs) while adhering to current regulatory requirements.
By design, Blockchain enables direct engagement in transactions between market participants. Platforms are designed to enable the buyers and sellers of services to find each other and transact with confidence and efficiency. Our investment platform marries these two concepts. There is no need to imagine this reality, it already exists on iownit.
On iownit issuers transact directly with accredited investors during an offering period. Once an issuance of shares has completed, and the required time has passed from a regulatory perspective, investors can trade securely with each other on the secondary markets available on the platform.
Financial services providers like asset managers and financial advisors can also provide their clients access to these markets at a lower cost while enabling advisors and managers to efficiently report on their client holdings. iownit provides a secure ledger of securities ownership transactions and brings the transparency and trust necessary to ensure orderly private securities markets.
Our public capital markets work well because of the regulatory framework and the underpinning technology has worked in harmony with each other. The same elements have been created for private securities on the iownit platform by leveraging our combined experience in technology, financial services, and transaction management to accomplish this goal.
We believe that a less fragmented, deeper, and efficient market for private capital formation will have a material benefit to the global economy and allow all market participants to efficiently and transparently engage with each other.
The private securities markets need to evolve, and the technology already exists to enable that evolution. It is now up to the market participants to determine what the best solution is, creating the necessary network effect that will most benefit them. The direction of these markets is clear, it’s simply a matter of which route is taken.