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Unlocking the Potential of Capital Markets
This week, Robinhood CEO Vlad Tenev called for a new approach to capital markets in the United States. He suggested a number of policies – modernizing accredited investor standards is an old favorite among finance wonks – but one stood out. “There needs to exist a security token registration regime, allowing companies to create token offerings that are open to U.S. investors.” Here, Tenev seizes upon the skeleton key to unlock cryptocurrency’s full potential.
How Securities Markets Work in the United States
By default, companies aren’t really allowed to sell equity at all. The Securities Act of 1933 defines securities and prescribes conditions – and penalties – for selling them. If a company wants to raise money, it hires a lawyer like me and either registers or finds an exemption like Regulation D (Reg D).
Most Choose to Go Private
Most choose an exemption and go private. And as Tenev points out, many of those choose to stay that way – OpenAI, SpaceX or Stripe. But exempt securities do not trade easily. They’re generally encumbered by contractual and regulatory restrictions that make them illiquid. For the richest few companies, this might be fine – or even the point. But not for most. Without liquid secondary markets, investors can only realize profit through dividends. And where investors cannot realize gains, primary markets run correspondingly dry.
Registered Securities: Liquid and Accessible
Registered securities, on the other hand, are highly liquid on the secondary market. This means that investors typically jump to participate in an initial public offering. But this process is also restricted to the richest companies by its massive price tag. PwC estimates that even relatively small initial public offerings cost millions of dollars, along with millions more in annual legal fees and compliance. This is still before considering the onerous transparency and forfeiture of control that come with registration. For these reasons, even top firms “avoid going public,” Tenev says.
The Problem with Regulation Crowdfunding (Reg CF)
It’s no secret that this is a problem. Washington D.C. recently tried to address it by creating Regulation Crowdfunding (Reg CF) in the 2012 JOBS Act. The idea was to make exempt securities more accessible to small and medium businesses (SMBs), but they just couldn’t help themselves. Familiar restrictions on secondary liquidity hamstring the program. Combined with still-significant compliance costs, the result will never be a meaningful segment of U.S. capital markets.
A Regulatory Third Way
Instead, the solution came from outside. Ethereum developers introduced the ERC-20 standard in 2015, allowing anyone to create an arbitrary number of tokens and sell them into instant liquidity. Project founders could restrict resale as they chose. But, in practice, the best projects developed deep, efficient markets quickly. These fungible tokens took various names and functions, but practically, for a time, they were the internet’s capital market.
Tokenized Real-World Assets
Tenev emphasizes the future: “Tokenizing private-company stock would enable retail investors to invest in leading companies early in their life cycles…enabling them to draw additional capital by tapping into a global crypto retail market… [It] would [ ] provide an alternative path to the traditional IPO.”
A New Approach
He calls this “tokenized real-world assets.” I call it a regulatory third way. Sitting between exempt securities and public offerings, the SEC should promulgate rules that allow projects to sell securities in the form of cryptocurrency tokens with limited compliance and disclosures – combining the relative simplicity of a private placement with the secondary liquidity of a public offering.
The Potential Benefits
We already know the first-order effects of such a system. In 2017 and 2018, more than 2,000 projects sold tokens to raise over $13 billion. As Tenev points out, “the risks are highest where the opportunity for upside is greatest” and many of those early crypto companies failed. Many survived, though, and are still building today. Early investors grew rich, and their leaders remain faces of the industry.
A Regulatory Framework
The second-order effects are where the real value accrues. Compared to any traditional securities offering, cryptocurrency token launches are trivially cheap. By some estimates, there is as much as a trillion dollars of potential SMB capital demand in the United States. This suggests vast potential for on-chain fundraising. Nobody knows what access to this capital would mean – some would no doubt be vaporized – but there is real potential that underserved markets experience asymmetric growth.
Conclusion
In conclusion, a regulatory third way – tokenized real-world assets – offers a new approach to capital markets in the United States. By allowing projects to sell securities in the form of cryptocurrency tokens with limited compliance and disclosures, we can unlock the potential of the internet’s capital market and create new opportunities for retail investors to participate in the growth of leading companies.
FAQs
Q: What is the current state of capital markets in the United States?
A: The current state of capital markets in the United States is restrictive, with companies often choosing to go private or remain exempt from public registration due to the costs and regulatory burden associated with going public.
Q: What is the problem with Regulation Crowdfunding (Reg CF)?
A: Regulation Crowdfunding (Reg CF) was created to make exempt securities more accessible to small and medium businesses (SMBs), but it has been hamstrung by restrictions on secondary liquidity and compliance costs.
Q: What is tokenized real-world assets?
A: Tokenized real-world assets refers to the idea of allowing companies to issue tokens that represent ownership in a company, allowing for greater access to capital markets and more efficient fundraising.
Q: What are the potential benefits of tokenized real-world assets?
A: The potential benefits of tokenized real-world assets include increased access to capital, greater liquidity, and more efficient fundraising for companies, as well as new opportunities for retail investors to participate in the growth of leading companies.
Q: What are the risks associated with tokenized real-world assets?
A: The risks associated with tokenized real-world assets include the potential for market volatility, regulatory uncertainty, and the risk of market manipulation.
Q: How would a regulatory third way work?
A: A regulatory third way would involve the SEC promulgating rules that allow projects to sell securities in the form of cryptocurrency tokens with limited compliance and disclosures, combining the relative simplicity of a private placement with the secondary liquidity of a public offering.
