A security is a traditional financial instrument, such as equity, debt, or real assets. It represents ownership in (or the rights to ownership in) the aforementioned categories. Securities are also typically exclusive, rather than inclusive, because the process of buying and trading something like equity or debt is slow and expensive.
This is mostly true in private markets. Say you want to purchase equity ownership in a privately-listed company-it’s not easy to do for the Average Joe, nor is it easy for the average entrepreneur to offer equity shares for sale, unless they have the legal prowess (and financial freedom) to afford the fees for doing so.
Even once the equity is available for sale, there’s not much liquidity in private markets, and the fees for raising capital on the private market are often astronomical. This is where digital securities come in. Digital securities are securities, improved.
There are many potential benefits of digital securities, though keep in mind that some of these (such as higher liquidity) are somewhat hypothetical, given the relative nascence of the industry. It will take years for such potential benefits to materialize, as digital securities need an established secondary market with buyers and sellers. That being said, let’s get into it.
Benefits of Digital Securities
The main potential benefits of digital securities relate to inclusion (empowering the little guy, and not just wealthy, accredited investors) and operational efficiency (faster and cheaper transactions). Further, compliance is a huge deal in this industry, as securities fall under the purview of financial regulators, which threaten huge fees for non-compliance.
Digital securities promise easier compliance solutions, and even the possibility of fully automating compliance such that intermediaries are no longer needed.
Another benefit is “fractional ownership.” Let’s say you want to invest in gold, or sell gold you already own. If you have physical gold, it’s not easy to, you know, break it into pieces to sell just part of it. It’s basically an indivisible asset, while digital securities are divisible, so they allow easy fractional ownership of anything, whether it’s gold, real estate, or diamonds.
But, It’s Not All Sunshine and Rainbows
Given all the benefits we’ve talked about, you might think digital securities have an easy path to replacing securities, but that’s really not the case. For starters, the liquidity goal hasn’t been reached, and probably won’t for several more years. As a result, many people are asking “what’s the point?”, and potential issuers don’t want to create an illiquid asset for the potential of liquidity down the line.
Another issue is that there’s just a lack of awareness in the financial world as a whole. Most financial executives haven’t heard of digital securities yet, though that’s starting to change.
Finally, regulation hasn’t caught up with the technology. In theory, regulators should embrace digital securities with open arms, as they make compliance easier and faster, though we’ve yet to see how it plays out.