Providing Secondary Trading for Tokenized Securities: Current Hurdles and Solutions to Them

December 05, 2019 STO

If you conduct a small research on how security token issuance platforms promote their products, you might notice that 9 out of 10 companies tend to empathize that tokenized securities are destined to bring liquidity to traditional assets previously considered illiquid. The only thing holding this process back, as it’s commonly suggested, is the absence of a secondary trading facility. This thesis is usually followed by a cue indicating that a facility like that is already in development and probably wouldn’t take too long to launch.    

Well, here’s the thing: according to BlockState, as of 2019, there are more than fifty security token issuance providers on the market, and yet, as evidenced by our internal research, none of them currently offer fully operational and regulated secondary trading solutions. For all the security tokens on Earth being issued each day, there is no single secondary market in existence. This is a huge problem for both issuers of tokenized securities and investors.

But does the absence of secondary trading really hurt tokenized securities market that much?

Yes, it does. In fact, without secondary markets, the functionality of security tokens as an asset is significantly reduced, and so are your options as an investor. After all, a lack of liquidity is often identified is one of the main problems of traditional securities. An asset that you can’t properly sell might be a burden. However, there is still a number of benefits compared to traditional securities: automatization of processes, reduced issuance costs and most importantly tokenized securities open an opportunity for everyone to invest in companies that they believe in.

Right now there are plenty of platforms that deliver services regarding the issuance of tokenized securities without providing any secondary trading opportunities whatsoever. Some of these platforms might consider adding secondary trading in the future, whereas those focused primarily on the security token issuance might not bother at all. The fact of the matter is, the lack of secondary markets still remains the problem of issuance providers, not anybody else’s: few companies are going be interested in issuing their security token on a platform that does not provide secondary trading; little to no investors would be interested in purchasing such a token unless it pays considerable dividends. Eventually, the reluctance to introduce secondary trading options might result in these platforms losing potential clients and investors, meaning there will be no one to charge commissions from. And no revenue.

So where does the root of the problem lie?

It’s the same thing most other problems in crypto revolve around — regulation. As far as most jurisdictions go, the regulatory framework for the secondary trading of tokenized securities has not even begun to shape up yet. This circumstance is not to be blamed on regulators — after all, these secondary markets have started to take off relatively recently. More prominent examples of relatively successful legal framework developments in this regard include digital asset-friendly jurisdictions like Malta, Singapore, and Switzerland.

But how soon will other jurisdictions catch up? As more laws in various countries are beginning to cover the process of security token issuance, it probably won’t take governments too long to put similar rules for secondary markets in place. Given that issuance and secondary trading of tokenized assets basically represent different steps in the same “issuance-offering-secondary trade” chain, this assessment might be not far from the truth. We believe that one of the main mistakes of regulators is an attempt to apply the same old security laws to new instruments. As current laws don’t consider obvious benefits of blockchain technology and therefore tokenized instruments still exist in a system that is filled with intermediaries.

However, this doesn’t mean that waiting for the regulators to take action is the only option security token market players are left with. There are other possible solutions to the problem: for instance, the recent study by ASIFMA suggests that instead of building their own secondary trading facilities, companies could use the operational infrastructure provided by existing regulated securities exchanges and trading platforms — given their regulatory status and the fact that many of them have already started digital transformation projects to embrace blockchain, this could work.  

Our vision

The way we see it, there are two ways issuance platforms will address the issue of secondary trade: some will keep on developing their own secondary markets, while others will probably opt to partner with market players who already have the required infrastructure at their disposal. Since there is no clear answer as to what approach will prove to be more efficient in the future, Tokenomica is pursuing both directions at once, and we’re already making considerable progress in each of them.

As for the future of security token secondary markets in general, as stated before, it mostly comes down to regulation. That said, instead of anticipating the governments to make the first step in this regard, perhaps the issuance providers should take the initiative themselves and try to engage the other party in a constructive dialogue. At the end of the day,  it’s the future of the tokenized economy that is at stake here — someone’s got to take action.