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January 26, 2017

#Blockchain + The Secondary Market

2M blockchain (s)

#Blockchain is defined as the ‘great chain of being sure about things.” by The Economist. We are moving towards a blockchain future where the marginal cost of a transaction drops to zero and peer-to-peer commerce is facilitated by ‘trustless’ transactions.

Blockchain’s pace of development continues to happen at a relentless rate as we enter 2017, with a myriad of test implementations across the financial sector and a horserace between emergent fintech players to become blockchain beacons.

One of the most intriguing areas for development is in the secondary market for private securities in startup and venture companies. Since SharePost and Secondary Market (which has since been acquired by Nasdaq) became prominent for their role in helping Facebook’s paper millionaires cash-in their shares, the idea of a liquid market for shares in private companies has become the holy grail. Such a market would remove the ‘exit strategy’ line from the first slide of every startup’s pitch deck and enable both founders and early-stage investor to cash in some gains before the company is sold. In short, it would revolutionize both enterprise formation and venture investing.

+ #Fintech: Seedrs + Equity Crowdfunding

Equity Crowdfunding UK

TechBullion

The growth of equity crowdfunding over the last five years, especially in the UK, shows there is a substantial appetite for investment in new companies for both accredited and non-accredited investors.  OurCrowd, a global equity crowdfunding platform for accredited investors, did a study in 2015 highlighting this trend:

“Now, the outsized returns are going to private investors, not stockholders … the amount of venture capital more than doubled globally to over $135 billion in 2015 compared to 2013,3 as investors raced to grab a share of these private returns.”  OurCrowd – Democratization of Investing

Given this movement of capital into private, illiquid companies, there is a clear role for secondary markets.  The question is, what is the blockchain’s role in such a market and how long until we will see a global secondary market for private securities?

Secondary Markets

The role of the secondary market in the capital markets ecosystem is threefold:

  • discovery of counterparties – see who is interested (individual investors, funds, etc) in buying and selling securities
  • reducing complexity – without an official secondary market, the legal, tax and accounting complications for executing a deal between two parties can make deals extremely difficult to execute
  • transaction costs – the costs linked to the above considerations (legal, tax and accounting) are not fully known without a secondary market, and these costs, cumulatively, could make certain deals for private securities uneconomical

+ Future Secondary Markets

An efficient, platform-based secondary market could solve all of these problems.  That’s why the launch of Crowdcube’s secondary market is particularly timely for this era in global financial history – the platformization of markets. Especially given Crowdcube’s early-stage dealflow, the addition of a secondary market could create an additional incentive for investors to make bets on early-stage companies in the UK:

“Currently many early-stage investors are locked into their investment for the long-haul, a secondary offering of this nature will provide greater flexibility for equity investors, whilst further democratising investing by providing another avenue for anyone to invest in great British businesses.”

crowdcube

“The Company’s future plans include creating an environment for shareholders of any private UK company to sell their stake, if demand exists, so potential returns are not limited to just major exit events such as trade sale or IPO.” Crowdcube to Pioneer Secondary Liquidity

Crowdcube, one of two major equity crowdfunding platform for both accredited and non-accredited investors in the UK, has the dealflow volume and platform infrastructure to execute this type of secondary market, the first of its kind in the world.  It’s no surprise that investor interest was so high:

“The Company, which has invited investors to register for early access to its raise, has already received up to £50 million in expressions of interest, the first £10 million of which came through in just two hours.” Crowdcube to Pioneer Secondary Liquidity

The Blockchain

Fast forward five years. Imagine the continued growth of private venture capital for companies like OurCrowd and the inception of secondary markets on platforms like Crowdcube. Naturally, we would expect that investors on OurCrowd will want to invest in Crowdcube, and vice versa, then sell big winners on secondary markets.
2M blockchain

This is where the blockchain will come in. Imagine a global platform for trading ‘startup securities,’ one that is liquid, crowd-based and fully compliant with national regulations:

“It is the combination of these two technologies — networked/decentralized exchanges and Blockchain, that together have the potential to revolutionize both the front and back-end of trading in the secondary market” + Future Secondary Markets

To fulfill this vision would be impossible without blockchain. All of the various legal requirements, regulatory guidelines, transaction fees and other guidelines would make it impossible for global securities of non-public companies to be exchanged between investors, both accredited and non-accredited.

Blockchain will enable unification of all the individual ledgers for each individual platform and secondary market onto one integrated ledger, such as NEM‘s soon-to-be-launched Catapult blockchain:

 “a blockchain platform with multiple ledgers for multiple use cases – mutually exclusive or not – and at the same time, allowing transactions between ledgers to be frictionless.” Catapult White Paper

Blockchain will drop the marginal transaction cost to zero, and legal/regulatory terms will be programmed into smart contracts that enable seamless transactions between counterparties in different countries.  A unified, decentralized ledger will make all security trading secure and verifiable, and it won’t be subject to tampering by any individual entity to advance their own agendas. The combination of blockchain and secondary markets will completely revolutionize venture finance and enterprise formation, forever.