Ami Ben David is co-founder and managing partner at SPiCE VC, an investor in multiple security token-related companies and co-founder of the Ownera Foundation.
This article first appeared in ‘Institutional Crypto,’ a weekly CoinDesk newsletter focused on the nexus of Wall Street and crypto assets. The opinions expressed in this article are the author’s own.
As one of the very first people to tokenize a VC fund when the term “security tokens” almost didn’t exist, and as an early investor in the space, I have a unique point of view into the rapid growth of this ecosystem.
But growth is not just about numbers, it’s also about growing up.
The pioneers of the security token industry started it with an eye to retail investors – after all, security tokens (STOs) evolved from retail-focused initial coin offerings (ICOs). Fast forward two years, everybody understands a simple fact: It’s all about getting institutional investors to participate.
Security tokens may share some technology with ICOs, but they represent something completely different, the digitization of the way humanity decides who owns what on an immutable shared blockchain ledger. It is a vision that is several orders of magnitude bigger than ICOs ever were, and it is serious business – legal, regulated and grownup.
The supply of quality assets to tokenize largely depends on the availability of institutional investors to pick them up. Now, who is at the heart of the institutional investment ecosystem? Investment banks!
If indeed the goal is to tokenize billions and eventually trillions of dollars’ worth of assets, this industry will not get anywhere near that scale by trying to bypass the investment bankers that are at the heart of the securities market, entities like JP Morgan, Citi, Morgan Stanley, Goldman Sachs, Merrill Lynch and others that institutions already trust with their capital.
Even the name is changing – instead of “security tokens,” industry insiders have already switched to “digital securities,” and to the more appropriate “smart securities” (emphasis on the infusion of code and apps).
The focus is not crowdfunding tokens, it is digitizing the way all ownership of assets is managed.
I personally believe in the long-term viability of bitcoin, but that is irrelevant to the success of the movement to tokenize all securities, which should be tradable for cryptocurrencies, stablecoins, fiat, JPM Coins or any other form of payment invented tomorrow.
When we sold the tokens of our SPiCE VC fund, the majority of investments came in fiat, not bitcoin. It was not a good fit, because it’s too volatile (for now).
Long the Bankers
To understand why investment bankers will be so pivotal to the next stage of this ecosystem, let’s get down to some details.
There are three trust layers to a scalable smart securities market: information, verification, and distribution. Bankers have a critical role to play in all of them.
Trust Layer 1: Information
In order to invest, investors must know what they are buying. Institutional investors, in particular, are extremely risk-averse; they must know that this new format absolutely guarantees their rights in the assets – that nothing could go “wrong.”
If you look at the current wave of first-generation security tokens, you will see that a few of them provide detailed information and disclosures about token-holder rights, but most are lacking. With some security token,s you practically have to be a detective to know what you’re buying.
We’re not yet feeling the full scale of this fundamental issue, because the market is still in its “primary” stage, i.e. most people buy directly from the issuers and can demand whatever documents they want. Once the secondary markets kick in, people will realize we need a better information model.
I call this information model KYA (Know Your Asset) – documenting the “identity” of an asset in the same way KYC deals with the identity of token owners.
Basically, the KYA for a smart security should simply be a folder of documents, where everything you need to know about your rights as a token holder is clearly laid out. It needs to be complete, updated with disclosures, secure, privacy-enabled and immutable (so nobody can change it unnoticed).
Investment banks can be instrumental in shaping what information is needed for each asset class to bring institutional investors in.
Trust Layer 2: Verification
In blockchain processes, there is a difference between the preparation of the information and the process of verifying and agreeing it represents the truth. Similar processes apply in the current world of securities.
Can a person verify their own KYC/AML? Can they say “trust me, I’m not a money launderer”? No. They can supply a passport, but someone else, a trusted entity, must verify it.
The same applies to KYA – asset information. An ecosystem where every issuer can say whatever they want or change terms down the line without any external verification is an open call for trouble.
This task – verifying the authenticity and value of securities, is something investment bankers, broker-dealers and other underwriters have been doing for decades. This function evolved for a reason – it’s not some intermediary to get rid of.
This verification, the work and the reputation staking, is only useful when done by entities, like investment bankers, that institutional investors fully trust to understand their fiduciary duties and business needs.
Trust Layer 3: Distribution
Once investment bankers and other market players compile and verify the information, and stake their reputation to the assets they promote, they are in the perfect position to market it to their existing client base – including institutional investors and all other significant investor groups.
They are the distributors with the network of trust, they already manage much of the capital flowing into existing securities markets, and as the markets inevitably transition to smart securities, they are the key to the scalability and adoption of this new model.
And this is why the motto “Short the bankers” is so wrong…
Placing the bankers at the center of the ecosystem is the fastest way to grow the industry. Because while many of the big assets may go to the bankers, trillions more will go to new market entrants. In parallel, new infrastructure and technology solutions will be required across all levels of the value chain, from the blockchain itself to the last mile of investor management – this is where the next Amazons and Googles of the blockchain age will emerge from.
When we started tokenizing our fund, there were maybe 5 companies in the security token space. Today, a year and a half later, there are hundreds. It’s a tectonic digital paradigm shift, and bankers should, and will be at its center!