Tokenization and STOs “can be a driver of the real economy”- Bitfinex Securities' Jesse Knutson
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(Kitco News) - The tokenization of existing securities and Security Token Offerings (STOs) are quickly moving from experimental, novel and niche to credible, proven, and mainstream. When Blackrock’s Larry Fink called the tokenization of securities “the next generation for markets” on Nov. 30, it piqued people’s interest. When BlackRock's own iShares Core S&P 500 ETF (CSPX) was converted into a tradable token on the Ethereum network just three months later, it proved his point.
Citi’s Money, Tokens and Games report, released on March 30, offers some idea of the potential scale, with analysts writing that they expect to see “$4 trillion to $5 trillion of tokenized digital securities and $1 trillion of distributed ledger technology (DLT)-based trade finance volumes by 2030.” According to CoinGecko, the total market cap for all cryptocurrencies including Bitcoin currently stands at $1.2 trillion.
Bitfinex Securities is an exchange that enables the trading of tokenized securities such as equities and bonds, and it is one of the few platforms licensed to facilitate the issuance of new STOs. It is powered by Bitfinex, which operates the Bitfinex cryptocurrency exchange and also manages Tether, the largest issuer of stablecoins including USDT, whose nearly $80 billion in market share represents two thirds of the total stablecoin market.
Kitco News recently spoke with Jesse Knutson, Head of Operations at Bitfinex Securities. He believes the STO represents the next major evolution in capital markets, and he thinks tokenized securities are positioned to have a banner year in 2023, regulatory headwinds notwithstanding.
“There's always headwinds, isn't there?” he laughed.
Knutson described the STO opportunity as a puzzle that needs three pieces to be successful. “The first one is technology, and I think the technology box is probably ticked at this point,” he said. “We've got platforms like the Bitfinex main platform that trade $100 million in assets a day or more, with uptime of 99.99%. We've got issuance protocols like Blockstream’s Liquid Network which lets us issue assets like the Blockstream Mining Note. So I think the technology side of it is pretty much set.”
The second piece of the puzzle is investable assets. Knutson said the initial coin offering (ICO) boom of 2017 was an interesting proof of concept, but left a lot to be desired. “There was no investor protection, there was nothing about investor rights or issuers’ obligations, no regulatory frameworks,” he said.
|Jesse Knutson - Photo provided by Bitfinex Securities|
“One of the problems with the ICO boom was it was focused exclusively on these early-stage, high-risk, high-reward, very speculative VC-type investments, and I just don't think that's going to move the needle for most mainstream institutional investors,” he added. “What we need now is more investable assets.”
Knutson said Bitfinex Securities is focused outside the crypto space for assets that would appeal to the sensibilities of traditional investors. “We're looking almost preferentially to things that are more brick-and-mortar, more traditional things with cash flow, things that are modifiable, things that have ROI,” he said. “I think slowly we're seeing more of that stuff come to market.”
The third piece, which Knutson said has been missing for a long time, is commercially viable regulatory oversight. “People wonder why the STO market has been slow to develop,” he said. “Securities are a regulated market, we move at the pace of regulators, and the pace of regulators is typically very cautious and very thought out and methodical. Right now, we're finally starting to see all three of those puzzle pieces come together. I think over time, people who are entrenched in the incumbent system like Blackrock… even the Fed has been making positive comments about STOs.”
“I think people are increasingly seeing this as a natural evolution of capital markets.”
Security tokens over conventional securities
Knutson said the essential idea behind the STO is to harness the emerging technologies of the digital asset space and apply them to capital markets. “If you look at the history of capital markets, they’ve been very resistant to the adoption of technology, more so than almost any other industry you can think of,” he said. “The internet in the last 20 years has had a profound influence on almost every industry, except capital markets. There's been some superficial changes, things like online brokerages, but when you look at fundamentally, how assets are traded, custodied, settled and issued, not that much has changed in the last couple of decades.”
Knutson has been based in Asia for many years, and he offered stock trading as a clear example of the limitations of traditional securities markets. “In Taiwan, if you sell TSMC on Friday, you don't get your cash until next week, it's T+2,” he said. “We only trade 9:00 am till 1:30 pm, we don't do Chinese New Year’s, we don't do weekends. And there's no reason from a technological perspective why you can't do that better.”
He contrasted these conventional market limitations with crypto exchanges like the main Bitfinex platform. “It trades 24/7/365, 99.99% uptime, real-time settlement, you sell your Bitcoin, you get cash instantly, and you can redeploy it,” he said. “I think all of that is massively favorable towards investors. And then the liquidity, you can access really deep pools of liquidity in a way that previously wasn't possible.”
Tokenized securities must evolve further
Knutson said that when many securities are tokenized these days, investors get some benefits like fractional ownership, real time settlement, and 24/7/365 trading, but they’re still missing out on other key advantages of digital assets. “Those benefits are the ability to be able to pull your assets off the exchange, to self-custody them, to ping them over to another exchange, to do arbitrage or to even trade them peer-to-peer,” he said. “I think that's an important part of tokenization.”
But new tools and protocols are enabling them to deliver this functionality as well. “There's technology now, like Blockstream’s Liquid Network has a category of assets called transfer-restricted assets,” he said. “That means that you have a whitelist and once that whitelist is established, you can do all of these things within a whitelisted ecosystem. I think it's a really good balance between our obligations to KYC-AML and our regulators, and also ease of use for investors, and giving investors a degree of control over their assets,” he said. “That's pretty revolutionary.”
Security tokens can serve crypto investors
Bitfinex is a big name in cryptocurrency, and Knutson believes Bitfinex Securities can make a strong case for security tokens to the crypto community as well. “I think the market within the digital asset space is also very valuable,” he said. “Now, what are the opportunities for security tokens? The digital asset industry, the most notorious characteristic of it is high volatility. Bitcoin is the lowest volatility digital asset outside of the stablecoins, and that's enough to give most people heart palpitations.”
Knutson said that because volatility is so high within the digital asset space, he believes there's a strong appetite for low volatility, low friction assets. “I'm quite keen to do things in real estate with REITs or low volatility corporate bonds with a decent return on them,” he said. “And my pitch to digital asset people, crypto high net worth people is, you've got your Bitcoin position, you've got your Tether position, why not park some of your stablecoin position in something that's low volatility, low risk, and that gives you a return?”
Knutson believes security tokens are poised to take a big slice out of the stablecoin pie. “As a registered security, you've got ongoing reporting obligations and a level of transparency that's a real leg up for anything in the digital asset industry,” he said. “I think there's a really good opportunity in the digital asset space for boring companies and boring products. There's a lot of value for digital investors in something like a widget maker that pays a dividend yield of 5 or 7 per cent.”
“Those kinds of things can be boring in the real world, but could be very interesting to digital asset investors.”
The AIFC: Regulatory advantages and regional opportunities
Bitfinex Securities was one of the first companies to register and be licensed in the AIFC (Astana International Financial Centre) which is positioning itself as a global center for business and finance, and the exchange recently opened their new HQ in Kazakhstan to take full advantage of the opportunity.
Knutson said the move represents a strong vote of confidence in the regulatory regime for securities that Kazakhstan has established, and he believes the AIFC can serve as a catalyst for capital growth across the region.
“The [AIFC] has been modeled after the Dubai International Financial Center,” he said. “It operates on English common law, so its legal system is completely independent of the domestic Kazakh system, and then it's got frameworks and laws that are more familiar to institutional and foreign investors. The idea is to give foreign investors peace of mind and encourage them to deploy capital into Kazakhstan.”
It also benefits Kazakhstan by giving domestic companies better access to global capital markets. “I find the AIFC to be very front-foot on the adoption of technology,” Knutson said. “And you might wonder, why is there opportunity for STOs in places like El Salvador or Kazakhstan, smaller economies that don't necessarily come to mind when you think of global capital markets? The answer is because these places need the technology, they see the opportunity, and they're hungry for economic growth.”
Lumbering incumbents and nimble newcomers
Knutson said that the big incumbent players in financial markets have no incentive to quickly adopt new technologies because they continue to benefit from the status quo. “I think some of these smaller countries like El Salvador and Kazakhstan, although Kazakhstan is huge geographically, they see this as an opportunity to leapfrog a lot of their peers,” he said.
“It's difficult to compete with Singapore, Hong Kong, or London, but you can do it asymmetrically from a different angle and you might get similar results. So it can be a big driver not only for domestic investment, but also in the creation of a whole new capital market within the region. You think about places like Singapore or Hong Kong that are small, they don't have a lot of natural resources, and then became these massive financial centers,” he said.
“Why can't El Salvador be like the Singapore, the Hong Kong of Latin America? Why can't the AFIC be the Singapore or Hong Kong of Central Asia? I think it's completely doable.”
And those big incumbents are no doubt taking note of these developments as well. Even within the current anti-crypto climate in Washington, Knutson sees reasons for optimism for the future of security tokens and the broader U.S. crypto ecosystem.
“Coinbase has something like 60 million users, and the users skew heavily towards young people,” he said. “There's a strong cohort of people, across creed color,political affiliation, that like this industry, are passionate about this industry, and would be supportive of it.”
There are also champions for crypto at the federal and state level who believe these emerging technologies and markets should be cultivated rather than crushed.
“A lot of people see this as an economic driver,” he said. “So the mayor of Miami, he was making noises about this because he saw it as an economic driver. Texas, obviously, sees an influx of bitcoin miner investment. El Salvador has benefited in numerous ways from their adoption of Bitcoin, and Kazakhstan as well.”
“I think the underlying theme is that it can be a driver of the real economy.”