By Alexander Green on 29th May 2018
Globacap's Alexander Green argues the 'the Wild West of fintech' - crypto assets - is about to be tamed.
Transparency, or the lack of it, is a persistent issue in the traditional capital raising process. Companies raising capital and investors offering it are often clients of the same intermediary, presenting that intermediary with an inherent conflict of interests and meaning that the solutions provided aren’t always the ideal long-term option for the businesses raising capital.
This problem isn’t news to companies. In fact, the last few years have seen a rise in efforts to address it via direct investment methods such as crowdfunding, with over 300,000 projects launched to date. However, the quest for a secure and open way of connecting businesses and global investors at scale has remained unfulfilled.
The arrival of blockchain-based capital raising may be about to change that, providing greater clarity. To understand its benefits, we must explore the transparency issue.
Current processes: what are the flaws?
Within conventional investment banks, it’s common for the parties involved in capital raising to be ranked in order of preference: investors who consistently pay most are prioritised highest. When combined with the fact both companies and investors typically have limited visibility into transactions, this creates multiple problems.
First, businesses may end up with a less than optimal deal. For instance, banks may prioritise investors based on the existing revenue lines from them and how profitable these are, which may not always generate the best outcome for companies that are seeking lasting support.
Such risks are particularly pertinent for SMEs. Even though this segment accounted for 57% of economic value added, and 67% of non-financial business sector employment across Europe in 2016, it is often neglected by larger intermediaries that place the needs of large, influential investors above that of small businesses.
Second, small investors can also struggle to survive. Given their smaller investment ‘wallets’ relative to larger organisations, they can miss out on allocations in deals, as well as have more limited access to information than some of the more substantial revenue generating clients of traditional investment banks.
This leads to the third flaw: the uneven dissemination of critical deal insight. Intermediaries often selectively share the amount of detail around securities offerings, valuations and bids, frequently under the guise of following distribution regulations. Higher ranking businesses and investors are likely to have a more comprehensive view of processes upon which to base their decisions, while low-ranking players have a more opaque understanding at best.
Tokenised issuance: a route to full transparency
It’s important to note that crowdfunding has done much to boost capital raising openness by cutting out intermediaries. However, most efforts are focused on localised investor segments, thereby providing limited fundraising scope. Furthermore, opportunities for liquidity after deals are restricted, which reduces the method’s appeal for many investors.
This is where blockchain comes in.
As most financial professionals know, blockchain is a distributed record of transactions maintained by a decentralised network of computers. The entire network must verify additions or changes to a block, and once entered they become permanent and generally available. However, it’s less well acknowledged that blockchain can revolutionise the transparency and efficiency of the capital raising process.
To start with, blockchain technology vastly reduces intermediary control: creating a single source of truth that isn’t owned by any one entity and gives all parties simultaneous access to the same information. There is no more selective disclosure to a chosen few.
Furthermore, because details are continuously updated, keeping track of progress is easy. For example, investors can check for fluctuation in prices and businesses can trace the ownership of securities, meaning the integrity of the process is protected. This is becoming even simpler to do thanks to the development of smart contracts: programmes built into the blockchain that can execute agreements between businesses and investors, ensure compliance, and can provide a verifiable audit trail for regulators.
As an additional but not insignificant bonus, automation of capital raising procedures allows deals to be struck at scale and in safety. Companies can use standardised templates that enable securities to be issued around the world, easily modified using smart contracts to comply with any specific regulatory needs. Meanwhile, investors can purchase those securities using tokens with blockchain platforms and speed up liquidity.
Although still a nascent market, blockchain securities issuance is quickly gaining recognition as a solution to the transparency problem. By providing a complete and transparent view of transactions and a secure means of brokering deals, it is set to exert the necessary pressure on the fee structure to transform capital raising globally.
AltFi is returning to Amsterdam for its second annual Summit in the city. The inaugural event last year was a roaring success, with key figures from across Continental Europe's alternative finance and digital banking sectors highlighted. These included Jeroen Broekema, managing director of Funding Circle Netherlands, and Mieke van Engelen, head of innovative partnerships at ABN AMRO's standalone lending platform, New10.