What Are Digital Assets and Why They Are Important23.04.20 | Alex Davis
Life as we know it has undergone a technological transformation from physical formats to more efficient digital formats. Photographs that used to take hours to develop only take seconds to send across the world today. This digital transformation has revolutionized virtually everything we interact with in the modern world, yet seemingly have left private equity behind.
Public stocks have gone digital, but with a catch. When you buy stock through a brokerage, the stock is held in “book entry” form. Rather than keep track of each individual shareholder, stocks are registered “in street name” to a brokerage account, and the broker maintains a ledger of internal transactions between investors.
In order to simplify these transactions (which ironically makes it more complicated), most public stock is registered to a single brokerage named Cede & Co (a nominee of the Depository Trust Company, DTC), and brokerages have their own accounts in book entry form with them.
Think you really own the stock you just bought? In reality, what you bought is an “I owe you” of your broker’s “I owe you” from the DTC.
For private equity markets, the problem lies in a lack of digitally certifiable technology which allows investors to verify the authenticity of the assets they are purchasing. Private assets are not controlled by a centralized authority like the NYSE, and are traditionally issued as paper shares locked away in personal safes, or recorded on a lawyer’s computer as an excel file.
Simply taking a certificate and issuing a digital file in its place creates a plethora of major issues.
For example, remember when songs became digitized and were duplicated & shared across the world? This would be catastrophic if it occurred to private assets, and creating a digital asset had been impossible to implement until now.
So What Are Digital Assets?
Simply put, digital assets are a digital representation of any security whose digital authenticity is made possible by a distributed ledger network.
Digital assets are able to carry and enforce all of the same ownership & governance rights as their paper certificate counter-parts, but with increased functionality and benefits. While all of the traditional securities regulations still apply, digital assets are programmed to be “self-aware” of which regulations do & do not apply to it. Additionally, they can represent virtually any asset, from equity in a private company, to corporate bonds, real estate, and even art.
The digital wrapper is best understood by looking at how it has transformed correspondence from handwritten letters sent by mail to the digital communication of today.
In order to send a message, you used to have to physically write a letter on paper and send it by mail. Once mail undertook this digital wrapping, emails sent in seconds rather than weeks. Correspondence has evolved into more than just instant email, but also file exchange (pictures, video), read receipts, group chats, automated replies, and more.
The digital wrapper brings transformative benefits not previously possible and facilitates a world of new capabilities to private equity than ever before.
The Benefits of Digital Assets
Tapping Private Markets
Previously only available to institutional investors, private equity markets are an unattainable golden egg for investors as they are typically bought and sold through personal connections.
Digitally certifiable assets allow for online marketplaces to trade private equity between all investors without ever having to meet one another.
Now, businesses of every size can increase their chances of raising capital by not only opening themselves up to investment from across the country, but can raise capital from a global pool of investors from various countries.
Reduced Costs & Liquidity
Digital assets reduce the need for costly fees spent on lawyers, due diligence, and escrow, which lower the cost of capital for companies and transaction costs for investors.
Currently, fees for buying or selling private stock online costs 5% or minimum $5,000 to both the buyer and seller. Digital assets remove costly barriers and middlemen allowing for more investors to participate, creating a more egalitarian investment sphere. They also allow for investors to reap the benefits of their investment without having to wait for the business being bought or going public.
Entirely New Business Models
The benefits of programmable assets will also open a new wave a potential business models.
Bonds can pay interest on a weekly basis rather than yearly and online casinos can pay dividends on a daily basis. Small businesses can develop customer loyalty even further by rewarding their loyal patrons with fractions of shares rather than reward points. Sports teams can capitalize on their millions of fans and become partially “fan owned,” and even create “owners only” events to boost attendance and sales.
Fractionalized ownership is the ability to own a less than 1 whole unit of stock of an asset.
As the record keeping for digital assets are automated by the distributed ledger, wealthy investors of big ticket items will be able to sell smaller fractions of their assets to a broader range of investors. Fractionalized ownership opens the door for all investors to own a smaller share of expensive real estate, art, or even classic automobiles.
For example, as the value of sports teams have skyrocketed into the billions over the past decade, the NBA is looking to facilitate fractionalized ownership to allow for more liquidity in team ownership and bring in new investors.
While the digital assets ecosystem is still an emerging sector, there is no doubt that future of investing in private equity is around the corner. The world renowned accounting firm Deloitte even published that digital assets “could make the financial industry more accessible, cheaper, faster and easier, thereby possibly unlocking trillions of Euros in currently illiquid assets, and vastly increasing the volume of trades.”
We couldn’t agree more.