To some observers, trading security tokens on centralized exchanges might seem contradictory. After all, one of the most vaunted benefits of the distributed ledger technology (DLT) that underpins digital assets is its ability to reduce the role of intermediaries, thereby lowering transaction costs. So why do we need anything more, you might ask?
Practitioner Perspective with Andy Flury, Founder & Chief Executive Officer of AlgoTrader AG
Firstly, it’s important to recognize that different types of security token investors will have different needs. For private individuals who are investing smaller amounts and are comfortable with managing their own wallet, a fully decentralized exchange like Uniswap could be a convenient option. On the other hand, a professional investor or institution would be likely investing on a far larger scale, requiring ironclad security, operating under far more regulatory scrutiny, and potentially managing assets on behalf of multiple clients.
The role of the secondary market is to build the linkages between the traditional and digital asset worlds — providing the support infrastructure and services that make it possible for institutions to embrace tokenization with confidence.
This will involve building tools to manage custody, trading, settlement and compliance, while establishing connectivity to a wide range of liquidity venues including issuance bodies, token exchanges, brokers, and OTC desks. Ultimately, this will be good for the entire security token market, introducing much larger trading volumes and greater liquidity.
STOs — Great for Issuance, but What About Liquidity?
While DLT presents a highly efficient, secure and unbureaucratic way to issue securities, the question is: after a token is minted and issued, what happens next? Unfortunately, many early pioneering projects suffered from a lack of token liquidity, even after being listed on an exchange.
Although progress has been made since then, this is an issue that persists to this day. For example, in January 2021, the most active security token exchange was tZero, with a total combined monthly volume of $6,298,096 or around $203,164 per day. Even highly prominent assets such as tZero’s equity and revenue-sharing token TZROP only attract daily volume in the order of $30,000 – $40,000 a day on average.
The reasons for the relative scarcity of liquidity are multifaceted. In some respects, security token marketplaces face a “chicken-and-egg” dilemma. On the one hand, institutional investors want a platform with a wide selection of quality tokens which they can trade. On the other hand, the leaders of tokenization projects often do not want to pay the exchange listing fees until they can see evidence of liquidity on the platform.
On the other side of the equation, institutions tend to be cautious about the potential cryptosecurity risks associated with an unfamiliar technology and want a trading solution that is similar or ideally, interoperable, with their existing back-end systems. The secondary market will have a key role to play in addressing these concerns in order to bring more institutions into the fold and end the liquidity stalemate described above.
By far the biggest obstacle to a secondary market thus far, however, has been the burden of regulatory requirements, but in both Switzerland and on a wider European level, this is about to change. In next weeks article Andy Flury will therefore take a closer look at this change!
This article is an extract from the 90+ page Security Token Report 2021 co-published by the Crypto Research Report and Cointelegraph Consulting, written by thirteen authors and supported by Crypto Finance, Blocklabs Capital Management, HyperTrader, Ten31 Bank, Stadler Völkel Attorneys at Law, Riddle&Code, Coinfinity, Bitpanda Pro, Tokeny Solutions, AlgoTrader, and Elevated Returns.