Does Tokenization Equal Liquidity? Tackling a Commonly Used Dichotomy

• Makers And Takers
• A Token Of Truth

The following is a guest post by Tiana Laurence, EVP at ABE Global & Author of Blockchain For Dummies

In the investment community, are tokens seen as a magical solution to liquidity?

Let’s consider that thought. ICO tokens secured on a blockchain represented the new frontier, one where software cut out pesky middlemen and restrictive governments. You could own a piece of the future and get extremely wealthy without the need for physical assets. Because of their open access, it was easy to think that tokens were a magical solution to startup and venture capitalist liquidity issues.    

There’s just one problem: They are not and STOs (regulated token offerings, also known as security token offerings) are not either.

Creating a token on a blockchain does achieve many things, most notably the ability for anyone to acquire it. But availability does not translate into market demand. Someone still needs to purchase it. The more people that jump on that bandwagon and turn your token into a dynamic commodity, the more liquid your market becomes. But for assets that fit inside what is known as “small cap” (300 million – 2 billion range), it’s nearly impossible to ever get enough value. In these cases, many crypto markets can be ruined by a single person with enough accessible funds, regardless of popularity. One of the most well-known cases of this stems from the recent massive Bitcoin crash due to a large sell of Bitstamp, a European cryptocurrency exchange. 

Makers And Takers

A truly unregulated market opens the door for maximum flexibility. At the same time, that inherent flexibility is coupled with risk — the fewer the regulations, the greater the risk. On the flip side, regulated markets have solved this volatility issue thanks to groups called market makers.

Market makers are important to maintaining a healthy capital markets ecosystem. They agree to always buy and sell stocks and get some special treatment for the risk they take by providing liquidity. Money makers also make money on the bid-offer spread.

Separate from market makers are market takers. Market takers require liquidity and immediacy to ensure that reasonable prices exist whenever they need to enter a trade or close an existing position. Their existence is a tradeoff — by providing this service to a specific crypto market, they give up an edge in the investor marketplace. This does provide greater stability, and in general turnover less frequently than market makers. Because of that, they are generally less concerned about trading costs.

A Token Of Truth

There is the idea that because cryptocurrencies are inherently bearer instruments, they may be more stable. After all, you can send tokens directly to another person without any sort of middleman, broker, or agent. However, even though that’s true, parties in a negotiation still have to come to an agreement on price. They need a market to meet and to determine the best price at the moment. Without a fully functioning ecosystem, STO’s and other tokens are living in monocultures that results in sometimes lopsided transactions, particularly when crypto novices are involved. The intent to remove intermediaries also excluded other beneficial parties that help make markets work.

Thus, crypto exchanges get involved. But the problem is that exchanges are hackable. There’s actually quite the history of hacked crypto exchanges, which means that as reliable as the ledger is, it’s not infallible. Beyond that, though, is the actual listing. And the listing on its own does not make you liquid. Often times, a crypto whale will back a project just to keep the price up, buying the crypto whenever the price falls. Other times, clever actors will push up the volume of trades or even generate fake trading data by trading between multiple accounts. This fraudulent activity is known as phantom trading and can give the appearance of liquidity when in fact the activity is held up by a house of cards.

A Path To Liquidity

If all of these paths lead to volatility, then what options do you have? The alternative seems to be bypassing crypto for listings on a traditional exchange, which is expensive and expose you to high-frequency trading. Consider all of the costs associated with the execution of the IPO process: underwriting, legal, accounting, printing, SEC registration fee, and market listing fees. By far, underwriting costs make up the largest component of the direct cost involved with going public. Based on the public registration statements of 315 companies, companies incur an average underwriter fee equal to 4-7% of gross proceeds, plus additional offering costs of $3-5 million directly attributable to the IPO.

This creates a much higher bar for entry. Yet at the same time, it ensures safety and stability, and when it comes to finances, that is the most important element. If crypto tokens could adopt some of the market protections utilized by traditional securities, a similar level of stability may be achieved.

That, in the end, may be the only way to truly achieve the liquidity desired by everyone in the crypto industry. An unregulated digital ocean may have been the dream, but much like any other form of online life, a few bad apples have spoiled it for the rest of us. Thus, it’s time to get the industry out of the clouds and start thinking about reality.

If the STO and token markets could adopt some of the market protections that traditional securities utilize, we could see some more stability and liquidity.