Can Coinbase Replace NASDAQ? | The ORO Letter #2
Where traditional exchanges have largely stagnated in their comfort zone with little competition, crypto exchanges have been hard at work.
Thanks to its high-profile IPO on the NASDAQ in April, even the most Luddite of investors have now heard of Coinbase. The plucky little crypto exchange has helped bring Bitcoin to the masses.
But did you know that Coinbase has ambitions beyond being a digital wallet and exchange for cryptocurrencies? If founders Brian Armstrong and Fred Ehrsam have their way, Coinbase could one day rival the NASDAQ. Maybe even replace it. And it may be just the first among many.
Since late last year, at least four crypto exchanges have gone live with security tokens. Many more are in the development stage. Venture Capitalists take note. Startups and SMEs welcome to the future of capital raising!
Let’s dive into issue #2 of The ORO Letter!
For a closer look at the nature of security tokens, check out issue #1: STOs Are the IPO 2.0.
Coinbase’s Plan to Sell Securities
Buried on page 131 of Coinbase’s IPO registration with the SEC (i.e. its S-1) is a simple sentence. “Over time we expect to add other forms of crypto assets, such as security tokens, crypto assets that represent a traditional security.”
Wait, what? Isn’t Coinbase just a cryptocurrency exchange? Yes, at the moment it is only an exchange for cryptocurrencies like Bitcoin and Ethereum. But Coinbase evidently envisions more than that — namely a future as an exchange for tokenized securities.
This is no secret plan. Back in 2018, Coinbase acquired broker-dealer Keystone Capital so it could offer “blockchain-based securities, under the oversight of the US Security Exchange Commission.” In 2019, the Head of Coinbase’s institutional sales in Asia flagged that Coinbase was exploring IEOs and STOs.
This, of course, makes perfect business sense. Coinbase has shown what it can do with cryptocurrencies and is now looking to bring many of the same advantages to traditional securities.
But Wait — There’s More
Coinbase is not the only crypto exchange interested in security tokens. We are at the early stages of a revolution in capital raising. There is a sheer rush into the security token space by crypto exchanges, and even some traditional exchanges are looking to join the fray.
Security token exchange STOX (backed by the Singapore Exchange) went live with its first STOs in May 2020. It issues security tokens for investment funds and digitized bonds and commercial paper.
Amsterdam-based Nxchange recently launched its first STO and is launching another three in the coming months. The issuing companies are an interesting mix, including a startup accelerator and a company working in animal welfare. A traditional IPO is out of the reach of such companies.
London-based Archax is targeting institutional investors and is the first exchange to gain FCA approval. It recently helped private equity investment partner BridgeTower Capital to issue an STO. BridgeTower hopes to use an STO model for investing in future companies.
INX recently closed a $120 million IPO for its upcoming security token exchange, the first approved by the SEC. Its shares will trade on its own platform and the NASDAQ.
Why Traditional Exchanges Should Be Worried
The advantages of security tokens are abundant and clear. They promise a true digital revolution in the way securities are held and traded — a business that is centuries-old but has seen little innovation besides simple digitization that really only replaced paper with bytes.
Where traditional exchanges have largely stagnated in their comfort zone with little competition, crypto exchanges have been hard at work to dominate within their fast-growing and highly competitive sector. Over the last decade, cryptocurrency exchanges have evolved from obscure internet platforms widely regarded as dangerous into major players on the global market handling billions of dollars in trading volume every single day.
As a result, we would argue that crypto exchanges are now easier to use and more technologically sophisticated than the world’s leading stock exchanges. Here’s why:
24/7 Trading
Unlike traditional exchanges, crypto exchanges allow trading around the clock. Traditional exchanges have their main trading sessions during business hours because of legacy reasons and to lessen liquidity requirements during the night , but in an increasingly globalized world, these restrictions are becoming an impediment to growth. Computers don’t sleep — neither do exchanges need to.
Less Platform Risk
Crypto exchanges reduce and even eliminate some security exchange risks. If payment for a security token is made with a cryptocurrency approved by the exchange, settlement and delivery of the token to the buyer is almost immediate so credit and liquidity risk is practically eliminated (atomic settlement). Custody risk is reduced because the blockchain on which a security is issued acts as the single source of truth for ownership of securities and is completely transparent, including all past trades.
A Better Connection Between Issuing Companies and Shareholders
Crypto exchanges are built for 21st century users. If you own Apple stock, Apple doesn’t know that. Your broker knows. Nowadays, platforms like Robinhood have made stock investing more accessible for retail investors, but Robinhood is still a broker, and the barrier between company and investor remains. The potential risks that come with this were famously brought to light by the GameStop saga — holders of GameStop could not trade the shares they owned because their broker experienced operational problems (i.e. insufficient clearing collateral).
Because you don’t need a transfer agent or custodian to hold and trade a security token, you establish a direct connection with the issuer. Security token exchanges help bring liquidity and ease of use to your trading experience, but unlike traditional brokers, they are in no way mandatory for you to trade your tokens, as you could always switch to peer-to-peer trading if needed.
Lower Fees
As we discussed in our first letter on why STOs are the new IPOs, crypto exchanges tend to have lower fees both in the initial offering and in the secondary market. A lot of the old manual processes can further be automated or replaced by the programming of rules into security tokens.
Better Matching Engines
One of the key functions of an exchange is to match buyers and sellers of securities: bids and offers. Crypto exchanges of course do this too, but they can often do it faster than many traditional exchanges as they utilize more sophisticated technology. This is because of the growing competition in the crypto exchange market. If users don’t like one exchange, they switch to another. There is a lot less competition among the leading stock exchanges, so the pressure is off there.
Better UI
As Robinhood, Etoro, and others among the new generation of stock-trading apps have demonstrated, UI matters. This is why many crypto exchanges have an edge over traditional exchanges. Crypto exchanges have fresh and modern interfaces. Many users of traditional exchanges are forced to rely on third-party software to make trading bearable.
But What About Regulation?
Critics of crypto exchanges argue that they are the wild west of securities. As evidence, they would point to the current regulatory scrutiny in Binance and Coinbase’s recent $6.5m fine from the CFTC.
Every new technology has its growing pains, but what critics fail to highlight is that regulators in the US, EU, and across many other jurisdictions have already classified security tokens as legal securities (“transferable securities”). STOs and security tokens are regulated. And some even say they are better regulated than traditional securities, because exchange and security rules can be programmed into a token. Crypto exchanges are also able to gain regulatory approval for their activities.
Final Thoughts
Like most innovations, we will likely see a period of transition where old traditional security exchanges and new crypto exchanges coexist. Just look at any major city, and you will see diesel and electric cars side-by-side. But in the end, as the new technology matures and acceptance grows, innovation always wins. One day, we will only have electric cars. And if Coinbase doesn’t replace the NASDAQ, someone like Coinbase, or maybe hundreds of Coinbases will.