Secondary markets for illiquid assets, by digital securities

Takeaways

● Digital securities can increase liquidity in secondary markets as they are accessible globally and around the clock.

● Digital securities can also increase transparency and reduce costs due to increased automation.

● Typically, illiquid private markets assets can be traded on the secondary exchanges thanks to digital securities.

Understanding the secondary market:

Private market investments are typically inflexible and are often difficult to transact. Hence, the demand to access the secondary market began to emerge in the early 1980s and since the early 2000s, the secondary private equity has matured from a derivative asset class to a broader institutionalised market.

A secondary market is where investors buy and sell securities they already own. The investors exchange with each other, rather than with the issuing entity and the price of the securities is set by the basic supply and demand metrics between investors. A typical example of a secondary market is a stock exchange (SGX, NYSE, etc), although the stock market is also a primary market. Except for the issuance of new securities, all the world’s stock exchanges are secondary markets.

What is an illiquid market?

An illiquid market, by definition, is the absence of liquid assets in the market. This leads to asset holdings that are hard to buy or sell as buyers and sellers are few and far in between in such markets. The bid/ask price (the difference between the selling price and the asking price respectively) is wide. Fewer the number of assets, higher the gap between the bidding and asking price. Hence, liquidity in any market is of paramount importance.

Liquid Secondary Markets:

Liquidity in the secondary market is perceived to have lower risk as the transaction costs decline due to an even spread in supply and demand. A seller can sell their assets quickly at prevalent market prices which leads to increase in value of the traded financial assets.

With the recent advent of digitisation, digital securities encompassing stocks, bonds, funds, and other assets have started gaining interest in the financial services industry. The best advantage of digital securities over traditional forms of assets is they can be traded globally and around the clock, which helps boost liquidity levels in the market.

Digital Securities:

Digital securities are a representation of financial asset classes where investment contracts and ownership are recorded and verified over the blockchain. A ‘Digital Security’, also known as a security token, represents securities issued by financial institutions, corporations, governments etc.

You can read the ADDX article, ‘How digital securities will transform investing this decade’ here.

Why digital Securities?

Cost Effective and Faster

Digital securities can be directly bought and sold by investors from each other without the intervention of middlemen and fewer intermediaries in the process means faster processes.

Greater transparency in asset ownership

Data stored digitally is transparent and traceable, reducing the risk of fraud. Investors are assigned digital signatures for authentication ensuring reliable digital transactions when investing in digital securities.

Increased automation in compliance procedure

Maintaining compliance becomes uncomplicated and straightforward as lockup periods, regulations, and other rules can simply be integrated into smart contracts.

What should you know about the risks of Digital securities?

Faulty code

A crucial security concern in the possibility of bugs in the smart contract itself. This bug cannot be removed as smart contracts are immutable. Even if there is a possibility to ‘fix’ the contract, it is highly cost and resource intensive.

Complexity limitations

Most smart contracts levy fees for the number of lines of code to be executed. Higher the complexity, higher the costs for contract execution.

Conclusion

Digital securities are becoming a significant channel for investors to gain access to global capital markets at lower costs. Digital securities will democratise access to previously exclusive markets by increasing liquidity in secondary markets by improving market transparency, efficiency and making markets seamless and user-friendly.

ADDX is your entry to private market investing. It is a proprietary platform that lets you invest from USD 10,000 in unicorns, pre-IPO companies, hedge funds, and other opportunities that traditionally require millions or more to enter. ADDX is regulated by the Monetary Authority of Singapore (MAS) and is open to all non-US accredited and institutional investors.