The Vision for Modern Capital Markets
This week, Robinhood CEO Vlad Tenev published an insightful op-ed in the Washington Post, advocating for a transformative approach to capital markets in the United States. Among several proposed policies, one stood out as particularly compelling: the establishment of a security token registration regime. Tenev argues for the need to enable companies to conduct token offerings accessible to U.S. investors, positioning this as a crucial step to unlock the full potential of cryptocurrency.
Understanding the Current Landscape of Securities Markets
To grasp Tenev’s proposal, it’s essential to understand how securities markets currently operate in the U.S. By default, companies face significant restrictions when it comes to selling equity. The Securities Act of 1933 defines what constitutes a security and lays out the conditions and penalties associated with trading them. When companies seek to raise capital, they typically engage legal experts to either register their securities or find exemptions, such as Regulation D (Reg D).
While many companies opt for these exemptions and choose to remain private, this path limits their liquidity. Industry giants like OpenAI, SpaceX, and Stripe have chosen the private route, but the trade-off is significant: exempt securities are often bound by contractual and regulatory constraints that hamper their resale potential. For most investors, this means they can only realize profits through dividends, leading to a stagnant primary market.
The Case for Registered Securities
In contrast, registered securities enjoy the advantage of high liquidity in secondary markets. This liquidity attracts investors to initial public offerings (IPOs). However, the costs associated with going public are prohibitive, often amounting to millions of dollars in legal fees and compliance costs. As Tenev notes, these burdensome expenses deter even top firms from pursuing IPOs.
Recognizing this challenge, Washington D.C. attempted to create a solution with Regulation Crowdfunding (Reg CF) in the 2012 JOBS Act. The goal was to facilitate access to exempt securities for small and medium businesses (SMBs). Unfortunately, the familiar restrictions on secondary liquidity and ongoing compliance costs have stunted the growth of this initiative, preventing it from becoming a significant player in U.S. capital markets.
The Emergence of Tokenization
The real breakthrough in the evolution of capital markets came from the blockchain community. In 2015, Ethereum developers introduced the ERC-20 standard, allowing anyone to create and sell tokens with instant liquidity. This innovation enabled project founders to impose resale restrictions as they saw fit, but many successful projects quickly established thriving markets for their tokens.
The ability to buy and sell tokens freely on a secure and trustless blockchain was a game-changer. The demand for such products soared, leading to a staggering 100-fold increase in initial coin offerings from Q1 to Q4 of 2017. However, this unregulated landscape was rife with scams, prompting the SEC to clamp down on cryptocurrency fundraising efforts, making it increasingly difficult to conduct legal primary token sales in the U.S.
A Forward-Thinking Approach to Capital Formation
Despite the challenges of the past, Tenev emphasizes the importance of looking toward the future: “Tokenizing private-company stock would enable retail investors to invest in leading companies early in their life cycles, providing them the opportunity to tap into a global crypto retail market.” He advocates for a new framework that allows for the sale of securities in the form of cryptocurrency tokens with limited compliance requirements. This approach would create a middle ground between exempt securities and public offerings.
Such a system could yield significant first-order effects. In 2017 and 2018, over 2,000 projects raised more than $13 billion through token sales. While many of these early ventures faced risks and failures, successful companies flourished, and early investors reaped substantial rewards.
Unlocking Untapped Capital Potential
The second-order effects of Tenev’s vision could be even more transformative. Compared to traditional securities offerings, cryptocurrency token launches are considerably more cost-effective. Estimates suggest that there is a potential capital demand of up to a trillion dollars among SMBs in the U.S. Unlocking this capital could lead to unprecedented growth in underserved markets.
However, there are valid concerns about the risks associated with a more liberalized cryptocurrency regime. It may disrupt the current public securities framework, potentially reducing compliance and disclosure requirements for public companies. This could undermine market efficiency and increase the risk of deceitful practices.
Embracing a New Regulatory Framework
The question remains: why cling to the status quo? A third-way regulatory framework could impose necessary disclosures without the burdensome requirements of public registration. Consumer protection should evolve alongside advancements in technology, rather than relying on outdated laws.
Moreover, the existence of public securities may not vanish. As companies mature, investors are likely to demand traditional disclosures and may be willing to pay a premium for them. If not, perhaps it’s time to reconsider the relevance of these laws.
In conclusion, it’s clear that the current capital markets system is ripe for reevaluation. Tenev aptly states, “It’s time to update our conversation about crypto from bitcoin and memecoins to what blockchain is really making possible.” The time has come to put securities on-chain and embrace a new era in capital markets.
