The Challenges Of Bringing Private Markets Online

Did you know that private market AUM grew to almost 10% the size of the global public markets in 2018? That represents more than 100% growth in private markets in the past decade, a market most people don’t even know exists! That’s part of the reason we decided to form RealBlocks — a way for people across the world to gain access to private markets. One of the questions I am frequently asked is if it’s such a large market, why aren’t there more platforms online offering access to it, and why can’t things like the blockchain accelerate access? I’ve had the benefit of struggling with this question myself for almost two years now, and want to share the three big factors I’ve seen holding back significant digital presence of private markets.

Natural Transition to New

When we look back in 50 years and talk about the greatest challenges of blockchain adoption into the finance ecosystem, I think it’ll probably be summarized as ‘everyone became so obsessed with the idea of decentralized self-ownership, no one ever stopped to ask if people really wanted the risk and burden of it’. Did you know almost no one actually owns the stock they buy? This has actually been that way since the 1960s when the financial markets were crippled trying to update paper certificate to prove ownership and moved to a system that centralized stock certificates, making it easier to update records.

Could something like the blockchain change this and provide a more efficient ecosystem? Possibly, but why would anyone step away from a system that has more or less worked for the past 60 years and instead go with technology created in the past decade? And not only that, but the new proposed system is diametrically opposed to how the current system operates (self vs. custodial ownership). So does this mean anyone trying to build applications on innovative new things like blockchain for traditional, mature markets is doomed?

Not at all! But my point is to stress that radical innovation needs to be coupled with gradual steps to an end state. Even if a certain innovation radically improves someone’s life, adoption is still going to be gradual if it doesn’t fit into a person’s existing understanding of how their world works. If you give people an option between a risky new thing or an old proven thing, every risk-averse person is likely to go with the latter. Since we exist in a risk-averse industry, our focus is on how to make a gradual transition into innovation. For example, it may seem silly and even defeating for a blockchain firm to use a transfer agent ledger as the official record while still writing to the blockchain, but being able to show that new technology works the same as the old technology is an invaluable strategy to adoption. Removing fear from new technology is a must-do in mature markets to have any form of success.

Nascent Ecosystem

Usually when an entrepreneur thinks about starting a business and building a product, they try and find out what is the bare minimum you can do to launch and get feedback. The problem with the minimum viable product (MVP) approach is that it strives for ‘barely enough’, while mature regulated markets have many expectations to even be usable. So what does it take to build a system like this in the world of alternatives? Some bare minimums include:

  • A broker-dealer partnership to legally be able to host and sell an offering at all in the United States
  • Escrow services to hold money while an offering is live and ongoing
  • Custodial services to hold client funds after the offering closes, because no one in the traditional world holds assets in their own names (see street name)
  • KYC/AML/Investor Accreditation so you can legally qualify investors for an offering
  • The ability to buy using traditional currency, because almost no traditional firms are going to buy anything in the near future using mainstream cryptocurrency
  • A Transfer Agent / ledger service to account for who owns the shares
  • Money to pay for all the documents and legal analysis to make sure it does not violate any private market regulations in every country you plan to offer securities in

The list can go on, and shows private offerings expectations go far beyond simple KYC/AML procedures. Building an alternatives platform isn’t simply making a webpage with some commerce features; it’s enabling an entire ecosystem of events to run through your system. Many companies have started to tackle pieces of the puzzle, but without a heavily vertically integrated platform, it’s easy to see how much work is left for a potential client to figure out.

Compelling Differentiation

One of the biggest roadblocks beyond catching up to minimal acceptable products is that there are almost no compelling differentiators practically available. This includes both things not created yet, and things that are created but don’t have the necessary prerequisites for adoption. Especially in the blockchain area, there are so many things to play catch-up on that it almost predicates some level of completion before useful differentiating products are embraced. Take the Uniswap project, for example, which is building around the idea of automated market makers. The idea of liquidity pools could greatly decrease the illiquidity discount on private securities, but it is predicated on properly vetted and issued securities, vetting of parties involved, regulatory checks, etc.

This isn’t something that has to stay this way though, and most people don’t expect it to. A 2018 study from Fidelity indicated that 73% of the institutional respondents felt that significant change would occur in the financial industry by 2025, with 75% of the respondents believing non-financial services firms will be involved in the disruption.

Conclusion

As daunting as it may seem, it’s really a very exciting time to see an old industry adopt new legs to stand on. Over the next few years I expect we’ll see particular focus on more fully vertically integrated systems, faster and easier management of issuances and shareholders, and more efficient secondary markets that comply with sophisticated international regulations.

This has the potential to drive price efficiency in a historically illiquid market and access to markets all over the world, bringing a whole new generation of sophisticated investors into a digitally-compliant global market. We are still very much in the discovery phase of finding out how to best evolve the alternatives market, but disruption in the industry seems to be a matter of “when”, not “if”.

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