Digital securities: game changer for the DeFi sector?

For many crypto enthusiasts, digital securities in the sense of security tokens or crypto securities are likely to be far too boring and brittle. Who cares about a real estate bond or debenture for corporate financing that pays 5 percent interest per year? The digital embodiment of securities through tokens on a blockchain, rather than through a physical securitization of securities, currently seems to appeal primarily to people who work in banking and finance themselves, whether as issuers, financial regulators or lawyers.

Accordingly, risk-averse crypto investors are holding back with their market demand. The buyers of token-based securities tend to be groups of investors who tend not to be located in the crypto sector. Against this background, it is important to clear up a few misunderstandings.

Factor 100: The market potential of digital securities

Everything is going digital, not only our money, but also our securities. Just as we will have the digital euro from the European Central Bank in a few years, every security – regardless of whether it is a share, bond or fund – will be issued purely digitally in the future. While the crypto market has a market capitalization of just around one trillion US dollars, we are talking about around 100 trillion US dollars in the stock sector alone, not including derivatives or bonds – a factor of 100 compared to cryptocurrencies.

In addition to the prospective conversion of existing documented securitisations into tokens, it is above all the new issues that are driving the change here. One current study The Boston Consulting Group forecasts a market volume for token-based securities of 16 trillion US dollars by 2030.

The securities analysis company WEPEX forecast in a scenario that in Germany as early as 2026 around a third of all new securities issues should be based on digital securities, in particular the German special form of crypto securities (eWpG). And this with a market volume of almost 1.5 trillion euros – only in Germany.

Without coins, no digital securities

All these trillions of euros, US dollars and Co. will consequently be issued on public blockchains such as Ethereum, Polygon or Stellar in the form of security tokens. Due to the high transaction costs in Ethereum, cheaper alternatives such as Polygon have stood out in securities issues in recent months. No matter which public blockchains may prevail here in the future, in the end this means a demand for the respective cryptocurrency – no coin, no securities issue.

Trojan horses for Ethereum and Co.

Even more important than the inflow of funds for Polygon and Co. is the compulsion for banks, stock exchanges and other financial service providers to rely on token infrastructures. A bank that previously found Bitcoin and Co. stupid got away with this ignorance. However, no Sparkasse, Volksbank, Commerzbank or Deutsche Börse can ignore the securities sector in the long run. For this very reason, all banks are also working on crypto custody solutions.

It is then said, as communicated a few weeks ago by the German Savings Banks and Giro Association, for example, that this is only done for digital securities, but not for Bitcoin. But one could exaggerate that digital securities are nothing more than Trojan horses for cryptocurrencies. Once the token infrastructure is in place and the service providers for their securities business are forced to hold cryptocurrencies in their wallet solutions, it will only be a matter of time before the institute’s Bitcoin opponents give in. The crypto mass adoption in traditional banking will therefore receive a significant boost at the latest with the establishment of digital securities and the digital euro.

But even this is just the beginning. The real game changer and the total fusion between the traditional world of securities and the crypto sector comes to light in a completely different place.

Real World Assets for the DeFi sector

In the course of the current financial and economic crisis – by now it should be legitimate to call the current macro situation that – it has also dismantled the DeFi sector. However, the lack of stability and collateral could now be brought into the sector by so-called real word assets, i.e. digital securities or tokenization of gold, for example.

Let’s take a decentralized autonomous organization, or DAO for short, as an example, which is set up as an investment fund. This decentralized investment fund, in which the decision is not made by a single fund manager, but by the community, has so far only been able to invest in cryptocurrencies or NFTs.

Of course, this made such constructs very volatile. With professional portfolio management, on the other hand, you can fall back on various asset classes in order to be able to optimally control risks. So if we were to see digital securities becoming more established, also in regulatory terms, it would become increasingly easier to secure a DAO fund with, for example, real estate bonds.

This example shows that we are still at the very beginning with the merging of the token economy and the traditional financial world. Above all, it can be observed that both worlds depend on each other in order to develop further. More symbiosis than coexistence.

Cryptocurrencies and security tokens: kudos for regulatory efforts

While politicians and supervisory authorities are often quite critical of cryptocurrencies, they are very open and positive when it comes to digital securities. Even a Bitcoin opponent like Olaf Scholz thinks digital securities are great. Finally, in his role as Minister of Finance in 2021, he himself is actively responsible for the Electronic Securities Act (eWpG), on which the so-called crypto securities are based driven.

Since the previous digital form of security, the security token sui generis, is subject to certain restrictions, a special form of crypto securities has been developed in Germany in accordance with the eWpG. So far only for bonds, the crypto securities are to be extended to equities as early as next year, as described in the recently published future financing law. At European level, too, attempts are being made to create a uniform legal framework for digital securities with the DLT pilot regime. This is particularly important for secondary market trading. Finally, there is still a lack of exchanges for digital securities.

With digital GmbH shares to the “new market”

It could be particularly exciting if you decide to tokenize GmbHs as well as stock corporations as a form of equity. The result would be the emergence of a new market for German medium-sized companies. After all, most of the approximately 765,000 corporations in Germany are limited liability companies put on – the potential is correspondingly gigantic.