Tokens are coming for your stock, public companies.
But not yet. According to a Bloomberg article (subscription required) from Scott Patterson, veteran market-structure reporter (long at the WSJ) and author, regulators have delayed a plan to grant exemptions for tokenized stocks.
Because there are big questions. In an earlier Patterson article, SEC Commissioner Hester Peirce asked if parties creating tokens to trade alongside stocks should get permission from the issuers of stocks.
And Brett Redfearn, who will again take the main stage at the NIRI Annual Conference Jun 6-9 to talk about Market Structure (I hosted him there in 2019 when he headed SEC Trading and Markets, along with Lee Cooperman and Joe Saluzzi) said in the same article:
“If third parties can tokenize Apple or Amazon without the issuer at the table, there’s no theoretical limit on how many wrappers of the same company exist at once [which] could create a whole new level of market fragmentation and could leave investors less certain what their shares are actually worth at any moment.”
Speaking of NIRI, don’t miss my Express Talk (apply that filter here) on rethinking how you report earnings in today’s market (hint: do it when volume is biggest): 3:05-3:25p CT, Monday, June 8.
We used to time our earnings for the sellside. That should not be your focus now, public companies. (UBS yesterday raised its target for MU from $535 to $1,625. How, pray tell, is that helpful or relevant?)
I have said here before that I’ve been reading (now finished) “More Money Than God,” by Sebastian Malaby. I recommend it. Great education on hedge-fund strategies.
A takeaway is the centrality of arbitrage to disasters. Yes, it’s true that leverage in these schemes is a key ingredient. The problem with tokens trading as wrappers is the arbitrage opportunity.
By “wrappers,” I mean an instrument that depends on underlying shares for prices. Well, what things are like that?
Derivatives. They all depend on arbitrage. Options. Swaps. Futures. ETFs. And now tokens. They are “wrappers” around an underpinning asset. (Yes, ETFs are derivatives even if the entire industry vehemently denies it. Read the definition of a derivative.)
Sure, tokens could replace stocks and maybe that’s different. Swap out your shares for tokens and the token takes the property rights that shares today possess, except you cut out the middleman called the DTCC for clearing and settlement (not if they can help it, mind you).
Shares would clear and settle instantaneously on the blockchain. That might be superior from a record-keeping standpoint, I don’t know. I’m no expert on blockchain.
But here’s the matter today: We have a market-making model in the stock market. That is, broker-dealers make bids and offers for stocks. And stocks are required to trade between those prices. Doesn’t always happen, but that’s the “Trade-Through Rule,” a core tenet of Regulation National Market System.
The House Financial Services Subcommittee on Capital Markets held a hearing on that rule and other topics May 20 that included testimony by market-structure expert and longtime ModernIR friend Joe Saluzzi (my panelist in 2019 and many other times).
If you can spare an hour and a half, listen to the replay.
My problem with tokens is that we’re ramming technology into an ill-fitting regulatory regime.
Same with Prediction Markets. They get legal imprimatur from swap regulations. Except they don’t fit the definition, which requires an exchange of value. It’s a legal matter that probably lands at the Supreme Court as soon as somebody who’s been harmed figures it out.
Just think: the most popular betting instrument clashes with legal definitions. How do you end up with an industry that violates the law?
Popular demand.
Alexander Hamilton in Federalist 78 addressed popularity as the basis for decisions, writing that just because “momentary inclination happens to lay hold of a majority of their constituents,” Congress is not greenlighted to violate the Constitution.
Ah but what did Hamilton know anyway.
Back to tokens. Peer-to-peer trading contravenes thousands of pages of regulation governing the US stock market. Even if it’s the best idea on the planet. Regulators are ignoring Section 11a of the Securities Act.
Like 24-hour trading (or 23 hours a day, five days a week). Reg NMS, which I have called Reg Nemesis, makes no provision for round-the-clock trading. We’re ramming that square peg into the regulatory round hole. (If you want more on the effects of Reg NMS, read this and this.)
Reg NMS is flawed. It turned the market into a footrace around midpoint prices. That in turn made ETF arbitrage the world’s most profitable trade and gave dominance to Passive models seeking beta over alpha.
On tokens and stocks both, I’m for letting markets do what they will, for better or worse. We have too many referees, not enough laissez faire.
But. Tokens don’t fit the rules. And tokens trading with ETFs and options and futures and stocks magnifies arbitrage, which distorts values.
The biggest debacles in market history – LTCM, Amaranth and others – involved arbitrage trades. We are already in the mother of all arbitrage markets, thanks to pervasive ETFs and options around a shrinking set of stocks. Now tokens?
We’ve gone too far already. See you at NIRI next month.
