How Blockchain is going to disrupt the Neobroker market


Neobrokers have done remarkably in recent times.

RobinHood has reached decacorn status with European players like TradeRepublic receiving massive funding rounds off their explosive growth.

And why should that be a surprise? Millennials are on the receiving end of the biggest wealth transfer in history at a time when interest rates are zero. They’ve got to put their money somewhere and a zero-fee, mobile-first broker experience is certainly going to win out over the traditional brokerage that your Dad is using.

Today, young people are flocking to neobrokers (myself included) to start investing in stocks and ETFs.

Neobrokers have only disrupted the distribution, not the infrastructure

Neobrokers have been disruptive. There’s no denying that. But when you look at where the disruption lies, it is primarily at the distribution layer.

Disrupting the distribution layer is all well and good, but it is an intermediate step at best. There is tremendous room for improvement in the underlying infrastructure layer.

Stop for a second to reflect on the following statement as if you were hearing it for the first time: stock exchanges are closed at night.

I’ll just let that sink in for a second.

Something that has the veneer of being a fundamental pillar or our capitalistic, free market societies, intentionally decides to stop functioning past a certain hour. What’s up? Do they get tired or something? Weekends are also off-limits and for some Asian markets, they even pause for lunch.

Our financial world is antiquated. It’s slow moving, inefficient and was built in a time when technology was very, very different.

We believe that we will see a second wave of disruption:

Blockchain & Equities Today

There are two main ways to take off-chain assets like equities and represent them on-chain today:

1. Tokens that are backed by the asset e.g. Tokenised stocks

The crypto exchange FTX has partnered with Germany’s CM-Equity to offer tokenised version of the stocks. The user is trading a token that is backed by the stock and “They can be redeemed with CM-Equity for the underlying shares if desired” according to the help page.

While this approach has successfully brought equities ‘on the blockchain,’ there’s significant counterparty risk e.g. in this case, against the relatively small CM- Equity.

Trading Dogecoin against Tesla — a match made in heaven.

2. Synthetic assets

Synthetic assets are a little harder to explain. These are assets that simulate the underlying asset, without necessarily being backed by it. We already have this in traditional finance by combining different derivatives e.g. a fund might buy a call option (right to buy) and a put option (right to sell), giving it exposure to the underlying asset without having to hold or settle it. For perspective, the derivative market is $1.2 quadrillion and the global stock market is $73 trillion.

There are a handful of projects in DeFi enabling the creation of synthetic versions of stocks, currencies & commodities. These typically involve locking up collateral and ‘minting’ the synthetic assets against said collateral. For example, with Synthetix, the leading synthetic asset platform in the space, the native SNX token is locked and used as collateral. Synthetic tokens e.g. sUSD are minted against it which track the price of an underlying asset. If the price goes up, the locked collateral ensures that you can sell it at a premium.

Decentralised synthetic assets are still in an early stage and there are still challenges to overcome. For example, Synthetix requires a 600% collateralisation ratio, meaning locking up $1000 worth of SNX would only allow you to mint $133 worth of synthetic Tesla.

Synthetic assets can be used to track the price of anything. Check out the San Francisco “Poop token” for a rather wonderful example.

3. [In the future] Native blockchain securities

Until today, we need to ‘hack’ equities onto the blockchain. In the future it will undoubtedly be possible for a stock to live purely in a digital format. Germany, for example, has paved the way for this with its electronic securities law published last year.

Exactly how this will work is a matter of debate, but there will certainly be a degree of centralisation, just like there today in the securities market.

This is definitely a step in the right direction. But my own personal conviction is that securities will live natively on a blockchain. Here’s why:

Blockchain vs. Traditional Finance

Securities markets were designed for a time when the cost of electronic storage and transactions were very high. For this reason, transactions are done in a batched, asynchronous way. When we dematerialised securities (removed the need for certificates) we moved to a ledger based system, but that is still far from perfect.

For example, settlement in the US still takes two days or “T+2”. In fact, it’s for this reason that RobinHood needed to suspend GameStop etc. trading in January; they needed to keep cash on hand to cover counterparty failure risk during that settlement period and, with the market volatility, this rose so fast they were under funded and had to suspend trading.

This might well lead you to ask what happens when you buy a stock on RobinHood? Well, you don’t really own it. You own an IOU from your broker, who owns an IOU from a custodian, who owns an IOU from a centralised authority (e.g. DTCC in the US).

Imagine the cost of keeping all of these ledgers in sync, especially when the systems were built in a time when the number of electronic transactions were minimised for cost reasons.

It’s beginning to make sense why markets are closed on weekends. There are also some hilarious examples of the shortcomings such as when Dole had too many shares.

A lot of what the securities infrastructure actually does is keep track of all the IOUs and make sure the system is reconciled. Blockchain has this built in by default.

Switching to blockchain will dramatically reduce the complexity and cost of the infrastructure that we have today. Doing so, will allow us to create a global network of value just as the internet has become a global network of information.

What’s in it for me? Killer use cases for the consumer

Blockchain enabled securities, in addition to all the cost and speed efficiencies mentioned above, would create killer use cases for the end user.

When you have a token on a blockchain, it’s part of a composable and standardised ecosystem. You are not restricted to using it with just one application or use case e.g. trading on the exchange you used to buy it, but rather you can use it across the whole ecosystem.

1. Easy to move to another platform

If you decide you don’t like your broker you can easily switch to another. Just take your tokens and send them from A to B. Transferring securities from one account to another today is typically a Kafkaesque affair.

2. Lend out your stocks to earn returns

If you have a “buy and hold” strategy, why not consider lending out your stocks to get a return on them?

This may sound novel, but it’s already happening in Wall Street — mostly without your consent and only to the broker’s benefit. It should be possible for retail investors as well.

3. Borrow against your stocks

This also works the other way around.

If you’re cash poor one month, why not borrow against your portfolio? You could borrow e.g. €5,000 against a €10,000 portfolio. The advantage is that you wouldn’t be forced to sell your position. This is great if you’re long the asset or don’t want to trigger a taxable event.

Borrowing against collateral is going to be cheaper than borrowing on credit as the risk for the lender is lower.

4. 24/7 trading

In the future, our kids will laugh at us for not questioning why markets closed on the weekend, just as we marvel at our parents for having to communicate via letter.

5. Transparency

Because blockchains are public, it’ll be much easier to see who is involved with a transaction or the custody of an asset.

This also works great with structured products, like ETFs. It will be far easier to see if you’re investing in something unsavoury.

6. Wider geographic availability

In Europe efforts are being made to create open banking with services like PSD2. But no such equivalent exists for securities.

In fact, companies who are trading real stocks (TradeRepublic) opposed to CFDs (Bux), need to have a custody bank in every country where they serve customers. That’s a lot of complexity. With digital assets on a blockchain, you avoid this, meaning your favourite app can serve you in your country as well.

7. Cheaper fees / Less conflicted monetisation strategies

Neobrokers have to make money, but they are targeting a customer that doesn’t want to pay fees. Until today, that has been solved by controversial business practices like RobinHood’s selling of deal flow.

Blockchain can significantly reduce the cost. Businesses will no longer be stuck between a rock and a hard place.

How does blockchain affect neobrokers

If neobrokers were successful at disrupting distribution, will they do the same with this new infrastructure?

Not necessarily.

Neobrokers have successful businesses models that are already running on traditional infrastructure with traditional partners. Switching that out is a massive effort and there’s no guarantee that they will be both willing and able to do it.

Eventually, customers will be attracted to the players who do offer the blockchain-enabled functionality, just as the neobrokers took business away from the traditional brokers before them.

What now?

The migration of securities to the blockchain is not going to happen overnight. In fact, it took Wall Street “six years of unheralded efforts” to get settlement down from three days to two.

But the beautiful thing is that we don’t have to wait for Wall Street.

Synthetic assets and tokens backed by securities are great examples of this. Blockchain and DeFi are creating a parallel financial system, rather than building on top of the existing one. We don’t have to wait to see what the future might look like. Cryptocurrencies and decentralized finance is showing us today.

Ultimately, blockchain and DeFi will innovate faster than traditional finance. It is the delta between the two systems that will drive the change.

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How Blockchain is going to disrupt the Neobroker market was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.