Blockchain technology is being used to revolutionize a number of industries, including the fixed-income market. Securitized products represent a sector of this market, as these products are pools of financial assets that are brought together to form a new security, which is then divided and sold to investors.
Securitization describes the process of pooling financial assets and turning them into tradable securities. For example, home mortgages were the first products to be securitized. This was followed by commercial mortgages, auto loans, student loans and many other financial assets.
Bonds backed by home mortgages are commonly referred to as mortgage-backed securities (MBS). Bonds backed by non-mortgage-related financial assets are called asset-backed securities (ABS). Both of these bonds are examples of a “securitized product.”
While the process of creating a securitized bond is relatively simple, there are many middlemen involved. For example, when a financial institution (also known as the issuer) has assets to securitize, they are sold to a special-purpose vehicle (SPV). This is a separate entity from the financial institution and only exists for the purpose of purchasing the institution’s assets.
Once the assets are sold to the SPV, the issuer receives cash and removes the assets from their balance sheets. This allows the issuer to have better financial flexibility. The SPV then issues bonds to finance the purchase of the assets, which can be traded on Wall Street as “securitized products.”
Blockchain Technology To Issue and Sell Securities
Securitization issuance, including agency and non-agency mortgage-backed securities (MBS) and asset-backed securities (ABS), totaled $2.2 trillion in 2016. This represents a 9.3% increase from 2015 ($2 trillion).
And as this market continues to grow, decentralized trading platforms are demonstrating how blockchain technology can be applied to allow issuers to sell securities themselves, without having to go through any middlemen. As a result, a number of benefits become evident, such as more revenue going directly to e-commerce providers, along with assets that are fully secure and transparent over the blockchain.
“When looking at the fixed-income market, the question comes to mind: Why do I need a human broker to issue and sell securities? We want to use blockchain technology to make this task fully automated,” said Dr. Michael Yuan, Chief Scientist at CyberMiles.
For example, CyberMiles is focused on building a public blockchain platform that is optimized for e-commerce applications. Since securitization of cash flow is widely used in e-commerce, the project plans to use blockchain technology to issue fully regulation-compliant security tokens.
One reason for applying blockchain technology to this industry is because e-commerce platforms generate very little revenue from selling products, as the profit margin is usually razor thin. Yet these platforms can make a huge amount of money by monetizing other people’s cash flow with tools like securitization.
“It is well understood that Wall Street makes far more money by reselling subprime loans for used cars as securities than the combined profit of all used car dealers. That is just one of the most visible cases (thanks to a full hour HBO expose by John Oliver). Such opportunities for securitization is everywhere, especially within the e-commerce value chain,” explained Yuan.
And recently, e-commerce giant, JD.com released plans to issue asset-backed securities (ABSs) on the blockchain. According to China’s Securities Regulatory Commission (CSRC), subsidiary JD Finance will issue the ABS in conjunction with Huatai Securities and Xingye Bank.
Together, the partners will evaluate blockchain’s potential to ensure asset security, according to JD Finance head, Hao Yanshan.
“…The alliance chain must meet the actual needs of all participants in the asset securitization business in order to fully reflect the application value of blockchain technology,” he explained.
JD Finance aims to issue the securities using a consortium blockchain that will see each party act as a node, recording the transactions in a transparent manner. This will demonstrate if the blockchain can meet the demands of the various parties involved in the asset securitization process, such as issuers, underwriters and buyers.
Moreover, one of the partners CyberMiles works with is OpenFinance Network (OFN), which aims to become the first compliant security token trading platform in the US. To date, many of the security token projects looking to list on OFN have been issued by investment funds or are real estate related.
“The goal of the OFN is to support a broad ecosystem of high-quality service providers, working with the most innovative companies to issue security tokens,” said Juan Hernandez, founder and CEO of OFN. “We share an unrelenting commitment with these partners to advance this industry and to keep raising the bar.”
OFN is currently working with leading banks, brokerage houses, custodians, and transfer agents that are all a part of alternative markets. This venture may provide a new vehicle for asset liquidity.