Key Insights From This Interview
Traditional stock exchanges have much to learn from digital asset markets, especially in attracting small and medium-sized enterprises (SMEs) as issuers.
The SME market has great potential. But at present most of the capital value created by these businesses is being captured by the private equity industry (this is obvious in the shrinkage of public listings and Initial Public Offerings (IPOs)) and most of the remaining transactional fees and spreads generated by the sector are accruing to the banks.
In 2021, a total of 350 SME funding rounds were recorded in Switzerland alone, none of which involved an exchange. And there are likely to have been tens of thousands of bank loans advanced to SMEs during the course of the same year.
This domination of SME financing by private equity capital and bank loans persists in the limited appetite of smaller company issuers for liquid secondary markets in their liabilities. They see it as a threat to their control of the company. Some SME investors have a similar view, regarding their investments as long term buy-and-hold assets which do not necessitate a secondary market exit.
This helps to explain why, although almost every traditional stock exchange has a programme designed to encourage smaller companies to go public, they have met with limited success. IPOs are also expensive, and it is not hard for private equity to outbid the exchanges.
An alternative approach is to create an entirely new, robust and scalable capital-raising, trading and asset-servicing infrastructure for SMEs as issuers, without the need for them to go public. This is what SDX, the digital assets arm of the Swiss stock exchange, is building.
Blockchain technology enables that infrastructure to be provided at low cost through automation of issuance, distribution and asset-servicing. It also allows it to be built with sufficiently rich functionality to enable debt and equity issued by SMEs to attract new investors; attain their highest values through offering the investors greater liquidity; and be useable as collateral in other transactions. In short, the infrastructure makes SMEs more investable and their financial obligations more bankable.
An infrastructure of this kind need not imply disintermediation of existing functions either – only their enhancement. For example, debt and equity can be issued in a way that is familiar from existing issues of dematerialised securities, but one which allows the instruments to be issued, traded, atomically settled and custodied between member-controlled nodes on a permissioned, blockchain-based network operated by SDX.
Even the (usually expensive) advisers and service providers to conventional issuers – investment banks, distributing brokers, marketing agents, lawyers, transfer agents/registrars and so on – can not only survive but even thrive as members of (or nodes on) the network, where they can make use of more efficient technologies such as smart contacts and tokens.
Registrars that belong to the SDX network can update registers of holders in real-time because records of transfers are available immediately – allowing issuers to understand who owns their liabilities at any time and communicate directly with them.
This is one reason why registrars, long thought to be an early victim of the disintermediating power of blockchain technology, are likely to survive. Accurate registers also enable corporate actions to be notified and investor holdings updated immediately.
Specialist agents can run Know Your Client (KYC), Anti Money Laundering (AML), Countering the Financing of Terrorism (CFT) and sanctions screening checks that draw on faster access to databases.
Although not much cost-reducing disintermediation occurs, the efficiency of the technology also ensures the costs of primary market issuance and of servicing investors – paying dividends, for example – are low enough to attract SMEs.
In addition, the retention of longstanding functions and familiar processes reduces resistance to entering the digital asset markets as either an issuer or an investor. It also provides an opportunity to introduce inhabitants of the digital asset markets to the benefits of traditional services.
For example, SDX operates a dedicated central securities depository (CSD) for digital assets. This has allowed SDX to offer private company issuance platforms, such as those controlled by Berner Kantonalbank (BEKB) and Aktionariat, the option for their issuers to issue digital assets into the SDX CSD. From there, because the traditional SIX SIS CSD is also a member of the SDX CSD, they can even be transferred to traditional CSD accounts.
The value of this, in making it easier for digital asset issuers to reach traditional investors, is obvious. Investors can settle and hold their assets in either the digital or the traditional CSD via a bank that is member of the SDX network. An additional advantage is that, once digital assets are held within a CSD, they can be used as collateral.
All of which testifies to the fact that, far from displacing the traditional securities markets, the digital asset markets are over time going to converge with them.
Blockchain technology has the power to improve the experience of the issuers and investors that use capital market services. But at the same time applications of blockchain technology have much to learn from the trust, consistency, corporate governance processes and regulatory compliance culture of the traditional capital markets.
Indeed, SDX believes that traditional financial market infrastructures (FMIs) such CSDs, but also exchanges and central counterparty clearing houses (CCPs), will play an important role in driving this process of convergence between the digital asset markets and the traditional capital markets.
This is mainly because issuers and investors are demanding an infrastructure flexible enough to support seamless switching between traditional and digital asset markets.
But convergence also reflects the fact that FMIs are adopting blockchain technologies in various areas of their operations that will make traditional techniques – such as netting – available to participants in digital asset markets. Using collateral more economically to mitigate risk is one example where the new markets can learn from the traditional markets.
The likeliest outcome of the convergence is networks of networks. SDX is building such a network by working with third parties to identify issuers, and to provide services such as registration and financial crime compliance services,
The underlying networks will not be completely decentralised, peer-to-peer networks, as imagined by some Decentralised Finance (DeFi) visionaries, but will retain some centralised functions.
The clearing and settlement functions of FMIs are likely to prove a case in point. FMIs will become nodes in these networks but also continue to provide some centralised services, such as issuance into CSDs.
In sustaining the pace at which convergence evolves, digital asset issuers, investors and intermediaries can take comfort from two quarters.
The first is the derivatives markets, where innovation has been unceasing since the 1970s. It has also focused, like digital assets, primarily on achieving greater efficiency in the management of operations and risk (including the efficiency of margin calls).
The similarities between derivatives and digital assets in the breadth of their liquidity spectrum are also suggestive. Derivative markets span a gamut that runs from highly liquid futures and options traded on centralised exchanges and cleared through CCPs to illiquid bi-lateral OTC derivative transactions.
Likewise, the major cryptocurrencies trade on centralised exchanges while it is the decentralised automated market-makers (AMMs) that traders rely on to generate liquidity in the DeFi markets. DeFi, like OTC derivatives, so far defies the logic of centralised order books as a source of liquidity.
The second source of comfort is the fact that the digital asset markets have successfully decoupled their future from that of the cryptocurrency markets.
The bearish market conditions in cryptocurrency that set in late in 2021, and culminated in the collapse of FTX, have not tainted the digital asset markets – in large part, ironically, because the origins of the problems in the cryptocurrency markets were grimly familiar from the traditional capital markets. As a result, the case for change remains intact, even strengthened.
Four years have elapsed since the Swiss stock exchange (SIX) took the bold decision in 2018 to respond to the challenge tokenisation has issued to traditional securities exchanges. SIX opted to build alongside its existing infrastructure an entirely new, blockchain-based trading, settlement and custody platform for digital assets. In September 2021 the SIX Digital Exchange (SDX) received its operating licence from the Swiss regulator, the Financial Market Supervisory Authority (FINMA) – itself now part of the SDX network – and opened for business. The leadership of SDX also knew they could count on a supportive legal environment in Switzerland, and SDX has since November 2021 hosted digital bonds for its parent company and UBS that can be traded and settled at both SDX and SIX, and launched a service for cryptocurrency investors to earn a return on their holdings of cryptocurrencies. But its principal focus now is capital-raising for small and medium-sized enterprises (SMEs). Dominic Hobson, co-founder of Future of Finance, spoke to Massimo Butti, head of equity at SDX, about the range of services SMEs require to issue tokenised securities successfully, the partnerships that SDX is forming to build a supportive eco-system for issuers and how the remaining obstacles to the self-sustaining growth of the tokenisation markets can be cleared.
 See the interview with Stefan Bosshard, product head, fixed income, at SDX, at: https://futureoffinance.biz/sdx-explains-the-challenges-of-pioneering-a-regulated-digital-bond-issue/
 See the interview with Alex Smith, crypto product lead at SDX, at: https://futureoffinance.biz/sdx-web3-services-non-custodial-ethereum-staking-service-is-live/
A full recording of the interview is available on this page. A transcript of the interview, which follows the questions below, is also available if you click on “Read the Transcript.” If you click on any question you will be taken to the exact point in the recording where the question is asked and answered.
Your background is in exchange-traded derivatives. How do you think that’s coloured your approach to digital securities?
Do you think blockchain-based networks could replace centralised central counterparty clearing houses (CCPs) with decentralised, peer-to-peer collateralisation?
Can digital assets rescue traditional stock exchanges from the secular downturn in public listings and the secular upturn in private ownership?
It would be unusual for a stock exchange to take on all the advisory functions associated with a traditional IPO. How extensive do your services have to be?
Share registrars were once seen as an early target for disintermediation in blockchain-based networks, yet the SDX model accords them an important role. Why?
What are the goals of the partnerships with Berner Kantonalbank (BEKB) and Daura?
What are the goals of the partnerships with Aequitec and Aktionariat?
Does SDX allow users to access its services through existing intermediaries such as custodian banks?
Does SIX take the view that the traditional securities markets and the digital asset markets are on a long-term path towards convergence?
Do you expect SDX to create and lead a network of its own or to be part of a wider constellation of networks?
Are there synergies between what SDX does and what SIX SIS does?
How much do issuers care about secondary market liquidity and post-trade services, as opposed to obtaining a lower cost of capital?
How much do investors care about secondary market liquidity and post-trade services?
How important has the Swiss legal framework been in helping SDX build its business?
How large is the opportunity to attract privately owned and managed companies as issuers?
Have tokenised digital assets decoupled themselves successfully from what happens in the cryptocurrency markets?