Crypto promised to eliminate stockbrokers, but 94% of its tokenized market now relies on an Alpaca

Introduction: The Promise of Crypto and the Reality of Brokerage

In recent years, cryptocurrency and blockchain technology have heralded a new era in finance, promising to eliminate intermediaries and democratize investing. The concept of tokenization, which allows real-world assets to exist as digital tokens on a blockchain, has received significant attention, especially in the context of equities. However, as the tokenized market evolves, it appears that the promise of a fully decentralized trading environment is more complicated than it seems. A critical player in this landscape is Alpaca, a relatively obscure brokerage that now custodizes more than $1.5 billion in shares and clears approximately 94% of the tokenized U.S. equities market.

Tokenization Explained: How It Works

Tokenization refers to the process of converting a physical asset into digital tokens that represent ownership or a claim on that asset. In the context of equities, it means that investors can own fractions of stocks, such as Apple or Nvidia, stored in a crypto wallet and traded on blockchain-based exchanges. This method allows for 24/7 trading, fractional ownership, and faster transactions—all appealing features for a modern investor.

• Advantages of Tokenization:
• Accessibility: Investors can participate in markets that were previously out of reach.
• Efficiency: Transactions occur almost instantly, reducing the time and costs associated with traditional trading.
• Fractional Ownership: Investors can buy portions of high-value stocks, making it easier to diversify portfolios.

Despite these advantages, the tokenization process requires a trusted intermediary—often a brokerage— to handle the actual shares and ensure that the token supply matches the underlying assets.

Alpaca: The Centralized Broker in a Decentralized Market

Founded in 2015, Alpaca is a self-clearing broker-dealer that has rapidly become a cornerstone of the tokenized equities market. Its role extends beyond simple custody; Alpaca also executes trades, processes corporate actions, and partners with market makers to ensure liquidity. To put it into perspective, Alpaca's reach encompasses:

• Custody of $1.5 billion worth of shares that back tokenized equities.
• Clearing 94% of tokenized U.S. stocks and ETFs.
• Support for multiple platforms, including Binance and Kraken, which issue tokenized stocks to retail investors.

In July 2023, Alpaca raised $135 million, indicating strong investor confidence in its model and future prospects. However, while Alpaca has positioned itself as a critical player, the very structure of the market it serves raises questions about the decentralization that was initially promised.

The SEC's Concerns: Intermediary Risks

The U.S. Securities and Exchange Commission (SEC) has voiced concerns over the risks associated with third-party tokens. According to the SEC, tokens not directly issued by the companies they represent may expose investors to additional risks related to ownership and intermediaries. A significant implication of this concern is that holders of Alpaca-backed products generally do not possess voting rights or direct entitlement to dividends. Instead, their claims lie with the token issuer under contractual terms, which complicates the notion of true ownership.

The Role of Market Makers and Corporate Actions

Alpaca's responsibilities do not stop at custody and trading; it also manages corporate actions for the stocks it holds. This includes processing dividends, stock splits, and other significant events that affect shareholders. Market makers, which are trading firms that maintain liquidity and align token prices with their underlying stocks, are crucial to this ecosystem. By partnering with companies like Broadridge, Alpaca aims to integrate proxy voting and corporate governance into its tokenized equities offerings.

The Tokenized Stock Market: A Case Study

The recent turmoil in the tokenized stock market serves as a powerful case study. In June 2023, SpaceX attempted to price the largest IPO in history, and platforms like Binance and Bybit sold over $1 billion in tokenized pre-IPO access. However, the shares never materialized, leading to refunds for all buyers. This incident highlighted the tenuous nature of tokenized assets, where the promise of ownership is often contingent on a chain of intermediaries.

The Upcoming DTCC Launch: A Game Changer?

As we look ahead, October 2023 looms as a potentially transformative month for both Alpaca and the broader tokenized market. The Depository Trust and Clearing Corporation (DTCC) is set to launch its Tokenization Service, which will allow securities held by the DTCC to be issued as tokens. This means that investors will eventually have access to tokenized stocks that carry the same legal rights, dividends, and ownership protections as traditional shares.

• Key Implications of the DTCC Launch:
• Legitimacy: Tokens issued through the DTCC will carry full shareholder rights, setting a new standard for tokenized equities.
• Direct Access: Institutional investors, who have typically avoided third-party token offerings, may finally engage with a regulated tokenized market.
• Competition for Alpaca: Should the DTCC's service gain traction, it may undermine Alpaca's current business model and create a more competitive landscape.

Three Possible Outcomes for the Future

As the DTCC prepares to disrupt the current tokenized market, three potential outcomes emerge:

1. Alpaca's Dominance: Alpaca could remain the preferred gateway for issuers seeking to access the DTCC's services, solidifying its position in the market.

2. Erosion by Competitors: Competitors may replicate Alpaca’s connectivity and functionalities, creating a more fragmented market that diminishes Alpaca's initial advantage.

3. Parallel Markets: We could see two distinct markets emerge: a regulated one with rights-carrying tokens for institutional investors and an offshore market for third-party tokens.

Conclusion: Bridging the Gap Between Decentralization and Centralization

The evolution of tokenized equities presents a complex paradox: while the technology promises decentralization and democratization, the reality shows a landscape heavily reliant on centralized brokers like Alpaca. As the market matures and regulatory frameworks develop, the balance between innovation and protection will be crucial. The upcoming October launch of the DTCC's Tokenization Service may serve as a watershed moment, potentially reshaping how tokenized stocks operate and who controls the market.

In this new era of finance, the challenge will be to ensure that the promise of tokenization delivers genuine ownership and accessibility for all investors—without sacrificing the protections that traditional markets provide. As we navigate these waters, one thing is clear: the world of tokenized stocks will continue to evolve, and so too will the roles of the players involved in this fascinating intersection of finance and technology.