Is the US Stock Market Putting on a "Token" Jacket: Innovation or Regulatory Arbitrage?

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Original Author: Matt Levine
Original Translation: Bitpush

Author Bio: Matt Levine is a Bloomberg Opinion columnist. He was an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz, a clerk for the U.S. Court of Appeals for the Third Circuit, and the editor of the Dealbreaker website. The following is the original text:

First, let me briefly summarize the history of the U.S. public stock market: In the early years, anyone could finance a project by selling stock to the public, and many did so, often accompanied by false promises.

This phenomenon peaked in the 1920s, with people rushing to buy stocks and borrowing money to speculate with leverage. The stock market then crashed, leading to the Great Depression. To restore market confidence, Congress passed a series of laws (especially the Securities Act of 1933 and the Securities Exchange Act of 1934) to regulate the public stock market. Since then, if a company wants to offer stock to the public, it must disclose business details, publish audited financial statements, and publicly announce significant events to ensure that investors are informed.

Of course, this only applies to public companies, with exceptions for companies that do not raise funds from the public. If your father-in-law gives you some seed money to open a local hardware store, the federal government obviously will not require you to submit audited financial statements.

Over time, these exceptions have become increasingly significant. In the 1920s, the best way for companies to raise funds was to publicly issue stock to thousands of individual investors; by the 2020s, the best way to raise funds might be to simply call SoftBank's Masayoshi Son and ask for $10 billion—he'll likely agree, and you won't need to disclose financial reports or deal with retail investors.

“The Private Market Has Become the New Public Market”, I often say. In the past, the main benefit of going public was the ability to raise a large amount of capital, as funds were more abundant in the public market. Today, the private market holds trillions of dollars, making going public no longer necessary. Tech companies like SpaceX, OpenAI, and Stripe can raise billions at valuations of hundreds of billions without going public.

And they have indeed done so, as going public is indeed troublesome: you need to disclose financial reports, update on business progress (and risk being sued if the information is inaccurate), and may attract unwanted shareholders. In addition, public stock price fluctuations can also give management a headache. For popular private enterprises, this is actually convenient—they can raise funds and avoid the hassles of going public.

However, for the general public, this may not be a good thing. Retail investors who want to invest in companies like SpaceX have no way to do so and can only purchase fragmented equity through gray channels at a high price. Over the past decade, a narrative has gradually become popular: “Modern economic growth is largely driven by private companies. The most exciting companies are private, and ordinary investors cannot participate. This needs to change.”

How to change this? As my earlier discussion has shown, this is very difficult. Many large private companies simply do not want to go public because the public market is both cumbersome and expensive. The reason why the private market can replace the public market is that global capital is highly concentrated in the hands of private equity funds, venture capital, family offices, and individuals like Masayoshi Son—they simply do not need retail investor funds (at least SpaceX doesn’t need them; perhaps some private companies do need retail investors, but they may not be quality targets).

Nevertheless, people still want to try. Conceptually, here are some ways to solve the problem:

Make going public easier. Reduce costly disclosure regulations. Make it harder for shareholders to sue companies, make it harder for activists to win proxy battles, and make it harder for short sellers to criticize companies. Obviously, there are trade-offs here, but it might be worth it. If going public is no longer more troublesome or more expensive than staying private, perhaps SpaceX, Stripe, and OpenAI would just shrug and say, “Sure, let’s go public.” Historically, this is a common refrain when people talk about solving problems.

Make staying private more difficult. Increase costly disclosure regulations for private companies. Through a law, stipulate that “if you have more than X dollars in revenue, you must release audited financial statements, and if any errors are found, anyone can sue you.” You occasionally see efforts in this direction; in 2022, the U.S. Securities and Exchange Commission (SEC) began “developing a plan to require more private companies to regularly disclose their financial and operational information.”

Restructure the economy and wealth distribution so that large institutional capital pools decrease, and the only way to access large amounts of capital is by selling shares to the public. This seems challenging.

But there is a more radical way: to directly abolish public company rules. Allow any company to sell shares to the public without disclosure or auditing. Let the public assess the risks themselves—if a company refuses to provide financial reports, you can choose not to buy (but you can also buy!). Fraud would still be illegal, but mandatory disclosure would become voluntary. If a company believes that disclosure helps with financing, it can still comply with current securities laws; if not, it can sell shares directly to the public.

Few openly support this proposal. After all, U.S. securities regulation has generally been seen as successful over the past century—deeper markets, more reasonable valuations, less fraud—all because of public company disclosure. However, the cryptocurrency industry has found a “shortcut”: by issuing “tokens” (a type of equity-like economic interest) to raise funds without complying with securities laws. This theoretical result has been mixed, but in recent years, there seems to be a resurgence.

Today, most companies still issue stocks rather than tokens. However, tokenization offers a new approach: renaming private company stocks to tokens and selling them to the public. You call it "Stock Tokenization" and bring it to the blockchain. In 2015, I wrote about "Muttering the Word 'Blockchain' Won't Turn Illegal into Legal," but today this is no longer obvious.

Tokenized stocks have other advantages: stocks on the blockchain may achieve self-custody, DeFi platforms with high leverage loans, 24-hour trading, and more. But the real allure is that merely by being labeled "tokenized," private company stocks can be sold to the public bypassing US disclosure rules. This means that the securities laws established in the 1930s could be circumvented.

Of course, the US has not reached this point yet, but that is the goal. This week, Robinhood announced the launch of tokenized stocks (initially limited to non-US users and focusing on US stocks): Robinhood Markets Inc. joins the blockchain stock trading trend, offering tokenized US stocks to 150,000 users in 30 countries for 24/5 trading. The structural details show that the underlying assets are held by licensed US institutions (in theory, tokenization allows naked shorting of stocks, but Robinhood's tokens are fully collateralized).

More notably, Robinhood also gave away private company tokens as a promotion this time: Robinhood's Crypto Chief Operating Officer John Kuffour stated: "We aim to address historic investment inequality—now everyone can buy into these companies." While currently limited to Europe, the goal is clear: allow the public to buy OpenAI and SpaceX stocks through the brokerage app without the companies having to disclose financial reports.

Robinhood CEO Vlad Tenev stated in a podcast: "For private companies, the excuse of barring retail investment simply doesn't hold water. People can buy depreciating items on Amazon, buy meme coins, but they can't buy OpenAI stock? That's illogical." He's right! The public can already speculate in the stock market (zero-day trading), the crypto market (meme coins), and even in sports betting (Robinhood previously promoted Super Bowl bets). In comparison, SpaceX or OpenAI are actually better targets. The public-private distinction truly has nothing to do with risk—public markets have junk, and private placements have gems.

But we must recognize the essence: the idea of "the public should be able to invest in private companies" is a paradox.

The core features of a private company are:

(1) Not open to the public,

(2) Not subject to public company disclosure requirements.

Therefore, "letting the public invest in private companies" is equivalent to "allowing companies to sell shares to the public without disclosing information." This may not be absurd—perhaps you believe disclosure rules are outdated and hinder innovation, but this is the essence of tokenization.

Tenev is not alone. BlackRock CEO Larry Fink has also advocated for tokenization, explicitly stating the goal of circumventing disclosure rules. In his shareholder letter this year, he wrote: "Tokenization democratizes investing... High-return investments are often limited to large institutions, primarily due to legal and operational frictions. Tokenization can remove barriers, allowing more people to access high returns." The "legal frictions" here refer to some companies being privately held because they do not want to comply with securities disclosure rules, and the tokenization solution allows them to sell shares to the public without following these rules.

Once again, this solution has not yet worked in the U.S. You still cannot directly sell "tokens" of private company stock (or private credit loans, private equity funds, etc.) to the U.S. public without disclosure. However, many financial industry players are advocating for this, and the regulatory environment seems quite receptive, which you can also understand. The public wants to buy into private investments, intermediaries want to sell, but disclosure rules hinder all of this. Saying "we should abolish disclosure rules" sounds terrible, backward, and greedy. Whereas saying "tokenization" sounds good, modern, and cool.

Now for a bit of the old-fashioned history. Around 2020, crypto projects raised funds frantically from the public through false promises. People leveraged for speculation, then the bubble burst, ushering in the "crypto winter." As we reach the end of 2022, you might have envisioned various possible outcomes, including:

1) Crypto permanently fading away;

2) Congress regulating crypto like they did the stock market in the 1930s, possibly creating new rules to restore confidence in the crypto market, requiring disclosure, regulating conflicts of interest, and imposing capital requirements. (We have indeed seen some of this; the "Genius Act" imposed capital requirements on stablecoins.)

But the reality is the third path (which I personally did not anticipate), the financial industry seems to be seeking a way to abolish stock market disclosure and trading rules, making the stock market more like cryptocurrency rather than making cryptocurrency more like a regulated stock market.