When we consider the potential of tokenizing capital markets, the most common security type is Equity, however it’s larger counterpart Debt receives less attention. With the use of innovation, specifically blockchain technology, Debt has the potential for streamlining and standardising the efficiencies that traditional debt and structuring never had.
In understanding more about this untapped potential, this week I had the pleasure to interview Prath Reddy, Director of Cadence, a company that has pioneered alternative investments in the form tokenized debt offerings. To date, Cadence have successfully completed a number of offerings on their platform which are live on a public blockchain.
What is your unique selling proposition?
Cadence is distinct in two unique ways. Firstly, we are the only online alternative investment platform offering ultra-short term high yield debt securities to accredited investors. Given where we are in the credit cycle, there is outsized demand from both retail and institutional investors for high yield, short duration securities. We are capitalizing on this trend on the investor side. Secondly, on the supply side, we work with originators that are focused on sourcing and servicing high quality, high yield assets but face balance sheet constraints. Our securitization technology built on distributed ledger technology streamlines the process of structuring these underlying assets into securities, executing them efficiently and servicing them over their life in a very scalable way.
Can you explain the type of assets being offered on the Cadence platform and the process of how they are selected?
The type of assets we offer to investors are structured notes supported by high quality, high yielding private credit assets. We partner with originators that have built successful non-bank lending and alternative finance businesses that seek alternative sources of capital. Our platform efficiently packages up certain assets on their balance sheet into regulated securities that we offer to accredited investors. These underlying assets span merchant cash advances, factored receivables and consumer loans that all return attractive annualized rates but are short duration in nature. We painstakingly diligence every one of our originators and only work with those that have established a strong track record, have institutional-grade risk controls in place and maintain robust underwriting standards.
What are the benefits of tokenizing debt that would attract institutions and investors to participate in this new era?
By digitizing conventional debt assets, many of the frictional costs associated with structuring, issuing and servicing debt will be greatly reduced. These cost reductions will ultimately be passed along to accredited investors in the form of higher yields. Additionally, issuers of debt can now enjoy lower barriers to entry and raise funds directly from investors who previously could not meet the high investment minimums. Cadence’s minimums to invest are just $500, compared to $10,000+ on other online investment platforms. Our origination partners can now also raise funds from institutions and retail investors under more favourable terms due to investor accessibility driving up the number of investors in the marketplace, allowing issuers the ability to leverage demand and achieve best execution.
With the appropriate exemptions filed, an issuer of security tokens can also easily open their investment to a wide variety of both domestic and international investors in a legally compliant manner.
Alternative assets are known to have low liquidity compared to conventional assets such as stocks and bonds. How can liquidity be improved?
By tokenizing an alternative asset such as private credit, the instrument is inherently structured into a tradable product. While there are SEC-mandated lock-up periods and processes to follow, the ability to manage a perfect cap table on a distributed ledger removes many of the friction costs involved. Traditionally, managing holding periods on an investor-by-investor basis required significant manual effort. The cost required to make a trade (think legal, compliance and trust entities coordinating) often times outweighed the return, rendering the assets illiquid.
Smart contracts are auditable code that reference real world actions and oracles to immutably record and execute actions onto a decentralized ledger. They are able to identify the investor, the trade, the timing, and whether the investor is eligible for the transaction. This entire process is what defines a security token. At Cadence, we have developed such a token to originate, structure, execute and service structured debt securities supported by real world assets and cash flows.
Additionally, Cadence’s security tokens enable tradability across global exchanges upon the expiration of regulated lock-up periods. The end result transforms what was once a previously illiquid asset into a very transparent asset that is well-equipped to trade in an open marketplace. In order to bring liquidity to any asset or market, information asymmetries must be addressed and our end-to-end approach provides the market with the data it needs to make informed trading decisions.
Can you share any future plans or goals?
Our vision is to provide alternative investments for all. Many novice investors are not aware of the various benefits that come with including alternatives as part of a well diversified asset allocation strategy. These advantages range from the ability to hedge against volatility to generating above-market risk-adjusted returns. Furthermore, many investors who have the credentials to be accredited investors and participate in private alternative investments do not know they already qualify. It is our mission to educate investors and help get them started through our low investment minimums and robust supply of opportunities. Additionally, we want to help expand access for sophisticated and institutional investors who have the means to participate in such investments but are often restricted by the lack of visibility into new opportunities or have liquidity constraints.