Bloomberg columnist Matt Levine: U.S. stocks dressed in "Token" vests, good or bad?

Author: Matt Levine (Matt Levine)

Author Introduction:

Matt Levin is a columnist for Bloomberg Opinion. He was a Goldman Sachs investment banker, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz, a clerk for the U.S. Court of Appeals for the Third Circuit, and an editor at Dealbreaker.

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 raise funds for a project by selling shares 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 on leverage. Subsequently, the stock market 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 stocks to the public, it must disclose business details, publish audited financial statements, and disclose significant events to ensure that investors are informed.

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

As time goes by, these exceptions become increasingly important. In the 1920s, the best way for companies to raise funds was to publicly issue shares to thousands of retail investors; by the 2020s, the best way to raise funds might be to directly call Masayoshi Son of SoftBank and ask him for $10 billion—he is very likely to agree, and you won't have to disclose financial reports or face retail investors.

"The private equity market has become the new public market," I often say. In the past, the main advantage of going public was the ability to raise large amounts of capital, as the public market had more abundant funds. Today, the private equity market boasts trillions of dollars, making an IPO no longer necessary. Star tech companies like SpaceX, OpenAI, and Stripe can secure billions in funding at valuations of hundreds of billions without going public.

They indeed did so, because going public is really troublesome: financial reports must be disclosed, business progress updated (if the information is incorrect, they may even be sued), and they might attract unwanted shareholders. Moreover, the public fluctuation of stock prices can also be a headache for management. For popular private companies, this is actually convenient—they can raise funds while avoiding the complexities of going public.

But for the public, this may not be a good thing. Retail investors who want to invest in companies like SpaceX have no access and can only buy fragmented equity at high prices through gray channels. Over the past decade, a narrative has gradually become popular: "Modern economic growth is largely driven by private enterprises, and the most exciting companies are private, yet ordinary investors cannot participate, and this must change."

How to change? My previous discussion has indicated that this is very difficult. Many large private enterprises do not want to go public at all because the public market is both annoying and expensive. The reason the private placement market can replace the public market lies in the fact that global capital has become highly concentrated in private equity funds, venture capital, family offices, and people like Masayoshi Son— they do not need retail investors' funds at all (at least SpaceX does not need it; perhaps some private companies do need retail investors, but they may not be high-quality targets).

Nonetheless, people still want to give it a try. Conceptually, here are some ways to address the issue:

• Making going public easier. Reducing costly disclosure regulations. Making it harder for shareholders to sue companies, making it harder for activists to win proxy fights, and making it harder for short sellers to criticize companies. Clearly, there are trade-offs here, but perhaps it's worth it. If going public is no longer more troublesome or expensive than staying private, maybe SpaceX, Stripe, and OpenAI will shrug and say, "Sure, let's go public." Historically, this is something people often say when discussing solutions.
• Make it harder for private companies. Increase expensive disclosure regulations for private companies. Through a law, stipulate that "if you have more than X dollars in revenue, you must publish audited financial statements, and if any errors are found, anyone can sue you." You occasionally see efforts in this regard; 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."
• Restructuring the economy and wealth distribution, reducing the capital pools of large institutions, where the only way to obtain significant capital is through selling shares to the public. This seems difficult.

But there is an even more radical way: to directly abolish the rules for listed companies. Allow any company to offer stocks to the public without the need for disclosure or auditing. The public can assess the risks themselves—if a company refuses to provide financial reports, you are free not to buy (but you can buy too!). Fraud remains illegal, but mandatory disclosure will become voluntary. If a company believes that disclosure helps with financing, it can still follow the current securities laws; if not, it can directly sell shares to the public.

Few people publicly support this proposal. After all, the overall securities regulation in the United States over the past century has been regarded as successful – with deeper markets, more reasonable valuations, and less fraud, all due to the mandatory disclosure by listed companies.

However, the cryptocurrency industry has discovered a "shortcut": raising funds by issuing "tokens" (a type of economic equity certificate similar to stocks) without having to comply with securities laws. This theoretical achievement is mixed, but it seems to have gained momentum in recent years.

Nowadays, most companies still issue stocks rather than tokens. However, tokenization offers a new idea: rebranding private company stocks as tokens and then selling them to the public. You call this "stock tokenization" and move it onto the blockchain. Back in 2015, I wrote that "just mentioning the word 'blockchain' won't make the illegal legal," but this is no longer obvious today.

Tokenized stocks have other advantages: stocks on the blockchain may achieve self-custody, high-leverage loans on DeFi platforms, 24-hour trading, etc. But the real temptation is that as long as they are labeled "tokenized," private company stocks can bypass U.S. disclosure rules to sell to the public. This means that the securities law system established in the 1930s could be circumvented.

Of course, the U.S. has not reached this point yet, but that is the goal. This week, Robinhood announced that it will launch tokenized stocks (initially limited to non-U.S. users and primarily focused on U.S. stocks):

Robinhood Markets Inc. joins the wave of blockchain stock trading, offering tokenized US stocks for 150,000 users in 30 countries with 24/5 trading.

The structural details indicate that the underlying assets are custodied by licensed US institutions (theoretically, tokenization could allow naked short selling of stocks, but Robinhood's tokens are fully collateralized).

Notably, Robinhood is also giving away private company tokens as a promotion:

To celebrate the launch, Robinhood is giving EU users who registered before July 7 tokens worth 5 euros for OpenAI and SpaceX, with a total allocation of 1 million dollars in OpenAI tokens and 500,000 dollars in SpaceX tokens. John Kibria, General Manager of Robinhood's crypto business, said: "We want to address historical investment inequality - now everyone can buy these companies."

Although currently limited to Europe, the goal is clear: to allow the public to purchase OpenAI and SpaceX stocks through brokerage apps without requiring companies to disclose their financial reports.

Robinhood CEO Vlad Tenev stated bluntly in a podcast:

"For private enterprises, the argument against allowing retail investors to invest is fundamentally untenable. People can buy depreciating goods on Amazon, can buy meme coins, yet cannot buy OpenAI stocks? This is illogical."

This statement is correct! The public can indeed speculate in the stock market (zero date options), the cryptocurrency space (meme coins), and the lottery (Robinhood once promoted Super Bowl betting). In contrast, SpaceX or OpenAI are actually higher quality targets. The distinction between public and private does not correlate with the level of risk—there is junk in the public market, and there are pearls in the private market.

But it must be recognized that the essence is: "The public should be able to invest in private enterprises" is itself a paradox.

The core characteristics of private enterprises are:

(1) Not open to the public,

(2) Not subject to the disclosure constraints of listed companies.

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

Tenev is not an isolated case. BlackRock CEO Larry Fink has also advocated for tokenization and has explicitly stated that the goal is to circumvent disclosure rules. In his letter to shareholders this year, he wrote:

"Tokenization democratizes investment... High-return investments are often limited to large institutions, primarily due to legal and operational friction. Tokenization can eliminate barriers, allowing more people to access high returns."

The "legal friction" here refers to some companies being private because they do not want to comply with securities disclosure rules, and the tokenized solution allows them to sell shares to the public without adhering to these rules.

To say it again, this solution has not yet worked in the U.S. You still cannot directly sell "tokens" representing private company stock (or private credit loans, private equity funds, etc.) to the American public without disclosure. However, many big players in the financial world are advocating for this, and the regulatory environment seems quite receptive, which you can understand. The public wants to buy private investments, intermediaries want to sell, but disclosure rules are hindering all of this. Saying "we should abolish disclosure rules" sounds terrible, outdated, and greedy. On the other hand, saying "tokenization" sounds great, modern, and cool.

A bit more of the old-fashioned history.

Around 2020, cryptocurrency projects crazily raised funds from the public through false promises. People speculated with leverage, and then the bubble burst, leading to the "crypto winter." By the end of 2022, you might have envisioned various possible outcomes, including:

1. encrypted permanent silence;

The Congress may regulate cryptocurrencies like the stock market in the 1930s, possibly establishing new rules to restore confidence in the crypto market, requiring disclosures, regulating conflicts of interest, and imposing capital requirements. (We have indeed seen some developments in this regard; the "Genius Act" imposed capital requirements on stablecoins.)

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