Bonds, with a history that spans hundreds of years, remain one of the principal methods businesses use to raise money. The journey from the oldest bond to generate yields issued in the 1600s until today demonstrates their enduring relevance. However, it doesn’t mean it is fit for purpose in the modern world.
Issuing debt has traditionally been an important method for companies to secure capital, but doing so has a high barrier to entry by way of strict assessment criteria and lengthy issuance procedures, in addition to subjecting issuers and investors to fluctuating interest rates that affect their returns. These factors contribute to challenges in the accessibility of debt capital markets, which can limit financial inclusion on a global scale.
As we aim to empower new companies, industries and markets, especially those who do not have the resources required by traditional financial institutions, it is critical that we introduce new technologies to power debt capital markets, to ensure the bond market adapts to a more digital and global world. Thanks to blockchain technology, we now have the tools to do so.
Blockchain can best address the challenges present in the existing lending landscape and power greater access to capital and financial inclusion for companies of all sizes, especially small- and medium-enterprises that make up 90% of businesses worldwide and emerging markets that contributed around US$42.6 trillion to the global GDP in 2022 but have traditionally been excluded from participating in debt capital markets.
Limitations of traditional debt capital markets
Conventional financial institutions have strict requirements when it comes to assessing a company’s creditworthiness, and the loan application process is long and costly. This is especially the case during times of rising interest rates, which cause bond prices to go down and negatively affect issuers.
Much of the high costs associated with traditional bond issuance can be attributed to the involvement of as many as 13 intermediaries, including arrangers, dealers, law firms, issuing and paying agents, financial market infrastructure providers, and custodians. For instance, issuing a US$50 million bond can incur costs of up to 5% of the bond value, and the process can take as long as six weeks. Given the high fixed costs, issuances below US$100 million often become economically unviable.
Furthermore, extensive lock-up periods of one to several months or time-restricted liquidity mean it takes quite some time for companies to access their funds post-issuance, creating additional pain points for them.
All of this contributes to unequal access to debt capital markets, especially for smaller companies that do not have the time and resources for application processes and actual issuance. Even larger corporations that are not as significantly affected by higher costs and invasive credit assessment processes feel the burn of lengthy lock-up periods for accessing funds and the effects of fluctuating interest rates.
Blockchain can streamline processes
The transparency, verifiability and immutability of blockchain technology can streamline the application process and remove the need to complete abundant paperwork. Companies can put the relevant data on a blockchain, ensuring it is hosted securely, where it can be verified by specific parties.
Additionally, blockchain-powered zero-knowledge proofs, which enable one party to prove a statement is true without disclosing sensitive information, are emerging as a way to preserve confidentiality during the credit assessment process, protecting companies’ privacy while enabling them to prove their creditworthiness.
By reducing the reliance on financial intermediaries, blockchain can also allow businesses to streamline the issuance of bonds and commercial papers on chain, where they immediately become available to investors. In doing so, blockchain significantly reduces the costs associated with bond issuance while expediting the process itself and enabling companies to more quickly access funds. This, in turn, helps them reach their next growth stage more quickly and effectively.
Regulatory compliance is a must
Blockchain provides the optimal framework for streamlining and improving access to debt capital markets, yet some blockchain-based bonds were not issued entirely on chain. That being said, end-to-end on-chain bonds constitute the next iteration of debt capital markets, propelling them into the decentralized finance sector and, in turn, making regulation a challenge for future issuances. Indeed, the DeFi space operates with less traditional oversight, which can sometimes leave companies and investors feeling vulnerable — and therefore affecting their confidence in the space — when they choose to engage with DeFi projects.
It is important for blockchain companies bringing bonds and commercial papers on chain to create new legal frameworks by adhering to existing regulations and obtaining licenses that are required for traditional bonds. By powering globally enforceable on-chain bonds, these companies provide the same certainty and protection as traditional bonds to any businesses and investors using their platforms. In doing so, projects bringing debt capital markets on chain have an opportunity to trailblaze, and demonstrate that these blockchain-based systems are not only possible, but compliant and superior in their efficacy.
Future-proofing the debt capital market
Traditional funding systems, while still useful, are archaic and riddled with unavoidable challenges. Blockchain provides the solution to modernize and future-proof debt capital markets by increasing access to capital for companies of all sizes, enabling them to scale. Harnessing the potential of on-chain solutions could greatly enhance the efficiency and accessibility of debt capital markets, benefiting companies of all sizes now and in the future.