Are digital stocks the future of the African stocks market?
In our two parts, we shall explore digital stocks as an alternative investment vehicle to traditional stocks. In this first part, we shall give background to the African stock exchange market and also give context as to why blockchain technology is the solution to the current existing obstacles or challenges in the traditional exchange market
There has been a considerable development in the African capital markets since the early 1990s. Prior to 1989, there were just five stock markets in sub-Saharan Africa and three in North Africa.
According to wikipedia, today there are 29 exchanges in Africa, representing 38 nations’ capital markets.
With the exception of South Africa, most African stock markets doubled their market capitalization between 1992 and 2002. Total market capitalization for African markets increased from US$113,423 million to US$ 244,672 million between 1992 and 2002.
The rapid development of stock markets in Africa does not mean that even the most advanced African stock markets are mature. In most of these stock markets, trading occurs in only a few stocks which account for a considerable part of the total market capitalization.
Beyond these actively traded shares, there are serious informational and disclosure deficiencies for other stocks. Further, supervision by regulatory authorities is often far from adequate. The less developed of the stock markets suffer from a far wider range of such deficits.
Indicators of stock market development (Table 1) show that African markets are small with few listed companies and low market capitalization. Egypt, Nigeria, South Africa and Zimbabwe are the exceptions with listed companies of 792, 207, 403 and 79 respectively.
The average number of listed companies on sub-Saharan African markets excluding South Africa is 39 compared with 113, with the inclusion of Egypt and South Africa. Market capitalization as a percentage of GDP is as low as 1.4 in Uganda.
The Johannesburg Securities Exchange in South Africa has about 90 percent of the combined market capitalization of the entire continent. Excluding South Africa and Zimbabwe the average market capitalization is about 27 percent of GDP.
This is in contrast with other emerging markets like Malaysia with a capitalization ratio of about 161 percent. African stock markets suffer from the problem of low liquidity. Liquidity as measured by the turnover ratio is as low as 0.02 percent in Swaziland compared with about 29 percent in Mexico. Low liquidity means that it will be harder to support a local market with its own trading system, market analysis, brokers, and the like because the business volume would simply be too low.
Are Digital Stocks The Future of The African Stocks Market?
Real world stocks can be tokenized into digital stocks which can be easily transferred using peer-to-peer blockchain technology hence facilitating the buying and selling of these stocks.
These digital stocks act similar to digital currency whose price in real time fluctuates. Stocks exchanged completely by peer-to-peer could resolve many of the issues facing the stock market today, including high frequency trading and short sales.
A stock exchange market is an aggregation of buying and selling offers corresponding to an asset. An asset can represent equities or stocks of companies, bonds, or other securities. People who buy or sell the assets are called investors while those who perform the transactions are called brokers or traders.
Modern stock exchanges are highly computerized and can handle vast number of transactions in a short amount of time, assuring the security, execution and authenticity of transactions at a cost of a transaction fee, usually directly proportional with the value of the auction.
The stock exchange like New York Stock Exchange or London Stock Exchange promotes buying and selling of equities of companies through the stock exchange which is regulated by a central authority.
The traditional stock markets are implemented in a centralized application that gathers all the trading actions. This architecture has many benefits by having a central authority that ensures the authenticity, security and validity of the transactions.
However, the centralization has also a lot of drawbacks, such as having a single point of failure, a possible performance bottleneck or susceptibility to attacks and time consuming. Furthermore, the central authority charges fees and there is a lack of transparency of the auctioning process for the trader.
Digital stocks that are basically tokenization of real world stocks onto equities tokens that can be easily sent across through a blockchain from one peer to another. Bitcoin, ethereum, ripple are famous digital currencies that allow easy buying and selling anywhere in the world.
This concept of digital currencies inspired the creation of digital stocks. This would involve making use of a decentralized stock exchange architecture to tackle the shortcomings identified above by using the new and emergent blockchain technology as stated by academia.edu.
The potential of the blockchain system can bring benefits to the entire system, the execution of the market orders and the correct settlement between the accounts. Furthermore, the ensured immutability of the ledger brings a valuable advantage with respect to the centralized system.
Also, by decentralizing the system, there is no central authority or intermediate needed for placing and executing the orders. This allows peer-to-peer transfer of stocks and direct buy and sell of equities between the traders without a need of third party to intermediate the trade.
This reduces the transaction costs charged on each trade, time needed for a transaction would be significantly reduced and provides enhanced security as well as transparency.
Why Blockchain For Digital Stocks.
- Transparency and Anonymity :
The prime reason blockchain is intriguing and attractive to businesses is that this technology is almost always open source. This means other users or developers have the opportunity to modify it as they see fit.
But what’s most important about it being open source is that it makes altering logged data within a blockchain incredibly difficult. Since a blockchain is a network of users, someone is probably going to notice if any data has been altered. This makes blockchain a particularly secure technology.
- Reduced transaction costs :
Blockchain allows peer-to-peer and business-to-business transactions to be completed without the need for a third party, which is often a bank. In the case of equities, there will be no need of brokers or stock exchanges to facilitate buying and selling.
Since there is no need of any middleman or third party that acts as an intermediate involvement tied to blockchain transactions, it means they can actually reduce costs to the user or businesses over time.
The brokers charge a percentage of the assets involved in trade or transaction fees which could be substantially reduced if it was directly bought and sold from the buyer and seller.
Another central reason blockchain is so useful is its lack of a central data hub. In traditional stock exchanges and banks a massive data center is employed and verification of transactions is executed through that hub.
Blockchain actually allows individual transactions to have their own proof of validity and the authorization to enforce those constraints. With information on a particular blockchain cut into blocks and spread throughout the world on individual servers, it ensures that if this information fell into unwanted hands (e.g., a cyber-criminal), only a small amount of data and not the entire network, would be compromised.
- User Controlled Networks:
The investors and users are really encouraged by the control aspect of blockchain without the need of a regulatory central authority to overlook the transactions and trades. Rather than having a third party run the show, users and developers are the ones who get to control the network. The reliable peer-to-peer communications of blockchain can help create more effective transaction and trade ecosystems. Integrating it as a layer on top of the internet will make it easier to control and manage a large network of devices, without any centralized controller.
One of the greatest benefits of blockchain is the absence of any single point of failure. When transactions are approved they are encrypted using complex cryptography and linked to previous records.
Every transaction is recorded and is shown to the public. This information is stored across multiple computers, instead of a single server, which makes it difficult for hackers to steal or modify. Ensuring protection of sensitive data is crucial in sectors like finance.
In our second part of our two parts series, we shall explore the application of blockchain in the stock exchange market.
More on blockchain application on African businesses: