CFX ARTICLES

As we’ve discussed before, technology is having a massive impact on the world of private placements. Technology is disrupting a number of other industries, though, and one of them is the financial services industry. Chicago is one of the cities at the epicenter of the FinTech revolution. This shouldn’t be surprising, because Chicago has always led the way in financial markets innovation.

History of the Chicago Financial Markets

The Chicago Board of Trade (CBOT) was originally established in 1848. Given Chicago’s location in the Midwest and at the base of the Great Lakes, it was (and still is) a natural hub for transporting and trading agricultural produce. The development of railroad and telegraph lines helped connect Chicago with the East and made it a center for commercial activity. The CBOT was established to give farmers and dealers a central place to exchange cash for produce, primarily wheat.

At the time, farmers would grow their crops and bring them to market without any indication of demand, often resulting in supply exceeding demand. This led to the birth of the “futures” contract in Chicago in 1865, as farmers and dealers began to commit to future exchanges of grain for cash. This allowed farmers to know in advance how much they would be paid for their grain, and allowed dealers to calculate their expenses in advance. Of course, it wasn’t long before speculators began buying and selling these futures contracts themselves, creating a “secondary market” in futures.

Chicago is also the home of the Chicago Board of Options (CBOE). While options have been traded throughout U.S. history, they historically were not standardized and were highly illiquid. This changed in 1973 with the opening of the CBOE, which became the first U.S. options exchange. The CBOE provided a two-sided market for options buyers and sellers, and helped popularize options as an accepted form of investing.

Modern-Day Chicago FinTech

Given this history of financial innovation, it shouldn’t be surprising that Chicago has emerged as a leader in the FinTech industry. FinTech is the name given to financial service companies whose products and services are based upon technology. Global investment in FinTech companies grew from $928 million in 2008 to $2.97 billion in 2013, and is expected to reach $6 billion by 2018. Some industry analysts credit this growth to new financial regulations that FinTech companies have been able to navigate easier than larger banks have.

One of Chicago’s most well-funded startups is Avant (formerly AvantCredit), which uses complex algorithms to match borrowers with loans. OptionsCity is an electronic trading software platform that allows traders to combine OptionsCity’s open API with the trader’s own proprietary technology. On the B2B side, Rippleshot uses predictive technology to help companies detect looming data breaches. These are just a few of the many Chicago companies that are bolstering the city’s reputation for innovation in the financial markets.

CFX: The Next FinTech Innovation

Of course, we’re doing our part to spur further innovation in the financial markets. When we began building the CFX Network last year, we believed that there would be great investor demand for high-quality commercial investment opportunities, particularly in the Midwest markets that have been underserved by other crowdfunding platforms. The equity crowdfunding industry is still relatively new, but we’ve been thrilled at the response we’ve received from investors for the offerings in the CFX Network.

We always knew, though, that equity crowdfunding would not reach its full potential unless investors had the potential for liquidity in their investments. While building the CFX Network, we’ve worked simultaneously to develop a secondary market for crowdfunding offerings. CFX: Crowdfunding CrossMarkets, will provide an open and secure network to facilitate secondary market transfers of private securities in alternative asset classes. Shares of crowdfunding offerings purchased on the CFX Network portals can be resold on CFX (subject only to SEC resale restrictions). We expect to officially launch CFX in Fall 2015.

While investors in our current CFX Network offerings will be the initial beneficiaries, our vision goes beyond any one platform, and even beyond the crowdfunding industry. Put simply, we believe CFX will, in time, do for equity crowdfunding what the Chicago Board of Options did for options trading. While options trading existed prior to the CBOE, it was a very difficult and inefficient process. The CBOE provided a centralized, standardized options marketplace, opening this form of investing up to many new investors. We believe that CFX, by providing the option of liquidity, will open equity crowdfunding up to many new investors who otherwise would not be able to participate.

We can’t wait to launch CFX, so stay tuned for its official launch soon!

Last week we wrote about liquidity, which is one of the challenges of real estate and crowdfunding investing.  Historically, liquidity was not attainable in private markets, and investors did not have the freedom to move in and out of their investment positions. This was especially true of equity crowdfunding. Investors risked getting stuck in equity positions with no hope for any form of liquidity in the future.

Today, we’re excited to announce that all of that has changed.  We’ve been working to address this problem, and we’re thrilled to announce the arrival of the first and only secondary market for crowdfunding assets: CrowdFunding CrossMarkets (CFX).  CFX brings the ultimate freedom and flexibility to a formerly illiquid marketplace.  It puts crowdfunding investors in the driver’s seat and allows them to take control and make investment decisions that best fit their needs and their lifestyles.

For current CFX network users, the mechanics of the secondary market are simple.  Shares of crowdfunding offerings purchased on one of our network portal can be resold on CFX, subject only to SEC resale restrictions.  The secondary market acts as a stock exchange for private investments, allowing investors to buy and sell shares from other participants in the market.

We’re also pleased to announce that we have a patent pending on the back-end technology and process supporting the secondary market.  Without going into too much technical detail, CFX acts as a centralized asset exchange system, managing the registration of listed assets and the ownership of participating investors.  The internal transaction engine manages incoming orders to buy and sell, and processes these orders using a matching algorithm with price-time priority. The CFX system handles the complete lifecycle of an investment purchase or transfer, including the clearing of investor funds and settlement process of the private assets.

We’ve built the CFX Network to be open and available to the public.  Our client portal technology is offered to select partners to increase the number of high quality investment offerings and participants within the global CFX Network.  We’ve already signed several premier partners onto the CFX network, and are in discussions with many more to expand the reach of CFX.

Creating a secondary market has been one of our primary goals for the industry, and we’re thrilled to announce the arrival of this secondary market to the marketplace.  In many ways, we feel that the skillsets of our team offer us with a unique opportunity to introduce liquidity to the private securities market. Our leadership team has a rich blend of investment and legal experience, which allows us to offer the highest-quality deals without losing our focus on compliance.  Our engineering team has a deep background in financial markets and trading technology, and have prior experience building electronic communication networks and alternative financial exchanges.

Our Chicago location is also vital.  As the home of the CBOE and the CME, and the birthplace of the futures contract in 1864, Chicago has long revolutionized the financial markets.  Chicago obviously is also a huge real estate market, and has a burgeoning tech scene.  The FinTech sector in Chicago is growing particularly rapidly, and we’re excited to be a key part of it.

The CFX Network was built from the ground up with the key principles of bringing access, transparency, and flexibility to a closed, opaque, and illiquid marketplace.  We’re excited to define the standard for the equity crowdfunding industry, and we look forward to continuing to bring institutional-quality investments to our users!

 

At CFX, we’ve talked a lot about the many positives that equity crowdfunding offers for investors, but we’d be remiss if we didn’t discuss one of the challenges of private investing.  All investments have their risks, and one of the risks of private securities has been a lack of liquidity.  Investors can typically sell publicly traded stocks at will on national stock markets, but when it comes to private placements there have historically not been many liquidity options.  These types of private assets are generally illiquid, meaning that an investor cannot sell their shares after purchasing them.  

Historically, there have been two reasons for this lack of liquidity – SEC regulations and the lack of a secondary market.  To (very) briefly summarize SEC regulations, securities acquired through private placements generally cannot be resold unless the conditions of Rule 144 are met.  This article will discuss the other issue, which is the lack of a secondary market.

The equity crowdfunding industry may be new, but private placements aren’t.  Industry experts have long noted the lack of liquidity of privately placed securities.  These private placements were generally only available to affluent individuals who were in a position to hold the investments for a number of years.  With the passage of the JOBS Act and the advent of crowdfunding platforms, though, these investments are now available to anyone who meets the definition of an accredited investor.  While these individuals are obviously affluent compared to the general population, in many cases they lack investment experience and are unpleasantly surprised by the lack of liquidity in crowdfunded investment offerings.  

The liquidity problem extends to all crowdfunded securities offerings.  Indeed, many of the most outspoken proponents of a secondary market are entrepreneurs who hope to use crowdfunding to raise capital for their own startups.  Many of the biggest critics of equity crowdfunding, including Mark Cuban, cite the lack of liquidity as their biggest concern.  In a recent blog post, Cuban wrote that “there is ZERO liquidity for any of those [crowdfunded] investments.  None. Zero. Zip . . . [i]f stock in a company is worth what somebody will pay for it, what is the stock of a company worth when there is no place to sell it?”

Although Cuban also criticized the SEC for failing to provide some form of liquidity, it appears that the SEC has taken notice of the issue.  In a speech that SEC Commissioner Luis Aguilar gave last month, he noted that ““[t]he lack of a fair, liquid, and transparent secondary market for these securities is a longstanding problem that needs an effective solution.”  

Many observers have suggested “venture exchanges” as a possible solution to the liquidity problem.  There are several different proposals, but in general, venture exchanges can be considered a stock market for small companies.  Of course, this raises the issue of regulatory hurdles that a small company would have to meet in order to be listed on the exchange.  Given that these companies would obviously be much riskier investments than traditional publicly traded companies, it seems clear that some hurdles would be required. However, too many hurdles would defeat the entire purpose of the exchange, since most startups won’t have the resources to comply with stringent regulations.

In his speech, Commissioner Aguilar concluded that venture exchanges “need to be considered . . . in a thoughtful and measured manner—fully cognizant of benefits, costs, and challenges—and always with the needs of investors at the forefront.”  Despite the cautiously optimistic tone, though, there is no indication that the SEC is taking any affirmative steps to help create a secondary market.  For the moment, the crowdfunding industry faces a situation where everyone acknowledges the need for liquidity, but no one has done anything about it to this point.  It now seems clear that any liquidity solutions will need to come from within the crowdfunding industry itself.