Direct listings have become a darling of the stock market, and they might soon shake up the blockchain world

The U.S. stock market is in a bit of a pickle. 

It has nothing to do with the recent volatility in the market, precipitated by President Donald Trump's headline-making trade war with China.

The problem is the U.S. stock market shrinking as companies opt to stay private longer to avoid headaches associated with going public. The reasons companies aren't listing their shares publicly have been well-documented. The initial public offering (IPO) process is timely and expensive, and once a company is public it is required to file cumbersome financials every quarter and deal with the scrutiny of short-termism in the marketplace. As such, the number of domestic publicly traded companies has fallen from 3,900 in 2010 to 3,579 last year, according to data compiled by The Block. 

As noted recently by analysts at Alliance Bernstein, companies going public later in the lifecycle has an impact on average investors. Namely, the high growth phase of these companies is limited to "those lucky enough to be able to access the best private investment vehicles."

Enter the direct listing

Still, there is hope for the market. New York Stock Exchange vice chairman and chief commercial officer John Tuttle told The Block in a phone interview that he expects the number of deals that hit the floor of the Big Board to pick up into 2020. There is also the direct listing, a non-traditional process of going public that some say could be the elixir that'll lure unicorns to the market.

Unlike a traditional initial public offering, a direct listing offers a way for a company to offer its shares to the public without having to raise capital. Thus, companies won't have to dilute their existing shares or go through the roadshow process — which helps a firm generate interest around the deal and set the IPO price. That removes the need for so-called underwriters, investment bankers who charge companies fees to market their stocks to mom-and-pop investors. 

Designated market makers, on the other hand, have a bigger role in a direct listing versus a vanilla IPO. Prior to the first trade, DMMs will evaluate supply and demand in the market to come up with an indicative price. And then work to dampen volatility when trading starts. 

“Direct Listing has proven to be a less onerous and more equitable path for companies that don’t have an immediate need to raise capital to enter the public markets," said Joe Mecane, head of execution services at Citadel Securities, which operates a DMM business on the floor of the NYSE. "However, the lack of a formal underwriting process or stabilization agent also increase the risk of volatility in these types of transactions, creating a potential heightened need for designated market makers to provide capital and liquidity so that these stocks trade as smoothly as possible."

The unique structure of a direct listing has garnered a lot of attention, especially from large technology companies. 

Such firms are more interested in providing early investors and employees with liquidity than adding to an already bloated balance sheet. Music streaming service Spotify and messenger platform Slack are two of the latest firms to opt for a direct listing over an IPO.

"Are companies waiting longer to go public later in their life cycle? Yes," Tuttle said. 

"Does [a direct listing] solve the problem? No, but it is a positive step."

Others are more bullish. Sequoia Capital Michael Moritz described the mechanism as a much-needed innovation in capital markets. 

"During the next couple of years, companies already well advanced with plans to go public will probably use the conventional approach," Moritz wrote. "But, for all others, the choice of a direct listing or a traditional IPO has become a test of two attributes: courage and intelligence."

Still, other market observers have cautioned that the direct listing isn't for every firm. 

"Direct listings won't solve everything, but they do give companies a choice on how they'd like to go to market," noted JJ Kinahan, chief market strategist at TDAmeritrade, in a conversation with The Block. 

For instance, a company with a low profile and desire for capital would likely not see the same benefits from a direct listing as a company like Slack. Still, Tuttle says the pool of companies interested in the direct listing is expanding. 

"They might not be the companies with the big profile and they might be outside the consumer tech space," he said. "There is meaningful interest from existing companies that are public."

"We are going to continue to innovate in this space," Tuttle said, declining to share specifics on exactly how to improve the direct listing process in the future. Tuttle also would not share if any direct listing transactions were in the pipeline for the end of 2019. 

Direct listings, but on the blockchain

Elsewhere, folks in the cryptocurrency world are watching the direct listing develop. Some are even looking at how they can integrate the approach into their business to help address the pain points of certain companies looking for liquidity. 

Vertalo, a company that works with early stage companies on tokenizing their private shares, is looking at ways to mimic the direct listing process in private markets. Chief executive officer Dave Hendricks told The Block that the firm is looking to expand its current platform, which allows companies to manage their cap table on a blockchain, to also support the tokenization of private shares. The tokenized share would then list on a secondary alternative trading system, offering early investors and employees a less cumbersome way to sell their holdings than traditional private marketplaces. 

To be sure, only accredited investors would be able to open an account to trade these private shares — which doesn't necessarily remedy the problem of the stock market getting smaller. Still, Hendricks notes that there are millions of American households who could participate in this new market.

Meanwhile, although tokenization is less costly and time-consuming for issuers, tokenizing the cap table also doesn't guarantee the same level of liquidity that exists in the private market.

Still, there are some benefits, according to Securitize chief executive officer Carlos Domingo, whose firm offers a platform for companies to conduct security token sales. 

Tokenization streamlines the process of buying and selling private shares, according to Domingo.

"It is automated and if you find a counterparty that wants to borrow it is as simple as a click," Domingo said. 

That simplicity could help drive more accredited investors to the private markets.

"A large majority of accredited investors don't have access to private Reg. D investment opportunities," he said. 

Currently, Domingo says there is strong interest from cryptocurrency firms that have raised money in an initial coin offering and traditional equity fundraising to tokenize their shares and directly list them on a platform like Open Finance or tZero.

"These companies have raised a lot of money via a token and they have investors stuck with equity with no value," Domingo said. 

"We have talked to mid-sized companies who see an IPO as far too expensive."

Domingo wouldn't say if those deals would close by the end of the year.

This post has been updated to include John Tuttle's most up to date title.