If you are not familiar with security token offerings (STOs), maybe you should be. With regulators gunning for initial coin offerings (ICOs) and now going after decentralised exchanges (DEXs) too, industry players are looking at news ways of raising money. Changing the name to “token generation event” doesn’t cut it with most regulators and, in and of themselves, neither do simple agreements for future tokens (SAFTs). According to CoinShares chairman Daniel Masters, STOs will be the next big thing in crypto.
Speaking as part of a panel at a breakfast briefing organised by Dow Jones media outlets Financial News and MarketWatch, he identifies a third wave for crypto. According to Masters, Bitcoin ushered in a “new era in value transfer”, with the second wave led by Ethereum with its “frictionless way to globally form capital” and today a third wave of security tokens “with particular advantages for assets that have historically remained in private hands”.
CoinShares sponsored the event and is the company behind the XBT Provider Bitcoin and Ethereum exchange traded notes. Trading in the ETNs in the US was temporarily suspended in September because of confusion over the difference between ETNs and exchange traded funds (ETNs are unsecured debt securities).
Untapped value of privately held assets
Some of the largest companies in the world are privately held, such as Cargill for example, valued at more than $109 billion that dominates agribusiness or Koch Industries, which straddles sectors encompassing consumer goods and oil. It is valued at $100 billion. Many are of course valued much less loftily. These companies prefer the freedom of movement that staying private allows but if they did come to public capital market for funds there values would rocket because of the simple fact that there are more participants in those markets – it’s all about liquidity.
Now think about a whole host of other privately held assets, such as classic cars, art, stamps, gold and so on. All of these assets could be tokenised and in so doing, their valued enhanced. It could open up a world typically hidden from view behind the private equity and venture capital shutters, where mere mortals are forbidden to tread. “Legacy financial institutions will not be able to avoid the tokenisation wave,” insists Masters. He expects a “magnetic force” to pull them towards these possibilities, regardless of their aversion to all things crypto.
What went right and what went wrong with ICOs
Briefly, let’s go back to the second wave to see how we get to this claimed third wave in the evolution of the crypto space. Initial coin offerings have been hugely successful. For the first time in human history it was possible for any one in the world with access to the coding skills to solicit for investment capital from contributors potentially at any locale in the world with internet access. It is estimated by ICOData.io that $13.3 billion has been raised by ICOs since 2015. By any measure that has to be seen as a success. But this year the story is different with investors sitting on losses of ninety per cent or more. Far from offering diversification, many of the tokens have turned out to be worthless as the projects and the services they aimed to provide closed.
As Chris Burniske from placeholder.vc pointed out last week, many of the projects involved in ICO fundraising concentrated almost exclusively on bring in investment capital but not on how to deploy it as productive capital (such as getting the consensus system up, running and growing). Put that another way, contributors to ICOs/TGEs effectively stuffed the bank accounts of the founders and team members with ETH and were left with no control over how the investment capital was used and no claim to a share of company capital. Contributors to ICOs are paying for access to network services. Some investors may have confused that with a share that gives the bearer legal ownership of a portion of company capital. But ICOs are not initial public offerings of the equity markets, despite the deliberately confusing designation.
ICO investors it is assumed were mostly aware of this crucial difference between tokenholder and shareholder, but invested anyway; indeed they continue to invest in ICOs although at a much reduced rate, in the expectation that the value of the native “utility” token will rise. The problem with all that, from a regulator’s stance is that ICOs look very much like securities when judged against the Howey Test used by the US Securities and Exchange Commission (SEC). For that reason many ICOs began to exclude US investors from their fundraising efforts, with hubs developing in Switzerland, Singapore and Malta, where no such stipulations were applied, although reputable projects will still require anti-money laundering (AML) and know-your-customer (KYC) rules to be adhered to.
ICOs are not just a problem for regulators. They are also obviously a problem for consumers caught on the wrong side of the fraudsters. The open decentralised and largely unregulated nature of ICOs, or TGEs if you insist, means they attract scammers to the space, and that of course worries both individual investors and regulators alike. Although there are still plenty of ICOs launching, the days of billion dollar fundraises, such as seen with EOS’s $4 billion, are over, at least for the near-term.
Enter the Security Token Offering
But with the SEC and various US states starting to clampdown hard on ICO promoters for not registering as sellers of securities and abiding by the appropriate securities laws, with other jurisdictions likely to follow in their footsteps, the days of the ICO may be numbered. That’s where security tokens come in. Instead of trying to fight the regulators there are those who seek their warm embrace. Cypherpunks and others wedded to hopes of decentralised disruption of the banks and other financial intermediaries, may well be suspicious of security tokens. Are they not merely another vector – such as putative bitcoin exchange traded funds – for the takeover of the crypto space by the mainstream?
However, supporters of STOs such as Masters, whose company has a foot in both the old and new world, see the advantages. On the one hand there is the regulatory safe harbour for project developers and on the other a huge opportunity to “make securities liquid, transferable and transparent” and opening a wide vista for “arbitrage between private and public capital markets”. The most successful STO to date is from tZERO, which raised $134 million for its trading platform and then there was electric scooter company SPIN‘s $125 million raise.
tZERO’s investors were required to have a “fully funded signed agreements for future equity (SAFEs) prior to the August 6, 2018 close of the company’s Security Token Offering (STO)”. tZERO is a subsidiary of Overstock.com, the publicly traded online retailer that accepts crypto. Another start-up, Securitize, was involved in transferring the first security over blockchain
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