Tokenized securities, or a security token offerings (STOs), are one of the much-hyped advancements that could help drive blockchain adoption going forward. While cryptocurrencies such as Bitcoin, Litecoin or XRP can be seen as “digital gold” or “digital money,” and others like Ethereum or EOS can be seen as an access key to open source computing power, tokenized securities are different.
While built on similar blockchain based technologies, tokenized securities are a version of digital ownership governed by smart contracts for any variety of public or private equities, debt, real estate, fractional ownership or other assets. Because of this, many jurisdictions are deeming these types of tokens as securities under existing classifications and regulations. Most famously, the SEC declaring that in its opinion, almost all tokens would be classified as securities under its definition.
According to Yoel Goldfeder, Chief Executive Officer of stock transfer agent VStock Transfer, “The SECs statements in the midst of the ICO boom demonstrated that technological advances cannot occur in a vacuum.” VStock believes that the regulations will evolve to address the nuances and capabilities of blockchain but, that changes to existing regulations can take time. Mr. Goldfeder further added that, “In 2018 the technologists and players involved in the crypto space started coming to the realization that to fully realize the potential for this industry they must work within the confines of the regulatory environment.”
A lot of talk about tokenized securities, but little action
While there is much excitement and expectation built around it, thus far, there has been little actual tokenized security activity to date. Part of this could be attributed to the downturn in the crypto markets as well as the impact of a regulatory vacuum in some jurisdictions. It appears that the regulatory path is starting to be clarified. We asked some key players in the space what to expect next.
Jamie Finn, President & Co-Founder of Securitize commented, “Capital Raising has become increasingly hard and ICO’s showed a new way of raising money that was absolutely mind-blowing.” Securitze provides primary issuance and compliance software for issuing securities on permissioned and public blockchains. Mr. Finn sees the need to educate investors to the fact that digital securities that are following regulations could be some of the safest and best ways to own a security. He added, “ICO’s showed how capital formation can happen but quickly poisoned the well as there were so many scams.”
This lack of a clear regulatory course of action for these tokens is making headway in some regions. While it appears that most of the filing requirements could eventually be satisfied with an appropriate registration statement such as S-1/F-1 or A/A+ among others. The part that is still undefined is where can these tokenized securities trade? In the U.S., there are emerging exchanges that are pursuing this opportunity to list these digital assets, but the rules around the process remain a grey area.
Why digital securities, why now?
Older paper-based systems have long been the heart of the capital markets, and are a comparatively slow settlement, inefficient with a ton of intermediaries, costly and opaque when compared to blockchain-based replacements. Additionally, in the past, the existing infrastructure has been accused of abuses and conflicted relationships such as facilitating naked shorting. According to Darren Marble, CEO of Issuance.com, “digital securities use blockchain technology to improve transparency, streamline capital formation, and reduce fraud.” Issuance.com is developing a platform to address the problem of distribution, which they believe to be one of the key challenges in the industry. Issuance provides investors with access to pre-vetted digital securities offerings and personalized deal flow based on their preferences in order to allow issuers to raise capital faster, easier, and more efficiently.
Mr. Finn from Securitize believes that there is a “real appetite for better ways to manage securities than a piece of paper.” Issuance sees from its business that demand is coming from digital asset funds in the U.S. and internationally, including legacy crypto hedge funds, as well as newer funds run by seasoned asset managers. In many cases, demand is being driven by a simple need for liquidity. Digital securities could provide some level of liquidity for assets that were previously illiquid. It is this combination of the need to migrate from legacy infrastructure, the emerging technical applicability of blockchain, and demand from a new class of eager investors that is the convergence pushing advancement in digital securities.
But, in order for digital securities issued on the Blockchain to really take flight this year and beyond, the right infrastructure needs to be in place for these assets to truly become liquid. Juan Hernandez, Founder & CEO of OpenFinance Network makes the point that, “blockchain-based trading platforms are the missing variable in facilitating a new era of smart securities along with much-needed liquidity”. With more regulatory certainty, combined with legitimate platforms in place, OpenFinance believes that mainstream adoption is inevitable, with interested parties like REITs and major equities players seeing the value in unlocking liquidity in a market where there was previously very little.
What is needed to make digital securities mainstream?
Many are concerned about repeating some of the mistakes associated with the ICO boom and bust with many high-risk investments ultimately providing little return for the majority of investors at best, as well as outright frauds in other instances. Consequently, this may have created challenges for the emergence of the first crop of digital security offerings. With the bar raised, the industry may need the first batch to be high-quality issuers in order to attract interest and investors to overcome the initial doubts.
While this first batch of digital securities doesn’t need to “moon” or offer outlandish promises or returns, it is critical that they are well vetted, legitimate investment opportunities. Securitize agrees that “the appetite is from cutting edge traditional investors but it’s still a science project.” Adding that, “We have not yet seen “GREAT” digital offerings in terms of the other industry benchmarks.”
“Alternative asset investors are seeking opportunities to properly diversify their broader investment portfolio. For these tokenized offerings to be properly received by the broader investor community, they need to have something real behind them,” added Hernandez from OpenFinance. Additionally, these offerings may need to bridge the gap between existing legacy infrastructure in order to be widely adopted. For example, VStock Transfer, through Vtoken, has been working to marry the potential of blockchain technology within the existing regulatory infrastructure to afford those wishing to conduct compliant digital security offerings with a path forward. This may make it easier for traditional systems to integrate the technology.
Ultimately, it will be the adoption of the technology by both retail and institutional investors in order to prove the model. In order for that to happen, all the parties need trust to be a key ingredient in the ecosystem.