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Bitcoin, Blockchain, Cryptocurrencies, security token

Week ending 17 January 2020 in Security Tokens

Announcing the Daily Fintech weekly news curation on Security Tokens

Here is our pick of the 3 most important Security Tokens news stories during the week:

One. Securitize Opens IRAs to Digital Securities Investors With Partnership

Digital asset issuer Securitize has facilitated what it says is the first direct IRA investment in security token offerings (STOs). A customer of alternative investments gateway AltoIRA purchased an initial investment in security tokens representing CityBlock Capital’s $20 million venture fund, with tokens issued by Securitize.

IRA is a mainstream way for retail investors in America to get exposure to this new asset class.  We can expect other pension friendly initiatives in other jurisdictions soon.

Two. US SEC Seeks $16 Million Penalty from Token Sales Platform Operator.

The United States Securities Exchange Commission (SEC) is seeking a default judgement against token sale platform ICOBox and its founder Nikolay Evdokimov. Documents filed with the Central District Court of California on Jan. 9 order the defendants to pay over $16 million in disgorgement to the agency within 14 days of the judgement’s entry. 

This again shows why anybody operating in this market must pay close attention to regulation, particularly what the top cop (SEC ) is doing.

Three. Quantum-Resistant QAN IEO Is Officially Starting on Bitbay Exchange.

The first IEO to launch on BitBay exchange is poised to commence its token sale on January 20. QAN, an Estonia-based crypto project that proclaims to be the world’s first quantum-resistant blockchain, went live on the Launchpad on December 16.

This shows where the Security Token market is today – Blockchain centric startups launched by Crypto exchanges as an Initial Exchange Offering (IEO).

We have a self-imposed constraint of 3 news stories each week because we serve busy senior leaders in Fintech who need just enough information to get on with their job.

For context on Security Tokens please read the chapter on Security Tokens in our Blockchain Economy book and read articles tagged Security Tokens in our archives. 

You get 3 free articles on Daily Fintech. After that you will need to become a member for just US$143 a year (= $0.39 per day) and get all our fresh content and our archives and participate in our forum.

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Bitcoin, Blockchain, Cryptocurrencies, security token

The Week ending 10 January 2020 in Security Tokens

Announcing the Daily Fintech weekly news curation on Security Tokens

Here is our pick of the 3 most important Security Tokens news stories during the week that just ended:

One. WisdomTree leads $17.6 million funding round for security token startup

Securrency, a provider of compliance tech for digital assets, has raised $17.65 million in a Series A funding round led by WisdomTree, the $44.5 billion exchange-traded fund (ETF) and exchange-traded product (ETP) asset manager. 

This shows traditional financial firms getting in on the security token action. 

Two. SEC seeks to force Telegram to reveal how $1.7bn ICO funds were spent

According to SEC, the encrypted messaging service app provider has so far refused to provide any financial information, including how the money has been spent in the past two years. 

The SEC is the top cop in this space and their actions are watched closely by all players in security tokens.

Three. Security Token Show features ZiyenCoin As One of the Leading Security Tokens in 2019

Ziyen Energy has been featured as “One of the Leading Security Tokens That Launched in 2019” by the Security Token Market (STM) on their latest podcast.

This shows Security Tokens breaking into mainstream markets as Ziyen Energy is in oil & gas, nothing to do with Crypto other than the financing mechanism.

We have a self-imposed constraint of 3 news stories each week because we serve busy senior leaders in Fintech who need just enough information to get on with their job.

For context on Security Tokens please read the chapter on Security Tokens in our Blockchain Economy book and read articles tagged Security Tokens in our archives. 

You get 3 free articles on Daily Fintech. After that you will need to become a member for just US$143 a year (= $0.39 per day) and get all our fresh content and our archives and participate in our forum.

The post The Week ending 10 January 2020 in Security Tokens appeared first on Daily Fintech.

Bitcoin, Blockchain, Cryptocurrencies, Daily Fintech Advisers, security token

Announcing the Daily Fintech weekly news curation on Security Tokens

utility security tokens.001Tomorrow’s post will be the first in our weekly news curation on Security Tokens.

Each Friday we will choose the 3 most important news stories during the week (in the opinion of the News Curator for Security Tokens). Daily Fintech believes in constraints, because our mission is high signal to noise ratio. We do not want to overwhelm you by aggregating every news story (which is technically simple to do). We serve busy senior leaders in Fintech who need just enough information to get on with their job.

For each story we offer a) an extract from the news b) a link to the news report and c) a brief commentary on why our News Curator considered it important. 

For context on Security Tokens please read the chapter on Security Tokens in our Blockchain Economy book and read articles tagged Security Tokens in our archives. 

You get 3 free articles on Daily Fintech. After that you will need to become a member for just US$143 a year (= $0.39 per day) and get all our fresh content and our archives and participate in our forum.

The post Announcing the Daily Fintech weekly news curation on Security Tokens appeared first on Daily Fintech.

blockstack, ico, Reg A+, regulation, SEC, security token, WealthTech

Amazingly, the SEC may have got it almost right with the Reg A Blockstack token offering and this may define a new innovation capital market

Reg-A-Quadrant.001.jpeg

TLDR. Napster blew up the music business with free and illegal. Then we had low cost and legal like Spotify, Pandora and iTunes. The same is happening to innovation capital. The summer of 2017 ICO, kicked off by Bancor, was the now illegal way to raise a lot of money easily and at virtually no cost. That was a lousy deal for investors and naturally then regulators jumped in.   

This update to The Blockchain Economy digital book covers:

  • What is broken in the legacy innovation capital business
  • Why the ICO went too far in the opposite direction
  • The news about Blockstack and Reg A
  • Reg A Basics
  • Blockstack Basics
  • Jurisdictional competition will continue
  • Context & References

What is broken in the legacy innovation capital business

In March 2017, in Crypto equity via ICO and the other innovation chasm we wrote that:

“Most entrepreneurs understand the chasm between MVP (Minimum Viable Product) and PMF (Product Market Fit). The low cost to build MVP increases supply, but real demand does not change that fast, so lots of MVP ventures fall into the chasm (i.e. they fail).

The next chasm is less well understood. This is the chasm between PMF and Liquidity (via an IPO on the Public Markets and failing that via trade sale).

Today, we don’t see this chasm so clearly because there is a very expensive bridge across it – in a few locations. The very expensive bridge is provided by the big PE/VC Funds.”

Why the ICO went too far in the opposite direction

In 3 hours that shook my world: the Bancor ICO in June 2017 we described Bancor raising over $150 million in 3 hours in an ICO that kicked off the ICO craziness in 2017 when ventures could raise huge sums on not much more than a “minimally viable white paper”. The ICO went too far in the opposite direction – good for the entrepreneur and bad for the investor.

The news about Blockstack and Reg A

The news as reported in many media outlets was that the SEC gave Blockstack the go-ahead to conduct a $28 million digital token offering under Regulation A (which enables smaller companies to raise money from the public with less strenuous accounting and disclosure standards than a traditional IPO).

This is big news because the SEC is creating a new protocol for token offerings under Reg A. This is tokenized early stage crowdfunding. While neither  tokens nor crowdfunding are new, this the first time they have been combined in a global market that US public investors can participate in.

America has been losing ground in crypto as it was not perceived as a friendly regulatory environment. This news is a big win for American entrepreneurs and investors.

Reg A Basics

Regulation A as per the SEC:

“is an exemption from registration for public offerings. Regulation A has two offering tiers: Tier 1, for offerings of up to $20 million in a 12-month period; and Tier 2, for offerings of up to $50 million in a 12-month period. For offerings of up to $20 million, companies can elect to proceed under the requirements for either Tier 1 or Tier 2.

There are certain basic requirements applicable to both Tier 1 and Tier 2 offerings, including company eligibility requirements, bad actor disqualification provisions, disclosure, and other matters. Additional requirements apply to Tier 2 offerings, including limitations on the amount of money a non-accredited investor may invest in a Tier 2 offering, requirements for audited financial statements and the filing of ongoing reports. Issuers in Tier 2 offerings are not required to register or qualify their offerings with state securities regulators.”

Blockstack Basics

Blockstack describe themselves as the” easiest way to build decentralized apps that can scale” and claim over 120 independent developer teams that have built apps on Blockstack.

Like Ethereum and many ICOs, Blockstack is a developer-focussed open source platform. It is the sort of innovation that the crypto community needs.

Jurisdictional competition will continue

In Some Governments Want To Shut Down Bitcoin But They Don’t Know How we wrote that:

“For a long time, entrepreneurs faced competition and regulators sent them the rule book. Regulators were government employees who thought about competition only in the abstract;  competition was something that other people had to worry about.Today, the environment is more fluid as governments recognize the economic return on innovation in terms of jobs and GDP growth. The regulators now face real competition because their political masters have to keep citizens happy and citizens care about jobs and GDP growth. Both Fintech upstarts and incumbent global banks are increasingly mobile; so jobs can disappear fast if regulators get it wrong. Plus, innovation is the primary driver of productivity which drives GDP per capita. Pity the poor regulator who must balance that with protecting citizens from fraud and enforcing existing laws.”

This jurisdictional competition is a good thing because while, the SEC may have got it almost right with Reg A and the Blockstack token offering, there is still room for improvement. If you look at the details, you will see that accredited investors get in early and the public get in later. The public gets in earlier than they do in a traditional IPO, but this is still a two tier market. In a global market with jurisdictional competition, expect big moves by Singapore, Hong Kong, UK, Switzerland the EU and other tech/finance centers.

Context & References

3 hours that shook my world: the Bancor ICO in June 2017.

Crypto equity via ICO and the other innovation chasm

Some Governments Want To Shut Down Bitcoin But They Don’t Know How

Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is CEO of Daily Fintech and author of The Blockchain Economy.

I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.

Subscribe by email to join other Fintech leaders who read our research daily to stay ahead of the curve. Check out our advisory services (how we pay for this free original research).

The post Amazingly, the SEC may have got it almost right with the Reg A Blockstack token offering and this may define a new innovation capital market appeared first on Daily Fintech.

Bitcoin & Blockchain, Regulation & Compliance, SEC, security token, tkj, utility token

The SEC TKJ No Action letter re Utility Tokens – takeaways & questions for entrepreneurs

SEC TKJ.001.jpeg

TLDR On 3rd April 2019, the US Securities Regulator, SEC, issued a public response to TKJ (TurnKey Jet Inc) that stated unequivocally that the Tokens issued by TKJ are not securities. This may offer regulatory clarity for Utility Tokens, but the devil is as always in the details. This post is one entrepreneur’s attempt to parse these details to understand the legal landscape around Tokens.

Here is the original SEC announcement.

IANAL Disclaimer. I Am Not A Lawyer. Get proper legal advice. This is just one entrepreneur talking to other entrepreneurs.

This update to The Blockchain Economy digital book covers:

  • Takeaways from each of the points in the SEC notice
  • Case Law is different from Civil/Code Law
  • Choose your playing field – Regulated or Unregulated
  • Context and References

Takeaways from each of the points in the SEC notice.

Our takeaways in italics

  • TKJ will not use any funds from Token sales to develop the TKJ Platform, Network, or App, and each of these will be fully developed and operational at the time any Tokens are sold;

Don’t use Utility Tokens to raise capital. For that, use Security Tokens. TKJ was not raising capital. In venture terms, you need to at least have working code ie MVP (Minimum Viable Product).

  • the Tokens will be immediately usable for their intended functionality (purchasing air charter services) at the time they are sold;

In short, use Utility Tokens for marketing, not for capital raising. PrePaid Tokens work when supply is limited. This is clearly true for air charter services (which is what TKJ offers) and most analog physical world services. If supply is limited, customers are motivated to order ahead. This is very different from most digital services which are defined by being unlimited supply (because of almost zero cost to copy). Smart entrepreneurs will figure out how to create premium digital services with limited supply but with digital efficiency. An example might be a physical artefact with some special branding for fans.

  • TKJ will restrict transfers of Tokens to TKJ Wallets only, and not to wallets external to the Platform;

The term wallet is confusing here. The SEC definition seems to assumes open source crypto wallets that anybody can use. No problem, plenty of choice here. This is not like physical wallets where we can have multiple tokens (cash, loyalty cards, credit/debit cards) in a single wallet. In the digital realm, the equivalent to that physical wallet is our mobile phone. The term wallet as used by SEC is more like a combination of loyalty card with pre-paid card.

  • TKJ will sell Tokens at a price of one USD per Token throughout the life of the Program, and each Token will represent a TKJ obligation to supply air charter services at a value of one USD per Token;

SEC jurisdiction is America where USD is the currency, so their reference currency is USD.  For other jurisdictions the token will need to be priced in other currencies. The more fundamental point is that these tokens are non-fungible. You can ONLY use them to buy air charter services.

  • If TKJ offers to repurchase Tokens, it will only do so at a discount to the face value of the Tokens (one USD per Token) that the holder seeks to resell to TKJ, unless a court within the United States orders TKJ to liquidate the Tokens

This is a sensible precaution against ponzi schemes, where the issuer gives early buyers a guaranteed profit. Note the words “unless a court within the United States”. Our mantra at Daily Fintech is “bits don’t stop at borders but money has to show its passport”; financial regulation is jurisdiction dependent.

  • The Token is marketed in a manner that emphasizes the functionality of the Token, and not the potential for the increase in the market value of the Token.

Note that TKJ is NOT a cryptocurrency business; they are a business in the physical world that is using cryptocurrency technology to grow their business. This would be like selling Taxi Medallions as Tokens. The Medallion/Token buyer aims to offer a taxi service and may or may not be able to sell the Token/Medallion for a profit later. Utility Tokens are about marketing not capital raising. For a brief moment in 2017, entrepreneurs got a two for one deal in ICOs that enabled both marketing AND capital raising. Those days are over. Although the new rules seem like a limitation, the biggest issue for most ventures is marketing, not capital raising. So using Utility Tokens to reduce Customer Acquisition Cost (as we explore in this related chapter) is a big deal.

Case Law is different from Civil/Code Law

The SEC letter is no guarantee and the SEC staff reserves the right to change positions.

This is just how case law works.

The law in the USA & UK and many countries is case law (aka common law), where the law is established by the outcome of former cases (aka precedent). This is very different from what is sometimes called civil law (which I call Code Law for reasons explained below) in countries such as China, Japan, Germany, France

For more background on Case Law vs Civil/Code Law please read this.

Civil/Code law originated in the code of laws compiled by the Roman Emperor Justinian. Civil law has codified statutes. I prefer the term Code Law to Civil Law as this style of law is what developers/coders prefer and instinctively assume. You can turn Civil/Code law into computer code in Smart Contracts. It is much harder to do this with case law where you will often be told “well, it depends” or “it will be judged on a case by case basis”. This is why you must consult a lawyer and why the SEC announcement has this boilerplate language:

”This position is based on the representations made to the Division in your letter. Any different facts or conditions might require the Division to reach a different conclusion. Further, this response expresses the Division’s position on enforcement action only and does not express any legal conclusion on the question presented.”

Choose your playing field – Regulated or Unregulated

Fintech Entrepreneurs have 3 basic regulatory strategies to choose from:

  • A. Full stack regulated. You ask for permission upfront. Budget for big legal and compliance bills. Compete directly with banks. Do this in every jurisdiction you want to do business in (state by state in America and country by country in Europe).
  • B. Full stack unregulated. This is what Uber, AirBnB and Skype did. You act boldly without upfront permission and either seek forgiveness or fight (depending on how powerful the regulator is). Banking is far more protected/regulated than taxis, lodging or telecoms, so this is a dangerous strategy in Fintech, but can work for some types of user for Bitcoin related services.
  • C. Lower in stack unregulated. Provide services to regulated companies north of you in the stack.

Bitcoin is C.  Companies northward in the stack provide the user facing functionality and can choose either A or B.

Context & References

Investing in Utility Tokens.

Entrepreneurs who use Utility Tokens to reduce CAC (Customer Acquisition Cost) will create the most valuable Security Tokens

Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is CEO of Daily Fintech and author of The Blockchain Economy.

I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.

Subscribe by email to join the 25,000 other Fintech leaders who read our research daily to stay ahead of the curve. Check out our advisory services (how we pay for this free original research).

Bitcoin & Blockchain, brexit, Fintech Global Tour, security token, seis

How the UK could become the early stage Fintech capital of the world post Brexit thanks to Securities Tokens

brexit

This week is Brexit week. Personal disclosure: I think Remain was the right option. However, as a business person I know that you have to work with whatever actually happens, rather than what you hope will happen and that you look for opportunities in problems that the world delivers to you.

At Daily Fintech we look at world events through the narrow lens of “is it good or bad for Fintech?”

So, here amidst the doom & gloom, is my optimistic case for Fintech post Brexit.

I specifically wrote early stage Fintech capital of the world. The tremendous tax incentives in the UK for investing in startups via Seed Enterprise Investment Scheme (SEIS), is a big driver for early stage. Other places may have bigger pools of capital for doing later stage deals (Silicon Valley is dominant there) but in few places are the incentives as good for early stage – and ventures have to go through early stage to get to late stage (said Captain Obvious).

SEIS offers unparalleled incentives for high income people to invest in startups. Even if a venture fails they get a lot of tax back immediately. On exit, they get zero capital gains tax, after 3 years minimum holding.

SEIS has been around a while. So has Fintech. What is new is the emergence of legal Securities Tokens. Look at these from the perspective of that early stage investor. The investment is priced by the market and can be traded (if Securities Token exchanges get their act together with some reasonable liquidity/spreads). Perhaps more important is it becomes harder for big Funds to come in at the next round on terms that disadvantage you as an early investor (not impossible, just harder).

For the entrepreneur/capital raiser, the fact that SEIS offers zero capital gains tax after 3 years minimum holding puts a de facto lock-up into the terms (because any investor selling before 3 years loses this tax advantage).

If the UK is the place where investors can go from angel/seed to exit within 3 years, the UK is where the best entrepreneurs will want to be – and where the best entrepreneurs want to be will be where jobs and prosperity is created.

What about access to Europe? Entrepreneurs can choose jurisdictional locations and strategies that give access to investors in different locations around the world. Many ventures today are decentralised with people in multiple locations. Consider Ethereum as an example (with developers and other employees all over the world. Talent can choose where they want to live; entrepreneurs and investors follow talent.

What about all those Banks relocating out of London due to Brexit? For those losing jobs and those who depend on them, it is 100% bad news. For Fintechs looking for talent and users it is good news.  Many of the jobs will be automated anyway and an HR policy of “relocate due to Brexit” simply avoids having to fire people due to automation.

So, London could become the early stage Fintech capital of the world post Brexit thanks to Securities Tokens.  There are lots of policy, regulatory, legal and technical issues to make this happen, but nothing that is rocket science. 

The real issue is London as a diverse, fun talent magnet. The passporting/regulatory issues are far more manageable. If Brexit means entrepreneurs cannot recruit talent from around the world regardless of country of origin, religion, colour, sexual orientation, then all bets are off.

The solution is simple. Every startup given SEIS status should have the right to offer work/residency permits to whoever they want, from anywhere, no questions asked.

It is a real opportunity, but we should never underestimate the ability of politicians to snatch defeat from the jaws of victory. 

What are you seeing? How will this play out? Please go to this thread on Fintech Genome to comment.

Image Source.

Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is CEO of Daily Fintech and author of The Blockchain Economy.

I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.

Subscribe by email to join the 25,000 other Fintech leaders who read our research daily to stay ahead of the curve. Check out our advisory services (how we pay for this free original research).

Bitcoin & Blockchain, Blockchain, Consumer Banking, DX Exchange, security token, wall street

DX Exchange Security token model could democratise Wall street

2019 is the year of the Security tokens. We have had several ebbs and flows in the Blockchain industry over the last few years. Events of the past 18 months especially have shaken the industry into some serious introspection.

Revelations around the lack of controls and regulations around capital raising models have brought the industry into serious disrepute – in such a fashion that the merits of the Blockchain framework have been challenged. Being a passionate student and a commentator of the industry, I still believe, the model is intact, its the controls around it that have failed to stop human greed from causing havoc.

On the brighter side though, security tokens were seen as the bail out for the industry in many ways. Towards the end of 2018, there were a lot of talks that the model has merits, and as soon as the year opened, we have had the news of DX Exchange platform launch.

The DX Exchange platform allows bluechip stocks traded in NASDAQ on Blockchain using security tokens – this would cut out the middlemen, and when rolled out across markets, would save Billions. The disintermediation that the model brings to the table, will also put several business models dependent on Wall street at risk.

Why is this a better model than an ICO? Is this just another hype? Is this a perfect model that will create the new inclusive Capital markets?

I believe, ICO was the wrong start to the right journey. Being an early stage Venture Capital investor, I understand that valuing a startup is more of an art than science. There are very few data points. So when a business that has no way to value itself goes on Blockchain, the intrinsic value behind the tokens will be challenged by the traditional financial services industry.

Blockchain purists will argue that the new capital markets driven by Blockchain wouldn’t need traditional financial services principles AS-IS. However, what we are trying to do with Blockchain is a massive change in the way we exchange value, and that can only happen by collaborating with the incumbents.

If value has to move from traditional markets to the Neo Market, it can’t happen without key stakeholders in the traditional markets understanding the value of the Neo Market and embracing it. Security tokens can make that happen.

DX stressed that its digital stocks are classed as derivatives — with the underlying asset being equity of 10 Nasdaq-listed firms — and that its platform is regulated under the European Union’s Mifid II directive

CNBC News

With Security tokens, the problem of intrinsic value is resolved. When you have a token that’s valued based on an underlying stock – most people who understand derivatives will get it. Of course, the tokenisation process, the exchange, its participants, operational details of managing transactions will have to be regulated and audited regularly to ensure that the security token industry gains credibility.

In doing so, we would have created a disintermediated Neo market on the Blockchain, but still largely within a traditional financial ecosystem. That is the first step, and I believe the right step for Blockchain in Finance.

Will there be scams? There will be – for sure. But I believe the worst of these scams are behind us, and with controlled progress, the Blockchain industry should see the adoption that it was meant to.

I am really hopeful that there will be a day when Mangoes from my farm in India and Buckingham palace will both go on Blockchain, and I will be able to trade some equity in the palace with Mangoes.

Arunkumar Krishnakumar is a Venture Capital investor at Green Shores Capital focusing on Inclusion and a podcast host.

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Bitcoin & Blockchain, security token, Uncategorized

“Build It and They Will Come” – Security Tokens at the Gate

castle_stock_parts__18_drawbridge_gate_chains_by_madetobeunique-d80t32y

This post, the 4th in a series of 4, is written by Sheldon Freedman, a fintech and funds lawyer at Hassans in Gibraltar. Click here for last week’s post in this series.

2019 is widely anticipated by blockchain bulls to be the year of the security token. In Instalment 1 of this 4-part series, we described how security tokens are created through strong cryptography, able to digitally represent ownership in an asset, such as shares in a company or fund, real estate, rights to cash flow or financial instruments.  In Instalment 2, we looked at how security tokens are generated on Ethereum-based platforms employing blockchain technologies.  In Installment 3, we observed how new regulatory frameworks for these new securities called “security tokens” do not yet exist – that the issuance and exchange of security tokens is being conducted under existing, traditional securities laws of registration and exemption, while complying with comprehensive, overlapping, global anti-money laundering/sanctions regimes. Today’s concluding segment previews what lies ahead in the coming months for security tokens.

Exchanges, Trading and Liquidity. 

Markets can only operate effectively with liquidity. The creation, i.e. issuance, of a security token is a preliminary step, giving birth to the token. But for securities markets and security tokens to live meaningful lives, there must be robust secondary trading via exchanges which is fully-automated, reliable, inexpensive, scalable, rapid in trade and settlement, compliant, always-on, global. Just as company stock issuance boomed with the development of centralized stock exchanges, so too the security token industry would flourish as decentralized security token exchanges develop. “Build it and they will come” is the mantra that is usually mocking engineers who build nifty technology and assume without any basis in market reality that everyone will want to buy it because it is nifty.  However, if people want to trade security tokens, this mantra is in fact true for security tokens exchanges: demand will follow supply.  Building security tokens exchanges and secondary markets requires enormously complex business, legal and technical collaborations married to massive amounts of capital, but in the coming months we will see beginnings of this integration of blockchain markets into traditional finance.

In Europe, most notably Switzerland’s stock exchange owned and managed by SIX Group is building a fully-integrated trading, settlement and custody infrastructure for digital assets, known as a ‘digital asset ecosystem’ – SIX Digital Exchange.  SIX (acronym for Swiss Infrastructure and Exchange) operates the infrastructure of Switzerland’s financial center.  In USA, the Boston Stock Exchange and subsidiary BOX Digital Markets have announced a partnership with token platform tZero to launch the world’s first regulated security tokens exchange Q2-19. 

tZero is championed by super crypto-bull, Patrick Byrne, CEO of parent company, Overstock.com.  Byrne is committed to integrating blockchain capital markets into the US National Market System (NMS). Byrne is, in effect, staking Overstock’s future on tZero, which is burning at least $2 million per month. “I don’t care whether tZero is losing $2 million a month, “Byrne was quoted yesterday in the Wall Street Journal. “We think we’ve got cold fusion on the blockchain side.” 

This is the creed of blockchain True Believers, which is powering the development of security token infrastructure.  Like other blockchain-related infrastructure companies, Overstock raised capital from the sale of its own security tokens:  $134 million to be exact.  Mr. Byrne is not alone, as investors and blockchain pioneers charge ahead. The Wall Street Journal reports in its article that, according to Overstock, Hong Kong-based GSR Capital has agreed to invest up to $270 million in tZero equity that would value tZero at $1.5 billion. GSR would not confirm this claim to the Wall Street Journal. 

Security Tokens Issuing Platforms.   

Security tokens issuing platforms are daily becoming faster, cheaper, smarter. Decentralized applications (DApps) with back-end code are being developed in every part of the globe where there is a developer-grade internet connection. Several outstanding, mostly USA-based, Ethereum platforms issue tokens, and manage the investor process and the tokens through the lifetime of the asset, such as Securitize, Harbor, Securency, Swarm and Polymath (Canada). tZero expects to be handling token transactions by Q2-19, beyond issuing and managing, as well as offering an alternative trading system moving into other investment sectors such as debt, real, estate and other tokenizable asset classes.

European platform, Token Market, based in Gibraltar, [disclosure – client of the writers]has this week become live as the first security tokens issuing platform offering to public retail (as distinct from private) investor markets. Token Markets was selected by the UK regulator to assist in carrying out security tokens offerings to test, measure and develop issuance of digitized equity in UK.  Lithuanian platform, DESICO plans in 2019 to launch a securities exchange that will provide immediate listing and liquidity for security tokens, operating in conjunction with the Bank of Lithuania.

Impressive platforms with breakthrough architecture/technology may move beyond Ethereum technology.  EOS is believed by many in the longer term to eclipse Ethereum with higher scalability and lower cost.  Distributed platform Cardano claims to be more scalable and more decentralized than Ethereum, as it scales through side-chains/horizontally. Cardano, administered by the Cardano Foundation in Switzerland, was created in Hong Kong, and is led by Charles Hoskinson, co-founder of Ethereum.

Regulation, Compliance.

Financial services represents about 15% of the world economy; inevitably, significant portions will be digitized and integrated.  Though counter-intuitive to some, in financial services industries intensive regulation and strict enforcement are key to establishing confidence, orderly operation and mass adoption. The stringent regulation and enforcement governing financial markets in the USA have helped make the USA financial markets the envy of the world, the model to emulate.  Securities industry regulators are the critical partners in any development of the security tokens industry.  All stakeholders, aware of this, – cheer regulators on to action, or condemn their inaction.

In coming months, there will be significant step-up in activity by issuers and investors under existing global securities regulation, smart contract-auditing procedures and disclosure practices, and evolving regulation of the blockchain-related ecosystem.  Enormous investments of time and acquisition of domain expertise are required for regulators to understand sophisticated systems, methods of capital formation and investor interfaces, and the complex financial services implications that flow from their deployment and development.  The SEC, for example, by its FinHub  is committing considerable resources to engaging ecosystem players.  In addition to being a resource for the industry providing information about the SEC’s views and actions in the FinTech space, FinHub is a forum for SEC staff to engage the public

UK has shown aggressive innovation in crowdfunding by providing exemption for equity offerings up to EUR8 million, stimulating the crowdfunding industry. It came as no surprise when UK regulators (Financial Conduct Authority) recently launched a dedicated regulatory sandbox which includes exchanges for security tokens.  Successful applicants benefit from lower regulatory thresholds and receive direct guidance from the regulator, while the FCA gains confidence and understanding working with new financial technology and processes.

Gibraltar, a first-mover in legislation for digital assets, is the world’s first jurisdiction to license distributed ledger technology for blockchain and fintech businesses. Next month, Gibraltar is publishing shovel-ready legislation for security tokens compliant with all EU directives, the fruit of unified efforts of Gibraltar regulators and local industry experts.

Conclusion

  Security tokens are theoretical game-changers for financial and ownership models, allowing any asset or fund to offer equity, debt, full or partial ownership or revenue share. Bulls and bears abound. For investors security tokens are secure, virtually incorruptible, and accessible to trade by anyone with an internet connection. In the longer term of three to five years, comprehensive fintech banks will have to emerge to conduct the securities token industry to act as traditional investment banks performing funding, underwriting, compliance, retail distribution, analysis, legal and advisory functions to manage processes, because the development of the security tokens industry going forward is about 20% technology, and about 80% regulatory/business. If security tokens will continue to provide access to compliance features for issuers, signs of liquidity for investors and a framework for oversight to regulators, then 2019 could belong to the security token.

Omri Bouton co-wrote this.  We are both at Hassans.

Recommended reading for further research: 

  • StartupEngine Summit – Tokenizing the World, with excellent panels from StartEngine conference October 19, 2018 Los Angeles

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Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is the author of The Blockchain Economy and CEO of Daily Fintech.

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The To Do List for Security Token Platform operators

checklist

Sheldon Freedman will return next week with the last of his 4-parter on Security Tokens. Today’s post is stepping back and looking at the motivations on both sides of the table. What do entrepreneurs and investors want and how do their needs offer a To Do List to Security Token platform operators?

Innovation comes from deep pain meeting disruptive technology. Security Tokens can tokenise just about any asset. Our thesis is that the early adoption traction will happen in early stage stock, because that is a big broken market where there is deep pain on both sides of the table.

The deep pain of entrepreneurs raising money from Legacy VC has been detailed many times, including here in our first take on ICOs in March 2017. During the ICO bubble of 2017, the pendulum swung too far in the other direction (evidenced by raising $100m+  in hours without even a working product). Now the pendulum needs to swing back a bit towards investors (but not as far as it used to be before the Token revolution started).

Investor Pain

The other side of the table – the investors – also suffer pain based on having a lousy set of options:

  • Public Equity Markets. Investors have an ugly choice of IPO valuations of tech growth stocks at nosebleed valuations or more conservatively valued old companies that are badly impacted by disruption (e.g do you invest in AirBnB at high valuation at IPO or in conservatively valued Hotel stocks that will be disrupted by AirBnB?).
  • VC Funds. Investors who want equity much earlier than IPO have the option of buying into sub par VC funds, when the lion’s share of returns goes to a few top tier funds that are not accepting new investors.
  • Direct Angel Investing. investing in early stage deals directly is risky when there is almost no price discovery, liquidity, or portfolio construction ability and a lot of Due Diligence overhead.

To Do List for Security Token platform operators

These are the 5 things that Investors want from a good Security Token platform. This the To Do List for Security Token platform operators:

  • Basic quality filtering to create a short list for investors. 
  • Price discovery & liquidity. 
  • Portfolio construction ability. 
  • Co-Investors.
  • A network of service providers.

Basic quality filtering to create a short list for investors.

It is NOT hard to get Security Token issuers (aka entrepreneurs). They will be lining up at the doors of Security Token platform operators. Within the crowd of entrepreneurs lining up at the door will be a mix of:

  • Really great ventures in their early days (what every investor wants).
  • Ventures that do OK, make some money for investors but not a lot 
  • Ventures that go smash with money back for investors from something like an Acquire Hire deal
  • Honest Ventures that go smash with zero back.
  • Scam Ventures that go smash with zero back.

The last two are similar in terms of returns but the last one is relatively easy in most cases to get via a fairly crude filter (but not all, think big public market failures like Enron and Worldcom). Basic quality filtering should deliver a short list to Investors and the platform needs to ensure that the ecosystem of investors, advisers and service providers are compensated well to do that filtering job.

Basic quality filtering only delivers a short list to investors. Then the hard work starts. Without that basic filtering the job is well nigh impossible – meaning investors ignore the platform and eventually entrepreneurs desert the platform. That is why basic quality filtering is Job No 1.

Price discovery & liquidity.

The public equity markets are excellent at delivering price discovery & liquidity. Private markets (where all early stage deals are done) are totally opaque. Valuation/price is set in bilateral negotiations behind closed doors. There is no price discovery via shorting (which explains the historically bizarre inversion where private stock has higher valuations than public stock).  The hope for Security Tokens is that markets develop that bring price discovery & liquidity to these opaque private markets for early stage equity. The question is how that price discovery & liquidity will come about. I can only see two scenarios:

  1. Centralised exchange dominance. We get something similar to the NYSE/NASDAQ duopoly plus a lot of second tier regional exchanges.
  2. A more decentralised data feed driven ecosystem, where aggregation can be done by whoever takes the data feed.

I reckon that two is more likely for one simple reason. In the Legacy Finance era we had one dominant geographic market (USA) and so it was natural for NYSE/NASDAQ to rise to dominance. We now live in a multipolar world and the Token market is naturally global. The promise of the Token market is that a great team anywhere can raise capital. That requires a decentralised data feed driven ecosystem. This means that aggregation can happen by whoever takes the data feed. So there will be competition to add value at this level. 

This data feed is also what enables a portfolio construction ability. 

Portfolio construction ability 

Classic portfolio diversity means getting ventures that are diversified across geography, domain, stage and business model.

Investors in early stage stock have two options if they want to follow prudential norms for risk management through portfolio diversity:

  • Delegate portfolio construction to a Fund and pay them 2 and 20. You accept their model for  portfolio construction.
  • Use a data feed to construct your own portfolio.

That is relatively easy to do if we get a decentralised data feed driven ecosystem. All the platform operator needs to do is make sure that Security Token issuers fill in a basic form detailing geography, domain, stage and  business model and make that data available in a data feed.

A more sophisticated form of risk management will be enabled by a platform operator that insists that entrepreneurs report financials using XBRL (see this post for more). Imagine, for example, being able to see total cash position and cash burn across a portfolio of early stage stock.

Geographic diversity is a particular issue for early stage equity. It is an axiom of early stage equity that entrepreneurs and investors must be close enough to meet regularly (the  famous “one tank of gas in a Ferrari” for Silicon Valley VC). That problem is solved by having co-investors who trust each other. 

Co-Investors.

This is where the interests of entrepreneurs and investors align. The biggest fear of both is the venture running out of cash – that is how ventures fail in practice.

If you are limited to investing in local ventures, your pool of investors is small (unless you are in Silicon Valley). This is where investors need to build relationships with co-investors in other locations. For example, lets say you are in London but you see a good deal in Dubai. If you know a good investor in Dubai, you bring that deal to him/her. He/she does the same for you if they see a deal in London. The same can happen by domain and business model. In some deals you are a Lead, in others you Follow.

A network of service providers 

Investors need Lawyers, Accountants, Domain Experts and other experts. Due Diligence is a critical step in investing. A winning platform will have a good  network of service providers who are vetted and rated.

What entrepreneurs want from a Security Token platform

Entrepreneurs raising money are always in a hurry. They see a window of opportunity and want some cash in the bank so that they can execute on a plan. Investor conviction needs to take time – it should be hard. It is the next bit that should be easy. The mantra is schmooze offline, transact online. Once you have a lead investor it should be easy to close the round. It is not easy today. This is a deep pain point for entrepreneurs. These entrepreneurs will be highly enthusiastic early adopters of Security Token platforms that will make the step from finding a lead investor to closing the round and getting cash in bank. What entrepreneurs want is a simple way for everybody who wants to invest to do it online.  Execution of what we all want should be easy. You know, all those boring bits from “yes I want to invest, to money in the bank”. Shaving say 10% off a boring process like that is…boring. Taking a 90% axe to processes like that is exciting and game-changing. Security Tokens can enable that. This is win/win for investors and entrepreneurs – nobody likes this cost/delay.

If we get Security Token platforms that deliver on this To Do List, it will be great for entrepreneurs and investors and for everybody else who benefit from good jobs and wealth creation from the increase in innovation. I am an optimist because a) none of the things on that To Do List is rocket science and b) the prize for a platform operator who gets it right is very big. 

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Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is the author of The Blockchain Economy and CEO of Daily Fintech. 

Check out our advisory services.

Get fresh daily insights from an amazing team of Fintech thought leaders around the world. Ride the Fintech wave by reading us daily in your email.