Current constraints of the global market of digital securities
Author: Gene Deyev (CEO, STOBox Platfrom), Eugene Pashchenko (Head of Communications, STOBox Platform)
Security tokens are already claimed as a future of fundraising, next big trend of 2019 and even ICO killers. Yes, all the forecasts could be real. But widespread optimism shouldn’t make us forget about pitfalls and constraints.
Question of definition
DSO? STO? DAO? TSO? ETO? SSO? What way else our concernment can be called? Lack of accuracy is normal for the newborn industry, but it’s still important to define what are security tokens.
Security Tokens are:
- Compliant and regulated;
- Digitally smart;
Yes, blockchain is not included in the list. Does it mean that security tokens can be issued on non-blockchain ecosystems? Actually yes, but blockchain is the most applicable technology for it.
Securities on blockchain can be of different forms:
- Traditional securities i.e. equity or debt, Loyalty points with advanced rights;
- Real Estate securities as tokenized area (m2);
- Professional Skills (tokenizing working hours of professionals);
- Alternatives (tokenizing and fundraising for music albums or pieces of art).
How do we see the future with digital securities being globally adopted?
Despite it takes time to get there, when security tokens will be adopted, it will have some definite properties.
- Secure & Transparent. Secure infrastructure and transparency of transferred data.
- Internationally compliant. All transactions are legally compliant and seamlessly.
- International trading & exchange. Seamless cross-blockchain cross-border securities trading.
- Personal decentralized wallet. Safely purchase, hold, trade.
Now the market is in the early stage of development, but experts are rather optimistic and regulators are quite clear.
Robert Greifeld, Former Chairman and CEO of NASDAQ: “100% of stocks and bonds trading on Wall Street today will be tokenized in five years”.
Scott Purcell, CEO and Chief Trust Officer at Prime Trust: “We will see more broker-dealers, more exchanges, more investment advisors, more lawyers and more crowdfunding portals embracing tokenization of securities. The market will get more professional, and far larger and more dynamic in 2019”.
Heather Pierce, Commissar, SEC: “The SEC applies existing securities laws to these securities offerings, which means that they must be conducted in accordance with the securities laws or under an exemption”.
Chuan Ji Lim, Senior Manager, Gibraltar Stock Exchange Group: “We view tokenized securities as just another variant of a security — is it a paper bond, digital share or tokenized security. So ask yourself — is your offering compliant with relevant existing securities legislature, and is the secondary trading occurring on a regulated stock exchange or equivalent”.
Digital securities market is a newborn
Let’s take a critical look at the industry.
We have only three fully compliant and security tokens active exchanges: tZero, Open Finance Network, Templum. First one, tZero, is active but the sole listed asset, for now, is its own token TZROP (which dropped 50+% since the launch). Second, Open Finance Network is really working and trading, adding some new tokens two weeks ago. The third one, Templum, let users request early access to the platform. The website points out three recent announcements. One of them, St. Regis Aspen Resort, after closing $18M security token sale, has already migrated its tokens to Securitize protocol.
Active issuers are only four: Neufund, Polymath, Swarm, Securitize. But Harbor and Securrency are on their way.
Information about the STO number could be quite confusing. Bloomberg says it was 25 in 2018, Kepler Network counted 32 projects, which were announced on platforms like Polymath, Neufund, and others. What is more, Inwara said it was 81 at the end of October 2018 and Security Token Group informs in February 2019 that market reaches 100 listed Security Tokens. The truth, as might be, lies somewhere in between.
Lack of professionalism
Despite all the titles “STO is the next generation of ICO”, it isn’t correct to the full extent. STO is not ICO 2.0. But while it isn’t as clear as day, players from non-regulated crypto fundraising market are convinced that the security tokens are just the next step. But it’s far more complicated — security tokens industry is much more closer to traditional asset market than to blockchain.
STO is not even about only issuing. We need the whole ecosystem, where the token can be safely held and compliantly traded at a space with liquidity. And we don’t’ have this infrastructure yet.
While the market is a newborn, it makes investors feel unsure — they are not ready yet. It is no wonder that investors feel uncomfortable in an unknown environment. And one of the challenges is to educate them that tokenized securities are fully compliant with governmental regulations.
So, we can summarize that the professional network is only forming. There are going to be a lot of new players — mature professionals with a clear view of the market. A lot of amateurs, we see now, are going to be pushed off the playing field.
We believe the regulated professional industry will include: Advisory services licensing & Regulation, Global professional networks, Open data of industry members.
Security token market is very perspective as far as global trading promises are of higher liquidity. Nevertheless, the market at the early stage has some problems with this. At first, the lack of regulation stops uncertain investors. At second, there are few active liquidity providers as we see and lack of interesting projects, worth to invest. And finally, the number of successful STO cases is rather low.
Daily trading volume for the security tokens is unavailable, but we are able to compare data from other markets. Nasdaq has 100+ Bln USD, London stock exchange — 5+ Bln, Frankfurt — 4+ Bln, and the whole crypto-market — near 20 billion. It’s a goal, the security token market is only aiming for.
Moreover, let’s not forget that the market is only forming and if the projects focus on the legal compliance and truthfulness of issuers they are on track to attract potential liquidity.
Lack of global legal infrastructure
A legal framework is in progress. All the frameworks and regulations are still being prepared. Although it’s a new asset class, it is still operating by old laws, which may create some collisions.
We still have some legal barriers at the global level. According to the existing order, it’s quite difficult to become a US accredited investor if you are a non-US resident. This can change when the global legal framework would be formed.
Local ST Providers will be developing. Until there is no clear global legal framework, there will be local providers in the security token industry. I.e. projects like seedrs.com — local investment platform for UK investors and UK projects only.
Liberalization of local markets continues. On the route to global investment market there will be a lot of transitional solutions. Some countries will liberalize the process of investment. E.g. Ukraine, where were increased currency and investment limits.
Public VS Private blockchains
Most of the current issuers use public blockchain like Ethereum or else. But it has potential risks. If you don’t see it, just remember 51% attack on Ethereum Classic network and near $1 million loss in January 2019.
First risk — technical. In the case of private blockchains any issues could be solved in the legal framework. Whom will you contact for in the case of Ethereum problems? Then — legal. Private blockchain provides legally bounded relationship between blockchain miners and issuers. Third one — publicity. We are sure there are a lot of companies, who are not willing to share their financial information in public, even data is hashed and cryptographically protected. And don’t forget about blockchain-GDPR compliance. Public blockchain can break the GDPR law. Despite the absence of notable cases, it is important to take that into consideration.
Tokenization of everything could be a reference for industry, but there will be some constraints in any specific sector.
For example, in the case of late-stage startup tokenization. Late stage startups have different SPA (Share Purchase Agreement) for tens-hundreds of investors from different stages. Tokenize all of them means a lot of legal, management and technical work and make all the process nonsense.
Another example — tokenizing music albums by famous artists. Fundraising for such an album in the US could be easy if you use Reg. D exemption. But artists are far more interested in their security tokens everyday use by as many people as possible. This means the artist needs Reg. A+ compliance, which may be complex, time and money consuming.
A bit of optimism
All the herein described constraints are meant not to discourage you from taking a part in the security token industry. Vice versa, our goal is to show most of the pitfalls and to help the young market and its’ players to develop security token network.
We already see successful STO in digital securities industry infrastructure and ecosystem (Neufund), projects with global products need for the global approach (Desico, Nexo), tokenized investment funds (tZero, Blockchain Capital) and first adopters in their sectors (Elio Motors, Aspen Digital, TheArtToken). All of these sectors will be developed at the first stage and new projects are likely to appear.
We should put effort to build a trustworthy network of digital securities market of professionals: entrepreneurs, international legal experts, financial experts and advisors, broker-dealers, blockchain technical specialists, marketers, international investors, industry experts.