With the ICO boom in the rear mirror, investors and issuers are moving towards the Security Token Offering (STO) model. We look at the current STO space, the evolving regulatory framework, recent STO issuances, and ask the question — what happens next?
Following the ICO bear market of 2018, and an increasingly hostile regulatory environment, most issuers, and investors came to the inevitable conclusion that compliant Security Token Offerings are the most viable way forward for new industry raises.
This year has already seen significant growth in security token offerings — which represent traditional securities represented via digital ownership on the blockchain.
A lawful alternative to ICOs for accredited investors, security tokens offer an improved market infrastructure for traditional securities, with increased liquidity, reduced issuance fees, and greater market efficiency.
Over the last six months, these advantages have begun to be realized as companies build the infrastructure to issue security tokens, and forward-thinking jurisdictions pass regulations to govern the offerings.
"2019, for the first time, allowed many legacy financial institutions to see the real benefits of security tokens," said Security Token Market CEO Kyle Sonlin to Brave New Coin. "Many are even considering how to leverage this technology themselves — Bakkt via the ICE, the Libra investment token, and IBM’s debt issuance protocol are all examples of larger players exploring the multitude of opportunities in this space."
From ICO to STO
The inevitable boom and bust cycle of the Initial Coin Offering phenomenon has paved the way for security tokens. ICOs attracted the attention of authorities who are now stepping in with regulations that pave the way for a new form of fundraising. According to Dave Hodgson, Director and Co-founder at NEM Ventures, the venture capital arm of the NEM blockchain ecosystem, the industry will welcome new compliant means of fund-raising. "ICOs worked in a strong bull market, but it became hard to raise capital as the market turned to a bear,” explains Hodgson. “Additionally, some scam ICOs damaged the overall attractiveness of this investment vehicle further. As we’ve come through the bear market and the industry has matured, many companies are seeking to raise capital in a more compliant manner where regulation exists, or in a way that they think will be compliant within future regulation.”
Hodgson told Brave New Coin that several successful issuances have taken place across several jurisdictions. He said current proposals are more mature in their approach to presenting a viable investment opportunity. “The future of fundraising in the short-medium term is likely to focus on traditional startup avenues, including crowdfunding, angels, VC, and private equity, coupled with the newer IEO and STO models. As we move into the era of decentralized finance, I believe a number of interesting finance raising approaches will emerge. We’ve only seen the tip of the creative iceberg in relation to new fundraising models."
Japan and Europe take notice
Japan, which often leads the way in cryptocurrency regulation, enacted significant upgrades to two acts concerning ICOs at the end of May. Both the Act on Settlement Funds and the Financial Instruments and Exchange Act (FIEA) were amended by Japan’s Financial Services Agency to include new regulatory requirements for Japanese ICOs that function similarly to securities.
These changes apply the same laws that govern securities to token offerings, including strict registration requirements, semi-annual reporting, and full disclosure of the mechanics of token issuance, transfers, and settlements.
In Europe, authorities are working towards a legal framework for the tokenization of securities. Malta first passed its Fintech Strategy and Virtual Financial Assets Framework in late 2018 to encourage blockchain development. Last month the Malta Financial Services Authority (MFSA) released a consultation paper that outlines potential regulations for tokenized securities and solicits feedback from the public. The MFSA stated it was pleased to “launch a Consultation Paper on Security Token Offering (STO) as a first and important step in the revision of the regulatory framework behind capital markets in Malta. In line with the MFSA’s Vision 2021, the proposed STO Policy takes into consideration the evolving needs of the industry whilst ensuring high standards of investor protection and market integrity.”
New token protocols
As the regulatory framework takes shape, token issuance platforms are creating their own standards that convert these legal requirements into code using token protocols.
Security token platform Polymath has recently upgraded its own ST-20 token standard to be compliant with Ethereum’s ERC-1400 — which is one of several protocols that allow security tokens to be tailored to the regulatory requirements of specific jurisdictions. This gives platforms the ability to issue securities in multiple different countries, while regulating certain criteria — like holding periods, whitelisted buyers and sellers, and the number of tokens per wallet — to remain compliant with the laws of each jurisdiction.
Polymath’s revised ST-20 standard joins several other tailored token protocols, including Securitize’s DS-token, Harbor’s R-Token, and Start Engine’s ERC-1450, that are already beginning to issue compliant securities on the blockchain to accredited investors.
On Brave New Coin’s Crypto Conversation podcast, Dave Hogdson of NEM Ventures said that NEM’s Catapult update will also add support for the issuance of Security Tokens. “NEM have adopted the Verified Token Framework that was put together by a group of companies including Techemy, Blockchain Labs, and the Gibraltar Stock Exchange, which is a cross-chain framework for how protocol level chains could approach security token issuance and how regulated exchanges could list the tokens and the type of behaviors that are needed to wrap around the industry to make it work."
Sold out offerings
Though there are still issues with security tokens — including low liquidity and an uncertain regulatory environment — launching an STO is already possible, and the first few months of 2019 have seen several blockbuster offerings.
Online lender Bitbond closed Germany’s first-ever regulated STO in early July, with more than $2.3 million raised from 87 different countries. This will soon be followed by startup investment company StartMark, which aims to raise $45 million in a regulated offering on the Ethereum blockchain.
In the US, token platform Securitize is now celebrating the issuance of its tenth on-chain digital asset, which represents an equity stake in the financial publishing analytics firm Curzio.
As blockchain-based equity tokens, all of these examples represent traditional shares in a company, but as time goes on, we could also expect to see more revolutionary applications of this technology, including the tokenization of different kinds of assets, including fine art, real estate and more.
Before that can happen, however, there are still several regulatory barriers to jump, meaning security tokens are unlikely to explode in the same way as ICOs. But as Sonlin suggests, the early signs point towards a technology that is just beginning to prove itself as a viable capital-raising method. "Security token infrastructure in 2019 seems similar to the continental railroad in 1967-68. It’s not ready for widespread public use, but we’re laying down the tracks."