Well not quite everything…
So lets get this part clear. A Security Token Offering (“STO”) is NOT a replacement for an ICO… And so anyone who used to be an ICO Advisor suddenly decides to be an STO Advisor will more likely end up in prison…
Is there really a new STO market or are we talking about a more efficient version of what is already there…
Well yes, arguably STOs mirror traditional approaches to finance removing friction, time, cost. A digitisation of existing securities on a distributed ledger. Tell me it is anything more than this..!
STOs are however inherently more efficient than Venture Capital and traditional funding models (bank finance or IPO), well yes again. STOs are a digital manifestation of a traditional funding model(s) using a distributed self auditing ledger and a ‘tokenised’ primary issued instrument, this time by private companies, rather than public that can trade their value in a secondary market.
It is the democratisation of capital given smaller and medium sized private businesses don’t have the luxury or means to trade their instruments as shares or bonds albeit for accredited and or sophisticated investors, as defined by the law makers, that do not want the retail crowd involved. So STOs are not the libertarian democratisation of access to capital for all, as the people, the crowd are not invited to play, seen as a step backwards by the core community.
It is for these reasons the ICO advisors, marketeers and launch platforms are finding STO deal flow much harder to come by, because you must be able to demonstrate capital markets experience, be familiar with capital markets processes and support complex valuations, not forgetting the design of the token (the smart contract as a new primary instrument) that must stand the test of time and the prevailing law.
As advisors and marketing firms are tempted towards STOs, as the ICO market evaporates, many fail to understand there is no comparators between ICO and STO other than process of generating inbound capital. STOs are about Securities Laws, most created back in the 1930’s and updated in the 40’s and then 70’s as the world moved away from the Gold Standard. A dark time when central banks became all powerful and ruled the earth (a dark day for value), allowing governments short term horizons who lack fiscal disciplines each year pushing our fiat currencies as they head to zero.
In the US advisors are not allowed to solicit business without a Dealer Broker involved, and in the UK (EU) financial promotion requirements are for regulated businesses only. It is a trap if you like, as many ICO turned STO advisors are falling into, with severe consequences. ICO rating sites promoting STOs are heading for trouble as this is indeed financial promotion of a security instrument.
Interestingly the SEC Web page for ICOs makes interesting reading. I paraphrase: just because you have called your token a Utility we may probably consider it to be a Security.
Traditional Capital Raising is on the ropes
There is a sea change coming and although many struggling ICO projects are coming forward, something we treat as SEED capital, because they havent been able to hedge the value during 2018 bears arriving. With 90% of successful ICOs last year (albeit a small number) are mostly down on capital. So what happens when an ICO project hasn’t hedged the value of the raise and its worth 50% or less…?
The STO markets is all about Series A and B equivalent as early stage deals are less likely to get funding via an STO. Early projects must get some SEED behind them and demonstrate a viable project first before contemplating an STO, and yes there are costs to absorb, for lawyers, for flying to meet investors, for professional services firms of lawyers and accountants to help prepare the gorund. Some capital is required to do an STO.
Yes STOs are seen as faster, cheaper and more efficient than traditional funding approaches but remain complex to engineer technically and the legal process as a legitimate wrap around the newly engineered instrument is key.
There is no doubt STOs have caught the eye of the traditional corporate finance houses working with established and listed businesses, who now see STOs are a legitimate and somewhat preferred approach to raising new funds, with some listed businesses now looking to tokenise existing company shares, offering a new dimension to fungibility, new asset classes and new freedoms. But when working with Broker Dealers and or regulated firms, the minimum ticket size tends to be $10m+ or the fees will not be interest to them. But this doesn’t mean you cannot raise smaller sums.
We are of course fortunate as we moved to cater for STOs quite early in 2017, as my business partner and I have 60 years experience of technology starts up and running larger businesses, we pivoted earlier than other firms. And it matters to have collectively helped projects raise private capital. In the past two years we re-invested our capital in building a Crypto Capital Markets infrastructure, that comprises a Primary Issuance Platform, Venture Investor Network (Family Offices) and two Exchanges, one for Crypto Pairs to fiat and the other Security Tokens to fiat.
There remains few businesses positioned to handle STOs and we appears to be the only one in the UK and one of two in Europe.
STO = increased complexity
A Security Token Offering requires the design and creation of a new financial instrument, a Security. But this is where the similarity with Utility tokens ends. Both are smart contract based however Security Token engineering is at an entirely different level as the smart contract logic has to reflect prevailing legislation and laws, as well as define the exchangeable and interchangeable store of value. This means coding the restrictions that prevent tokens as securities from changing hands while identifying both sides of the trade, where geographically two sets of laws will be different. Seller and Buyer!
And this is where native, bog standard ERC20 runs out of puff because it is a simple piece of engineering that unfortunately allows you to trade (move tokens) between any address on the Blockchain, delivering peer to peer functionlaity that in the world of secuities is not fit for purpose. So if your STO advisor is advocating ERC20 they are demonstrating way out of their depth and your project will be ruined.
Then there is the liquidity misnoma, as many believe the pancea that by tokenising something it will automatically mean the share, asset or bond becomes more liquid and fungible. It doesn’t. But it can. Some bastions of difficulty exists such as tokenising real estate assets that mistakenly doesn’t change their illiquid nature, is fraught with issues. The simple fact that makes these securities so attractive is they can be traded privately on an exchange, without the usual multi-year lock in with LP, GP models, makes them so much more attractive to investors.
But it is early days, and legislators are still coming to terms with STOs and issuance platforms and exchanges like ours, that include Polymath, Securitize, Securrency and others because we are all wrestling with the deeper technical aspects of how to remain on the complaint side of securities laws.
Our focus remains:
- Engineering new tokens and seeking new token standards and frameworks that embed new functions and legal obligations as token terms
- Enabling trading tokens between holders in different jurisdictions
- Catering for the local laws where the holder resides
- Logic Triggers, when the number of token holders exceeds 2000 for example the US consider this as a public offering
- New approaches to handling private keys and the options for recovery and re-set, where regulators concerns remain, as assets cannot be stranded if they are traded on markets, as this will impact price and hurt liquidity
- Rights to recall and kick out bad actors, preventing trading before tokens are exchange off-market, resulting in regulatory fines and closure
- Real time monitoring of Treasury, Cap Tables, Settlement and Reporting
- Fractionalisation challenges of… I will let you decide.
Advantages
So why do an STO?
So it really comes down to efficiency. An STO removes friction, time and cost for capital raising.
Well, it is all about fungibility and different types of security. And then we have Blockchain where we are treated to its inherent benefits and advantages. And the promise of being able to trade the instruments of private companies for the first time in a market without the penance of a long, expensive IPO process, is too hard to resist.
STO markets are emerging and liqudity on a large scale will take a few years to arrive as soon as accredited investors embrace them, and institutional traders arrive with their war chest of a few billion. Adoption will increase x1000 fold.
STO Structures
Security token raise our collective expectations and hopes as people dedicated to the Blockchain cause , offering new ways to make a living, a place where realistic valuations override greed, stupidity (on all sides) from where we were with the madness of ICOs. Ok lets raise $100m and think of something to build, get our White Paper out there, invent a board of advisors, hire a marketing team to build a community, do some airdrops and pretent we have build something…
And there were lots of advisors that did well out of selling shitcoins to retail investors, and retail investors sitting on profits took the bait, something the SEC has already stated when manpower allows, they will address.
The hard truth is there will be few takers for Seed STOs, where there is a vision and an idea, and little else. STO markets already focus is on Series A — working with projects with a viable built product, real customers and ideally in revenues. Above all investors want to see a pragmatic approach, where the founders are realistic. So if you are pre-revenues, do not be tempted to give your business a $30m valuation, you cannot possibly defend in any shape or form.
STOs Raises
They follow paths. Raise what you need on sensible valuations, deploy the capital and do another raise at at higher valuation, nes pas. Early money equals more risk for the investors, where exisiting busineses with customers and revenues will attract a higher valuation. And pre-Seed projects, pre-product and zero customers is a tough ask for any investor, as the company has little intrinsic value.
So how to value a security? If you don’t know, we do. How to design a token? How to package an STO project for investment? If you don’t know we do it every day.
A new generation of Security Token Exchanges
The talk of the town is that everything will be tokenised, every asset, commodity and share to create a multi trillion market. Well, so be it, because we are ready. All of us with Security Token exchanges, as co-conspirators in Act II of the Blockchain story, are building out this future, a future and essential Crypto Capital Markets.
New markets that are intrinsically fairer, more efficient and in time will allow everyone to trade. The dream is within reach and ready for the taking, but there is much to do and be working on.
A new generation of exchanges using the decentralised nature of Blockchain and the genius that is the ‘token’ (a smart contract) with all its inherent restrictions, is also evolving fast. A new generation of exchanges that supersede the old ways, involving layers of counterparts, payment providers and banks, offers a flatter more efficient model where banks accounts cannot be closed, assets cannot be held and the underlying information changed. No more manual distribution systems of share certificates, of corporate actions, manual banking and handling of monies. No more time delays, excess friction, lost time and increased costs manifesting in higher fees where banks inflate margins, because they can, and they do.
The naked benefits of STO Exchanges…
Blockchain based exchanges offer different levels of security, engagement and automation that speeds up execution times. Simply put they have out of the box core functions…
- Integrated compliance
- Automated settlement
- Real Time fraud prevention
- Interoperability with other systems and exchanges
But it doesn’t end there. Traditional exchanges operate trading hours Mon-Fri 8am to 4pm often, close for holidays and are massivel expensive to maintain and operate. Bankers, and regulators need time off, need to retrospectively look at trading performance, trends and data, to ensure best behaviours. And bankers need time to count their money. Sorry it is below the belt, but they annoy me.
The new generation of exchanges deliver:
- Are open 24/7 and never sleep where regional front ends feed the main order matching engine to deliver global trading any time and any place
- Remember tokenisation offers fractional ownership, not seen before
- Rapid and soon to be automated, close to real-time settlements
- Reduced direct trading costs
- Automated distribution of assets, dividends and payments
- Better liquidity and market depth
- Automated compliance and reporting
- Asset class interoperability
But there is so much more to come…
The potential to standardise securities through smart contracts, offering options to trades assets across different exchanges. The evolution of entirely new asset classes. Pass-porting of KYC between systems, jurisdiction and people. Integrated and insured assets through low cost custodians. Unified payment rails and further integration of BOTs as we move to HFT.
STOs are good news and will accelerate the adoption of crypto currencies as cash becomes obsolete and fiat currency goes to zero. This is the way forward, as what we have doesn’t work, maybe it never did as central banks kept the printing pressess going or everything would collapse. And it will.
STOs are complex, they are Securities after all. They come with baggage and responsibilities of Law. They matter, they are needed and they are our future.
Author: Nick Ayton is a Blockchain pioneer.
Twitter Nick Ayton
“Ignorance is Strengthened”
ICO Advisors are not going to help you…this time around.