With the security token industry beginning to heat up, we look at why 2019 will be vital in ensuring the success of the framework for the future.
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Many have deemed 2019 as the year that security token offerings (STOs) will come to fruition. Regulators are finally opening up to the idea of blockchain technology and, with some persuasion still needed, tokenising equity and debt. The advent of a brand new technology and a way for investors to gain early-stage access to cutting edge startups has had mixed reviews.
Ultimately, however, there is still much work to do. Businesses, investors and much of the wider world needs to understand just what it means for investors and businesses alike. Here we take a look at the reasons why 2019 is about setting the STO model up to succeed instead of rushing the process.
Time
Initial coin offerings (ICOs) ushered in a new wave of investment opportunities for many people around the globe. According to statistics from ICO Data, 1255 projects raised just over $7.8 billion USD in 2018 alone. For many, ICOs were a way in which they could invest in the next generation of disruptive tech startups at the very beginning. They created a community spirit for projects and, in doing so, had many people excited at the prospect of being a part of a growing business.
Whilst ICOs opened the floodgates for many businesses and investors, they also brought with them a whole host of trouble. In July 2018, a report by Satis Group, a New York-based STO firm, had them come to the conclusion that over 80% of ICO projects were in fact scams. This, for good reason, did not sit well with regulators like the Securities and Exchange Commission (SEC).
Although STOs are, of course, completely different from the ICO framework and are in fact securities, not utilities, for many they do not see it that way. In February 2018 Jay Clayton, Chairman of the SEC, infamously said: “Every ICO I have seen is a security”. Whilst his attitudes to the ICO framework may have changed as the year went on, it did not take away from his original message; ICOs, whilst beneficial for businesses raising capital, must stick to the securities law.
The SEC was not the only regulator wary of the new investment tool, China, another global superpower, also famously banned ICOs and cryptocurrency completely. Part of this reason will be to protect investors but, by tarring all ICOs with the same brush, ultimately it hindered those trying to get ahead.
STOs have the option to rectify a lot of the shortfalls that ICOs have. Further regulation, a heavily vetted process for the business to go through and backed by equity or debt, STOs ultimately give a well-needed legitimacy that the ICO market could not for many traditional finance investors. Being backed by a traditional asset, but in a tokenised format on an immutable database to us, makes sense.
However, capital markets are notoriously slow to enact change and, for the regulators, it can be slower. Time is a key element to ensuring that STOs become a success but, more importantly, regulators taking time to understand how the technology works are also vital.
For the regulators, and for much of the investment world, in order to become more accustomed and more understanding of the STO model, they simply need more time. Whilst these tokenised securities are backed by real assets, in traditional markets and placed under strict laws, the change will not happen overnight.
With Facebook’s recent announcement that the Libra Association had used a security token sale to give its early investors a dividend payout, the odds of adoption of the STO framework are looking favourable. As more businesses, new investors and traditional investors begin to understand the STO framework, then more people will begin to trust it. As that trust grows, so will investor attitude and the business that look to use the security token offering structure. Time waits for no man but, in this case, it might just have to.
Usecases
Convincing an estimated $68.179 trillion USD market with over 400 years of history to suddenly start buying into the world blockchain and tokens is going to need some serious convincing, as well as time. Just like any new piece of technology coming to the traditional financial market, there needs to be some proof that it works.
Blockchain has already completed half of this task and now major corporations around the globe are beginning to understand just how beneficial it can be. American Express, the Industrial and Commercial Bank of China, Walmart and even Apple are now beginning to look into the various ways which blockchain can help them with their business. HSBC reportedly used distributed ledger technology to settle over $250 billion USD of transactions in 2018 alone. These corporations are finally catching up in terms of development and using a truly revolutionary piece of technology. The same cannot be said for tokens, however.
Tokens, tokenising and tokenisation are three words that scare investors and venture capital (VC) firms. For some, tokens are something that they do not yet see the need to understand. For others, tokens represent all ICOs and they do not want to be involved at all. Whilst STOs are looking to change that viewpoint and stance, there will need to be some genuine use cases for STOs in order for them to work.
For many early-stage businesses, holding an initial public offering (IPO) is simply something that takes too long. It also means many rounds of funding before the IPO in which more equity is given away, something they may not want to do. The STO offers an alternative to traditional models of financing, something which means earlier stage access to the next generation of businesses. “Why not just use crowdfunding?” is also something that many investors will be thinking, however, they need to understand the benefits of tokenisation first; earlier liquidity, 24/7 trading, complete transparency and a public record of all transactions to name a few.
In order for more investors to begin to understand the world of tokenisation, they will need to see successful use cases. ICOs, whilst revolutionary in their approach, also alienated a lot of traditional finance in their approach. The STO will be able to validate and rectify a lot of the early mistakes that the ICO market experienced. However, in order to persuade investors that this framework is truly revolutionary, there need to be success stories first.
Trust
With traditional securities, investors know what they are getting. Whilst security tokens are merely tokenised shares, the thinking of classic investors is yet to differentiate: its a token, therefore its an ICO, therefore it’s a scam. It will require legitimate projects as well as exciting opportunities to present themselves using the STO framework which investors can then trust.
New technologies take time to receive adoption. It takes several use cases as well as multiple success stories for new technology to become a part of the main market. Disney only stopped issuing paper shares in 2013, after 56 years of issuing the stock certificates, with many other publically traded companies now following suit. Primary trading markets are not known for keeping up with technology and it is very much a “stick with what you know” mentality.
Ultimately, if one large investor looks into a STO, it could have a butterfly effect. Should Goldman Sachs, Morgan Stanley or Blackrock invest in a tokenised offering, then the rest will follow suit. It will just take one major investment bank to do so in order to create a ripple and, ultimately, a lot of trust from a traditional investment platform.
Trust is one of the biggest things needed if the STO market is to truly become a success. It is going to take time in order to build that trust and, more importantly, it is also going to take successful STO projects to come out of this new financing framework. The ICO market saw quite a lot of people have their fingers burned and, whilst the STO framework will change this, it is going to take people time to trust tokens again.
Final Thoughts
2020 has the potential to truly change the future of financial models if the security token offering market is a success. 2019 is about ensuring that attitudes towards the technology of tokenised securities are changed for the better. Fundamentally, this means having legitimate projects succeed in this emerging market.
More importantly, however, it’s about ensuring that the traditional markets feel that the technology of tokens is a viable method in which they can invest. Security token offerings have the capability to revolutionise the stock market. 2019 is simply about ensuring that they have the right foundations on which to build a lasting legacy.