December 3, 2018

Cryptocurrency: Security Token Offering (STO)

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2019 could be the year of the STO. Learning about the shift in the market now is important in order to be positioned properly in future years.

2017 Year of the ICO

2017 was the year of the ICO (Initial Coin Offering).

An ICO is an unregulated investment vehicle designed to enable investors to speculate on a broad range of ‘cryptocurrencies.’  Think of it like an IPO (Initial Public Offering) for blockchain projects that can trade on any one of the plethora of unregulated Crypto exchanges worldwide.  ICOs are carried out to help founding teams raise funds for R&D, marketing, and software development.  ICOs are much easier to launch in comparison to IPOs, as there is much less compliance, regulatory scrutiny, and barriers to launching an ICO, making it much easier, cheaper and more efficient than IPOs.  In theory, investors love ICOs as much as founding teams because it creates an instant liquid market for the tokens (ie. shares), whereas investing in traditional startup requires a 5-7 year time horizon to achieve any sort of liquidity (usually via an exit).  Additionally, ‘unaccredited investors’ (those without a high net worth) have been able to participate in ICOs, creating opportunities to invest in startups like never before. Almost $5bn USD was raised in ICOs in 2017, and as can be seen in the quarterly growth in ICO fundraising, the popularity of this vehicle grew exponentially from Q1 through Q4 (Crunchbase).

While a large amount of ICO capital continues to be raised in 2018 (mainly driven by Telegram’s record-breaking $1.7bn ICO earlier in the year), investors and regulators alike have soured on ICOs.

2018 Year of the ICO Meltdown

For investors, many have lost the majority (if not the whole amount) of what they invested in an ICO in 2017, as many tokens that were bought at staggering valuations have lost >95% of their value and some have no liquid market to trade.  Regulators, mainly the SEC, have begun to crack down on ICOs that are in clear violation of their security laws and fine promoters of such ICOs such as Floyd Mayweather.  Two of the projects that have reached settlements with the SEC, forcing them to file financial disclosures and pay fines:

“Paragon and CarrierEQ, which conducted unregistered coin offerings, each agreed to pay $250,000 in civil penalties and to notify investors they are eligible for refunds if they still own the token or can show they sold it at a loss. Paragon sold to 8,300 investors, while CarrierEQ’s coin offering reached 2,500 buyers, the SEC said.”


Airfox raised about $15mn USD in 2017 and will be allowed to carry on business under the following conditions:

“Airfox will follow the same rules as publicly traded companies,” the company said. “We will provide consistent reporting that includes our profits.”


And this is only the beginning for the SEC:

“Regulators have more than 100 investigations into cryptocurrency-related ventures, SEC enforcement co-director Stephanie Avakian said at a conference last week. The agency thinks terms of the deals with Paragon and Airfox can be a template to resolve investigations of other coin sales that didn’t involve fraud, officials said.” WSJ

These settlements will become templates for further investigations, and will likely see the SEC go after the bigger fish, including major exchanges, to try and send a message to the market that anyone raising capital from US investors must comply with securities regulations.  Within the cryptocurrency community, which tends to lean towards a more libertarian approach, the reactions are mixed on these regulatory changes, but many see it as a simple application of the law, which will help to create trust and reduce fraud in the market over the long-term:

“Federal law isn’t just something a bunch of VCs can make up on the fly. Did you guys really think the SEC, FTC and 93 USAOs were the same as municipal taxi licensing boards?” @prestonjbyrne

At the heart of the regulatory issue is the concept of a ‘utility’ token, whereby users who purchase the token are not doing so as a speculative investment, but as a way to use X protocol; therefore, it shouldn’t qualify as a security in the traditional sense.  In reality, the creation of such a concept was simply done to undermine existing laws, as most people were buying ‘utility tokens’ for products that weren’t even built yet. The vast majority of  ICOs were a simple speculatory trading vehicle on the future of X blockchain product.  The flip side of the argument is that ICOs are not designed to undermine Securities Laws, but Wall Street.  This argument carries some philosophical validity, but it still doesn’t change the law and the view of regulators that their mandate is to instill trust in the market and remove all vehicles for fraud.  Nevertheless, the current regulatory environment has created enough uncertainty to send a chill through the entire Cryptcurrency market outside of Bitcoin.

2019 Year of the STO (Security Token Offering)

If 2017 was the year of the ICO, and 2018 was the year of the ICO Meltdown, then 2019 is shaping up to be the year of the STO (Security Token Offering).

The STO is a regulated and compliant version of the ICO. Given all of the benefits we listed above for ICOs versus traditional IPOs – cost, speed, efficiency, participation – there is a clear value towards further developing the concept of ‘token offerings’ on the blockchain; however, such token offerings need to be coupled with compliance, due diligence, and investor protections.  The STO brings all of this to the market on the blockchain, meaning that such data can be created, captured, and stored automatically on the blockchain.  This effectively means the beginning of ‘distributed’ private equity and investment banks.

TheBlock does a good job at mapping out the current STO ecosystem and breaking it down into 6 distinct categories:

  1. Issuance
  2. Broker Dealers
  3. Custody and Trust
  4. Legal
  5. Compliance
  6. Trading

Within each category, there are several upstart companies vying to become leaders in the space, take Issuance for example:

German-based NeuFund (nicknamed the “Nasdaq of Crypto” according to this article), for example, has just launched its first STO in an attempt to raise up to €6.6mn for their own company.  Investors can invest both Euro € and Ethereum $ETH, for example, and the platform will create a record (hash) of the share on the blockchain, which can be traded in the future on their secondary market just like you would trade a security on the Nasdaq.

+ Neufund Platform

Below is an example of some of the trading platforms entering the space:

tZero is perhaps the most well-known platform in the space given that it is owned and operated by public company  The company raised $134mn in a SEC-compliant ICO earlier this year.  Furthermore, private equity firm GSR Capital invested an additional $270mn. tZero’s vision for the future is to scale the trading platform and compete with the major investment banks:

“This funding will allow us to globally scale our blockchain capital market platform on a rapid timeline, ushering in an era of trust through technology for the global economy.”

Trust is a word frequently used among those in the blockchain/cryptocurrency ecosystem, as the entire point of blockchain is to enable such commercial activities without a central middleman (ie. the banks) by creating a perpetual and fully-verifiable version of any transaction or share issuance.  In the case of tZero, they are trying to be the rails for major STOs to trade in the future.  Overstock is, in fact, selling their retail eCommerce business to focus strictly on tZero. The company has paid the price for this venture so far, losing millions each quarter, seeing their stock price decline in parallel to the Crypto market, and being struck with many delays as tZero is still not launched, yet the if the vision is fulfilled it will be big:cryp

“He envisions a platform that would trade assets that could be easily traced and tracked. Initially, it would trade security tokens—a combination of a bitcoin-like digital token and a traditional bond or stock. It is also developing a product called digital locate receipt, a way of tracking equities borrowed for short selling.”  MoneyMaven

And that is why this market is well worth watching in the coming years.  Equities, bonds, and all other financial instruments will likely be moved to the blockchain.  Arguably, the whole cryptocurrency market is having its ‘Dot-Com Bubble’ moment and will continue to decline in the short/medium term, but long-term the whole financial market will move towards these platforms.  Promising startups with a real business, worldwide, will be raising money via STOs and issuing their dividends on platforms like these. This underlying innovation in capital markets has the potential to revolutionize finance and make it 1000% more efficient for truly revolutionary businesses to raise money across healthcare, transportation, and other key areas of the economy.

The projected gold rush for this movement is 2020/21, so now is the time to pay attention and get involved. Let’s see if 2019 is the year of the STO.

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