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Will Security Tokens Make 2019 the Year of Finance Innovation?

As the cryptocurrency market keeps beating investors left and right, those who tend to be more optimistic have switched their focus to something that is promised to be able to overtake the future of digital assets – security tokens.

We are living in a world set by two different paces. Since the end of last year, security tokens and security tokens offering (STO) have been on the front news. It is officially the “buzzword” that the crypto and fintech community can’t stop talking about. Everyone is trying to understand the ins and outs of this digital asset and how to conduct crowdfundings compliant to regulation. Given how new it is, we are still faced with a considerable lack of coverage about the subject.

The laws for securities have been around for many decades, created in a time where the internet didn’t exist. Blockchain has been complicating all of this, creating a ripple effect of uncertainty as we are not 100% sure how regulations will affect the issuing of tokens. However, we can expect future blockchain projects to be financed by the regulatory compliant security token offering.

That is why Blockchain Land gathered experts from all sides on the subject – legal, finance and technology – on January 31st in the capital of France to share the stage in a first-ever conference with institutional guests to discuss the future impact that the tokenization of assets in Europe and the United States will have on the crypto-finance landscape of tomorrow.

Tokenization-Assets-BlockchainLand

Thibault Verbiest and Frederic Bellanca (Partners at DS Avocats), Natalie S. Lederman (Attorney at Sullivan & Worcester LLP), Daniel Coheur (Chief Strategy Officer at Tokeny), Marina Teller (Professor of Private Law at University of Nice), Soheil SK (Co-founder & VP Strategy at TBG) and Paul Bougnoux (Psion Finance)

Countries around the world are hopping on the path of digitization, but all eyes are on Europe as more and more countries are taking a pro-crypto stance such as Malta, France, Estonia, Germany, Switzerland and UK. The question lies on which European country will take the final lead in the blockchain economy racing against the United States.

In this in-depth piece, we’ll go over the evolution of security tokens, from their specificities to Europe’s current position regarding STOs, to the United States’s SEC compliance, to why institutions are adopting this trends. Will 2019 be the year of financial innovation?

The revolution of the tokenization of assets

Today, around one-third of the world’s wealth is held in cash. And as you guessed it, the rest is held in real estate and securities. All that liquidity is locked up, and security tokens can just shake that up. Now, imagine a world where you can sell your securities.

Simple concept, right? It has grabbed the attention of financial institutions worldwide, from stock exchanges to banks.

While in an initial public offering (IPO) you receive stock in exchange for the investment, in an ICO you receive a token. This brings us to the different types of tokens – utility tokens and security tokens.

So what’s the difference between security token and utility token?

Utility tokens can be seen as coupons which allow access to a particular product. As opposed to security tokens, utility tokens provide its owner with the ability to utilize the network of its origin, as well as products and services.

Security tokens are digital assets that rely on smart contracts to divide the ownership of some legal entity. They allow for the digitization of traditional investments through “tokenizations”. Tokenized assets are characteristically more stable than traditional cryptocurrencies.

They are smart contracts that represent the company’s equity, providing an owner with voting rights, and, most importantly, the right to share dividend. Apart from being digitalized, security tokens behave like traditional securities, and, analogically, fall under the same set of regulations as their conventional counterparts.

Security Token Offering is a fundraising campaign through which a company looks to receive financial backing for their project, giving investors security tokens in exchange for funds.

Financially, security token provides much more than utility token for investors who are not keen to utilize their coins on the project’s network but only speculate on secondary markets instead. As explained by Daniel Coheur, Chief Strategy Officer at Tokeny, investing in security tokens shouldn’t be harder than buying a security at the bank.

As explained quite well by Marina Teller, professor of private law at the Université Nice Côte d’Azur, the world of security tokens isn’t limited to those that can perform cryptography anymore. We are living in a world where the rules that were already created for traditional securities are being applied and adapted to the 2.0 generation of tokens that allows for the monetization of assets that haven’t been monetized yet. The scope of actions are broad, and we need to keep up with the developments.

Crowdfunding in accordance with the law

Since security tokens behave like traditional securities, it is seen as a safer way to raise money, providing a “foolproof” system against scams. In the post-ICO world, it doesn’t come as a surprise that startups and investors are hungry to understand more about STOs and all regulatory concerns involving the process.

That is particularly important since governments’ scrutiny is usually high when it comes to raising money. Complying to regulations can be a complicated process, which can either stall the project’s crowdfunding or discourage companies from raising money at all.

Let’s take the U.S as an example.

Regulations in the U.S.A

The talk of the year in the crypto-sphere was the US Securities Exchange Commission (SEC) with its highly skeptical stance towards crypto-assets. The USA was one of the first countries to initiate the legitimization of tokens, and the year of 2018 is marked by the SEC’s investigations on crypto companies and their tokens. To perform a crowdfunding compliant with the US laws, there’s an entire process to comply with. The company need to apply for the right to conduct an offering, and without previous registration in the SEC, they can’t issue or sell security tokens. Even though the process is long, the SEC never ruled out that, provided that the company fulfills all their requirements, security token offering can be approved.

This made STOs a more desirable kind of crowdfunding than ICOs, which were highly scrutinized by the US financial watchdog given the unprecedented amount of scam we witnessed the last couple of years. The regulatory pushback felt by startups, investors and regulators in the US and around the world, was a consequence of unregulated crowdfunding. As the SEC commissioners argued, “most, if not all, ICOs were in breach of securities registration rules”.

According to Natalie Lederman, attorney at the American firm Sullivan & Worcester LLP, “there’s a huge myth around the US market that it’s difficult to enter. Understanding the proper definition of a ‘security’ makes it simpler to do a security token offering in the U.S.”. Indeed, she explains that stocks and even debts can be classified as a security. However, Mrs Lederman advises creating a “robust communication document” and an efficient purchase contract.

Regulations in Europe

Currently, security tokens fall under the EU’s MiFIDII regulations, which are a set of rules that “strengthen investor’s protection and improve the functioning of financial markets”. In Europe, the overall opinion is that regulations are “cooler”. As explained by Thibault Verbiest, partner and lawyer at DS Avocats, Europe is home to countries that have allowed large crowdfundings to take place through ICOs, which were not seen as a direct infringement to “financial rights”.

As covered previously by The Blockchain Land, Malta was the first country to enact a legal framework that regulated blockchain and cryptocurrencies. When it comes to crowdfunding, Malta requires a “visa” for those that wish to do an ICO or STO.

Additionally, Liechtenstein has also been taking the lead in the development in the race to become the leading crypto nation in Europe. They issued their first document on ICOs in 2017. The Financial Market Authority (FMA) recommends that ICOs be clarified with the FMA in advance, explaining that activities relating to financial instruments were subject to licensing.

Meanwhile, France has also been positioning itself as a blockchain and crypto friendly government since last year, issuing the new set of cryptocurrency and ICO regulations, dubbed PACTE. Similarly to Malta, France also requires a visa to raise funds.

However, jointly with the country’s open stance to innovation in this sphere, the French monetary authority (AMF)  has most recently modified regulations to categorize IPOs of up to €8 million as legal, since it is not seen as a public offering of financial titles.

With its latest push for digital innovation, France has become one of the leading nations in Europe to invest and regulate securities. According to the Minister of the Economy and Finance on a statement in May 2018, the country intends to make “the registration of an issue or transfer of financial securities in a blockchain the same as the book-entry of financial securities.” 

STOs catering to the institutional world?

One of the things that we’ve been reading and hearing since the buzzword STO has started sounding is: institutions are coming for your crypto. Wall Street and crypto are clashing.

As two different worlds collide, there’s a contradiction in the “expectancies”. Do you want to get rich, or do you want a more efficient and inclusive global economy and independent control over your assets?

Either way, we are seeing a race to serve institutions after the fall of ICOs. Third party custody operators such as Fidelity and ICE are catering to the trading demands of large institutional investors who are seeking to participate in the crypto economy. Indeed, there’s irony in the fact that financial institutions are adopting a heterodox technology that was designed to do away with them.

Now, to replace ICOs, we saw the quick rise of the crypto-based version of a traditional asset, which can be a bond or an equity. As it is regulated, investors can’t see their tokens’ price take a dramatic downturn. Now we are seeing Wall Street firms, who once thought the ICO hype was absurd, excited about the idea of security tokens. On the one hand, they are bound to feel their impact, particularly in terms of smart contracts’ ability to optimize the issuer-to-investor model.

On the other hand, even though STOs are less “revolutionary” than ICOs, it is expected that the changes will be felt by those that participate in primary securities markets – traditional investment firms and other accredited investors. This means that retail investors will have more limitations to participate in STOs, calling for security brokers to be put in place to prevent it from becoming a purely institutional mode.

The Year of Finance Innovation

This leads us to the most common question in the cryptosphere today is: Are we witnessing an evolution of the current financial system?

There are two mains reasons why STOs are attracting a lot of attention from different spheres, from lawyers to government officials, to investors.  First, given its nature as a (digital) security, they are by design already compliant to regulations. Second, because they align with the laws of the securities market, they can even be traded on fully regulated exchanges.

This added layer of protection provides greater confidence to investors, which in turn results in an increased institutional interest in the crypto space. We are now experiencing other expected results – the rapid maturation of the industry and a wider adoption. These economic benefits on the crypto industry can be seen as a clear indication that STOs are the preferred means of crowdfunding. Differently from ICOs, they offer asset coverage and a regulatory framework that encourages investors.

So, what can we expect in 2019? This was a question on everyone’s mind, and the speakers addressed it during the conference.

The evolution of the market has brought us more mature investors, better regulations and a responsive market.  We went from a wild 2017, when ICOs were on fifth gear, to an environment where startups and investors are seeking regulations and security. The next step is for issuers to become more familiarized with the procedures in different countries and for trading platforms to introduce security tokens in a compliant and secure manner. We’ve already seen BitGo, Coinbase and ICE launch themselves into that world. In Europe, we have witnessed a rush of pro-crypto regulations with the UK, Switzerland, Malta, Liechtenstein, Germany and France positioning themselves in the market.

The key messages we could take from the conference were in line with the major trends. As highlighted by Mr Verbiest, in 2019, we can expect the European secondary market to be regulated. Consequently, major European stock and crypto exchanges will start trading security tokens. Similarly, fueled by a post-ICO environment, startups will launch themselves into the security token world to raise funds through a more secure method. We can expect the year of financial innovation to bring liquidity to the trade of security tokens.

As technology is changing the world around us, digitalization of traditional assets is unavoidable and highly needed. Even though it might not disrupt the world of finance as the cryptocurrency bull run of 2017 did, it most certainly will change the way we raise money, the way we invest, and the way governments deal with digital assets.  

For the recording of the conference, check out Langue de Geek’s full coverage:

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Laisa Lopes

Laisa is a journalist and a blockchain enthusiast. With her experience in different industries, Laisa sees the technology as one of the prime disruptors of the 21st century. She's a fierce advocate of decentralization and innovation. Laisa coordinates the team of writers at The Blockchain Land and on her spare time, she is globe trotting.

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