With titles like “Cryptocurrency ‘bloodbath’ as Bitcoin falls 30% in a week” no wonder the “untrained investors” run for the hills desperately trying to figure out why “digital gold” tumbled down from $20000 to just below $4300 in 11 months. Friedrich Ebert, the president of the Weimar Republic, must have felt the same way when he first looked at the “London payment plan” and started doing math in his head.

But, never mind the ancient history, what are we going to do today? Crypto is taking a beating like the one in Aug-Sept 2017 after the infamous announcement. And just like back then, $16 billion got shaved off the crypto market cap in only two weeks. The reason? Aside from the sad state of affairs with tech stocks and the BCH hard fork, the SEC yet again has flashed the badge to two more ICOs — Airfox and Paragon — for “failing to register initial coin offerings as securities.” A week later came the first-ever take-down of an unregistered exchange called EtherDelta and somewhere along the way the Commission had managed to wreck a pour soul by the name of Maksim Zaslavskiy who apparently sold the unsuspecting investors some bullshit coins. Amazingly, a year and a half-old lesson is not learned. What gives?

Nobody knows. From Jim Cramer to Jim Acosta, everyone’s got an opinion, and none presents a balanced outlook that could decipher the situation, explain it and give humanity the right direction. It seems the market is just really tired of us, like a rebellious toddler getting so sick of grandma’s kasha — he dirties his diaper in protest. Again, aside from Richard D. Wolff, a Marxist-professor who seems to have all his ducks in a row, and weird predictions by Erik Voorhees, nobody knows.

But, after spending a week at the Singapore FinTech Festival, I distinctly saw that at least two viable contenders are out to alleviate the ongoing Armageddon and to cushion the blow — stablecoins and security tokens. So, let’s get a better look at both.

Anybody who’s been in cryptocurrencies for longer than one market day knows that it’s an extremely volatile space. Yet despite actively decrying fiat currency and peddling the notion that somehow the USD and the Fed are all going to collapse, cryptocurrency die-hards are fixated on the idea of pegging their crypto to the USD value to get away from some of that volatility and maintain what they call stability, hence stablecoins. Over the years, we’ve seen several projects like BitShares back in 2014 and quite a few others trying to create a viable stablecoin, but it’s the last two years of rampant cryptomania that pushed stablecoins into the Thunderdome to face the S-curve and bring some stability into this, oh, so unstable world.

A lot of actors that rode the ICO wave of 2017 have acquired considerable crypto-gains, so they want to put their little chests of digital treasure into something that wouldn’t crash overnight (so far we’re looking at Ethereum down 15.84% in 24h, Litecoin down 12.5 % in 24h, Ethereum classic, Bitcoin cash, a whole host of others — all down, down, down), which, again, would be US dollar. There are multiple ways you can try and achieve this peg, and all of them revolve around collateral.

The fiat-collateralized approach is heavily favored by the whales of the industry who enjoy their full institutional support and invariably amicable relationship with Wall Street — the Winklevoss brothers’ Gemini, the Circle’s USDC, and a few others. Those “relationships” make it easier to sell you the rosy image of a perfect world where you’d be able to go to a custodian and buy one token for one USD but also at any given time sell the tokens back and redeem the USD from their reserves. This fully-backed reserve method is arguably the safest way to do stablecoin if you have cash in a bank and trust your banker. But it’s nearly impossible to scale and is one of the least efficient ways to deploy capital. Think of all that fiat just languishing somewhere with no other job but to back your token. In a world of fully digitized USD, it’s just wasteful. Besides, for example, Tether, whose DSDT tokens are irredeemable at this point, says that they maintain a one-to-one reserve of tokens to USD but their connection to the Bitfinex exchange and the inability to produce any actual audits that show reserves for the currency resulted in the Justice Department probe.

The crypto-collateralized approach is essentially the same as fiat collateralized but this time you’re using a pool of tokens that you’re already holding as collateral. The argument here is that it’s an entirely decentralized system devoid of banks with their rotten influence, it’s perfectly auditable on the blockchain in the most evangelical sense because you’re doing it through an Ethereum smart contract. Hallelujah. Although, one must wonder whether building a stablecoin and backing it with something even more volatile than nitroglycerin — a bunch of other coins — is counterintuitive to the idea of stability. Most of these schemes are over-collateralized, which means you’ll need to put in at least 1.5 or 2x the amount of cryptocurrency to get the amount of value you want. Supposedly, this is done to protect the value of the stable token in the case of downward pressure on the market.

But enough with the simple stuff. Let’s talk about non-collateralized stablecoins, which in my strongest opinion is the nature’s way of getting us back for screwing up the planet. To put it the way even your average Ph.D. can understand, non-collateralized stablecoins attempt to maintain a peg to a fiat currency by manipulating the supply of money available with no reserves held anywhere. As a rule, these projects maintain a central bank algorithm which strives to increase the supply when the price goes up but decrease the supply when the price goes down. Basis is probably one of the most prominent projects in this realm, at least one of the most visible ones, so it’s ideal for use as a case study.

When the price of Basis stable coin loses its peg and goes below $1, they start selling something called a “bond token” at a price below $1 with a promise that it can be redeemed for Basis coins in the future. So far so good: you speculate the price of Basis will go up, so you buy some bond tokens at under $1 and wait for a nice fat envelope to come in through the figurative crack under your door. In case the price goes up above $1, the Basis algorithm increases the money supply, and in doing so, they issue a 1 for 1 Basis coin for each bond token you hold. So, when they’re increasing the money supply to try and keep the price down, they’re just paying back the people who bought these bonds with Basis coins. To make it even more confusing, they also have something called a “base share” which is essentially an unpegged currency which issues out dividends to people if you’re holding Basis coins when they must increase the money supply. That’s a total of three coins for a single system. Did you get all that? Probably not, but have a cookie anyway.

The problem with Basis is that it’s predicated on people believing that the price of the token is going to go up. But if the price goes below $1 and the “central bank” just can’t sell any of its bond tokens because there’s just not enough confidence that the price will turn around, the whole market could go into a death spiral. A few months back Basis talked about utilizing its ICO money to buy back these bond tokens to balance the price but buying your own token back at a lower price seems like a regulatory nightmare. Also, the seed money, however considerable is the amount (and in case of Basis it’s huge: $133 million from the likes of Andreessen Horowitz and Bain Capital Ventures, Pantera, DCG, Polychain, and a few others) is not endless so, unless they plan on popping a seed round every time the bond token holders knock on your door, the entire model appears to be unsustainable at the very least.

Another big problem with this type of scheme is that the “central bank” algorithm must have a way of getting a feed of the USD to Basis token price from exchanges. They’ve talked about a decentralized article system in their white paper, but obviously, the simplest solution is to go to a centralized feed directly from an exchange which isn’t ideal.

Another stablecoin that for some reason is doing the rounds right now is called Saga. It runs an Ethereum liquidity pool, but it also has a fractional reserve of fiat money. It’s a mix of crypto and fiat collateralized scheme poised to hedge the exposure of Ethereum to the tumults of the market, but it’s not clear what is the ratio they’re trying to maintain. Saga’s success is a bit of a mystery to me personally what with all the promo dreck they put out and the website copy clearly ordered off Fiverr (and some lifted from the corporate bullshit generator). Oh, well, as a poet once said, if stars are lit up in the sky, someone must need it.

At any rate, I’m far from believing that stablecoins are actually stable enough to turn around the market and become a universal remedy for the cryptocurrency space altogether (if you read all the way to this point you see that I took my sweet time proving it) especially given that we’ve already digitized USD to a degree when it’s highly efficient. Besides, using good ol’ Coinbase, you could always hedge your crypto bets by just buying USD and be done with it. Even with all the de-dollarization tendencies, our aircraft carriers, nuclear subs, and private armies are ready to deliver freedom to the most remote areas of the world on a moment’s notice so I wouldn’t worry about the USD going quietly into the night any time soon.

With that, the question is, do we need a crypto economy at all? Absolutely, and it has nothing to do with the unbanked, financial inclusion, breaking away from or reforming the legacy finance system, IoT, and all other latest achievements in naming. I’m talking about security tokens — one of the sanest, most timely and logical applications of the blockchain technology to date. To answer my question, yes, we do need crypto-economy, which in the words of Jeremy Allaire, CEO of Circle, will soon evolve into the “tokenization of everything.”

Indeed, how do we focus on fostering capital facilitation for economic growth in a more efficient way that is fully transparent and has a defined pathway to secondary liquidity? Certainly not through IPOs, the challenges there are immense, IPOs are cumbersome, expensive, lengthy, and the tremendous shortfall in IPOs we’re observing today makes me even think that they’re not coming back at all, not anytime soon, definitely not for the small to mid-tier offerings. So, how? To me the answer is tokenization of securities as the most obvious next step in bridging the generational gap between real economy — you, me, and our little business ventures — and financial markets ripe for a new generation of investors.

Premium liquidity

Right now, with the exempt offerings under Reg D, there’s very little liquidity. There can be some OTC trades, but if you invest in a venture fund, you’re looking at three to ten years before exit. Tokenization creates the ability for an accredited investor to be able to transact or exit position earlier selling to someone who’s missed the initial offering but is still interested in investing at a later stage.

Some studies suggest that the illiquidity discounts of 20–30% are not uncommon for certain asset classes like commodities, bonds, etc. that are traded over the counter. The chance to take $11 trillion worth of assets and give back to investors at least a part of that sum is an important opportunity behind tokenizing those asset classes. Tokens can be structured in a way that represents the underlying ownership of the asset, and there are more and more issuers that are going to provide physical delivery and quick settlement of the underlying asset instead of buying cash-settled ETFs.

The compliance aspect

Now that we know that “companies that issue securities through ICOs are required to comply with existing statutes and rules governing the registration of securities,” it makes matters much more straightforward than a year and a half ago. The Securities Act of 1933, the Howey test and other regulatory measures formed at later times, as well as a number of current developments, demonstrate that the framework for compliance is already well in place. What is key for the security token issuers now is to fit their practices within the existing legal environment and fully comply with these regulations to become a vibrant part of the security token economy. One of the ways to handle the all-important compliance issue is to create security tokens with the identity embedded in so that only whitelisted persons/accredited dealers can participate in the offering under its terms and trade/hold the tokens. The efficiency of compliance in the security token space depends on the level of automation programmed into the token. For example, the ST-20 standard has the compliance layer built-in, which lifts the token upon the entirely new plane of efficiency.

This is going to be the next step forward: bringing the security token into the securities marketplace by providing comfort through verifiable assurances to the institutional investors. Once all the KYC/AML, suitability requirements, reporting practices, asset validation, etc. are all in perfect order, the institutional money will ensure a quick and painless migration of the entire industry into a new space.

Competition

No such thing. Even though the space is developing rapidly, simultaneously and internationally, it still goes back to regulatory frameworks in sovereign countries that are perfectly capable of reining in upstarts. There will be issues with sovereignty and jurisdiction, no doubt, but to put things in the perspective, there’s $2.4 trillion worth of unregistered security issuances in the United States alone. Compare it to the $1.6 trillion in the US aggregated public markets, and a clear trajectory appears towards the coveted ability to capture alpha early in the cycle, which back in the day allowed Spotify to get pre-listed on NYSE as a public company with colossal valuation. The point is, we have a massive market, and there’s plenty to go around for everybody. In fact, instead of competition, true partnerships are emerging between companies that, logically, would have to be at each other’s throats. They’re developing similar products, they’re in the same HR pool, and yet instead of competing they end up building common standards and create all-enveloping business practices that become a global trend.

The nuts and bolts

From the sheer utility standpoint, the execution of a trade via a security token shouldn’t be less or more complicated than what we’ve been doing for the last hundred years with the actual trade, custody, clearance, settlement, and depository. The obvious advantages here, however, are lightning speed, volume and access to new market infrastructure through the beauty of an individually written smart contract. In the case of Stellar, the contract carries multisignature, batching requirements for multiple transactions, sequencing, time bounds, and others. Ethereum has its own set of rules. Platforms like Smartlands now create new dynamic security instruments for profit participation, yield instruments, revenue participation instruments or the combinations of the above, revolving them around multiple asset classes like real estate, agriculture or other illiquid traditional assets and execute them through a blockchain-based ATS to have secondary liquidity.

It’s only fair to point out that we’re far away from meaningful P2P trading, but we already have the tech for putting all the necessary identifiers on a security token to track and audit them throughout the entire lifecycle. We already have the tech that would allow us to prevent any redundancies that may emerge from fraud, loss of a key, nefarious activities by bad actors. In other words, the “broker-dealer” institute, the “transfer agent” institute — both, though still firmly in place, are getting their extreme digital makeover.

Fractionalization

Now, there’s a major benefit of a security token for you. It is a way to invest differently in a whole new asset class spawned by fractionalization, which gives us decreased cost for structuring products and higher market efficiency. For instance, a REIT is a vehicle created by an owner of multiple properties that are bundled together and are sellable/executable as a contract. Naturally, a buyer is being charged a fee for the work done by the owner/agent in buying up those properties, structuring the product, marketing it and selling it. The fee is charged on top of the underlying asset value: 1% of the REIT — 1% of the stakes of all properties in the REIT plus the fee.

Let’s imagine that all Manhattan buildings are tokenized, therefore tradable on liquid and compliant markets. Now virtually anyone can go out and automatically buy a millionth of a percent of those buildings effectively creating their own Manhattan REIT without the need to structure the bond, no fees need to be paid for the underlying set of bespoke assets you’ve just created for your own convenience and investing needs.

The future

The World Economic Forum conducted a study in which the majority of respondents said they believe that 10% of the global GDP will be on blockchain by 2025. That’s about $8 trillion. So, it’s going to sound a bit loud, but I’m confident that in one to three years security tokens will comprise the most robust tradable asset class growing to be the largest conduit of capital aggregation, job creation, and economic growth within the existing regulatory framework. Particularly, as the mechanisms of custody clearance, settlement, and depository are being built on multiple blockchains, there will be a gateway created for massive amounts of institutional capital flowing into the space, which will forever change the current financial market paradigm.

In other words, the road from a brave new sovereign wealth fund delving into tokenization to the “tokenization of everything” is not going to be a long one. I tend to agree with Mr. Doom that the utility token market cap may remain around where it is right now or even go lower but the security token market cap in two-three years could easily be in the trillions. We will see traditionally illiquid assets become liquid and continue this never-ending march towards universal liquidity accessible to any individual with a smartphone.