Several venture capital firms have already issued blockchain-based shares. Real estate developers are getting in on the action too. Last August, investors bought $18 million worth of “Aspencoins” that represent real estate shares of a luxury hotel in Colorado, during a sale promoted by the crowdfunding site Indiegogo. In November, the token-issuing platform Harbor sold $20 million worth of digital shares in an off-campus housing complex at the University of South Carolina. Some companies are even trying to create a market for tokens that represent shares in fine art.

As for Agenus, the problem it is trying to solve is that biotech companies often have trouble raising money to develop new drugs and bring them to market, since the process is so risky and expensive. Agenus is betting its new crypto-token, which it calls the Biotech Electronic Security Token (BEST), will be more compelling to investors than traditional biotech financing instruments. Particularly attractive will be the ability to trade them on regulated internet marketplaces, the first of which are just now starting to go live. The new approach, proclaims CEO Garo Armen, has the potential to “revolutionize the financing of drug development.”

To many blockchain enthusiasts, the goal is much bigger: to revolutionize all investment markets, and even create brand-new ones. And before you roll your eyes, consider this: if nothing else, blockchains have proved to be phenomenal tools for raising money. This is an obvious takeaway from the boom in initial coin offerings (ICOs) in 2017 and early 2018, when projects were raising hundreds of millions of dollars seemingly overnight by issuing blockchain-based assets. The problem is, many of these ICOs were probably illegal—at least in countries like the US, where they ran afoul of decades-old laws designed to protect investors from being defrauded. There are alternative pathways, however, for legally issuing blockchain-based assets.

Whether they have issued or plan to issue “digital securities,” “tokenized securities,” or “security tokens” (pick your buzzword), this is essentially what Agenus and every other such project is aiming to pull off: an ICO that follows the rules.

ICO 2.0

You may have noticed a key word. A security is a financial instrument that someone can invest in. There are two major categories of securities: public and private. Stocks sold on the New York Stock Exchange are public securities. Selling stocks to investors in the US, for example, requires registering with the Securities and Exchange Commission and disclosing voluminous amounts of information to the public. Complying with these regulations is expensive, but it provides access to a very large market where there is a lot of trading going on (making this market “liquid,” in investor-speak).

When the ICO boom got going in 2017, organizers began selling digital assets directly to the public, and the vast majority didn’t bother to check with the SEC first. That was a mistake. In February of 2018, SEC chair Jay Clayton told Congress he had not seen an ICO that didn’t appear to have the characteristics of a security, and thus should be subject to SEC regulations. In the ensuing year, Clayton’s agency has prosecuted a number of ICO projects for selling unregistered securities, bringing the market to a halt.

But there are alternative rules that let companies do smaller, private security offerings, and it’s in these rules that blockchain advocates see a near-term opportunity to run what would essentially be legal ICOs.

Private securities sales face restrictions on who is eligible to buy and trade, how many shareholders there can be, and how much money companies are allowed to raise. So a typical transaction must go through a long line of intermediaries that check to make sure it’s legitimate. This “antiquated” system makes trades slow and inefficient, says Araby Patch, marketing director for Securitize, which helps companies issue digital securities. With blockchains, and specifically blockchain-based smart contracts, many of those checks can be automated, and trades can happen much faster.

For instance, tokens can be designed to check that a buyer is eligible before letting a trade go through. This could eliminate many of the middlemen and make securities trading cheaper and faster. On top of that, blockchains create a tamper-resistant audit trail of every transaction, making it easier for issuers to keep track of and verify shareholders.

But the killer app, according to Patch and many others working on these projects, will be the liquidity that regulated digital asset exchanges will provide to private securities markets, which have traditionally been “illiquid.” The ability to buy and sell crypto-assets via online exchanges (many of which are unregulated) certainly proved attractive to millions of people who invested in the first round of ICOs.

This is one of the reasons real estate is often held up as a compelling application of the technology. Imagine, for example, that you’ve invested in the construction of an apartment complex. If at some point you need to sell your share, it can be very difficult to find a buyer, making it likely you’ll have to sell at a discount. In theory, it will be easier to find a buyer using a blockchain-based market, so you’ll have a better chance of being able to sell at full price.

To be determined

The truth, however, is that the concept of a digital security is still mostly hypothetical. Only a few exchanges are live, and trading volume is still low. (Some of that may have to do with rules that require private securities to be “locked up” for several months to a year before they can be traded.) Perhaps most urgent, legal uncertainty clouds the future.

For instance, the rules for how crypto-assets should be stored are not yet clear. In the traditional world of securities, all those slow, cumbersome intermediaries exist for a reason. One of them, called a custodian, is in charge of securing investors’ assets, typically securities purchased using another intermediary called a broker or dealer. Custodians must be able to prove to a government auditor that they have possession and control (“custody,” in regulator-speak) of those assets. A stockbroker, for example, relies on a custodian to keep its customers’ assets secure.

But possession and control “could be hard to demonstrate with a digital asset,” said Valerie Szczepanik, a senior advisor at the SEC, at a recent conference in Washington, DC. That’s because controlling it requires controlling the private cryptographic key associated with it. “It’s hard to prove you have the only version of that key, or that you haven’t compromised your security in such a way that that key has been duplicated or stolen,” said Szczepanik, adding that this is something her agency is “thinking hard” about.

Unique technical challenges are not all it has to think about. The goal of blockchain advocates is to facilitate supercharged crowd investing, but so far it hasn’t been available to a very wide crowd. Agenus hopes to raise up to $100 million selling its biotech token. But as with all the security tokens that have been issued to date, regulatory constraints will leave it available only to a limited number of wealthy individuals and financial institutions.

A newer rule, meanwhile, would let companies raise up to $50 million from an unlimited number of investors that don’t have to be wealthy, almost like a public stock offering—or, potentially, a legal ICO. But thus far the SEC has been reluctant to approve tokenized versions of these offerings. It’s not clear exactly why, but after the ICO craze, it would make sense for the agency to be wary of opening the crypto floodgates again.

Agenus is taking a long view, says Chris Cortis, the company’s chief strategy officer and head of finance. Issuing the token this way is a “stepping-stone” on a pathway toward “turning these things into something much more like your typical publicly traded stock.”

If markets like that really appear, they will mark the full transformation of blockchain-based crowd investing from dodgy and probably illegal to just another way of doing business.