Rohit Kulkarni, Managing Director, SharesPost

If 2017 marked the emergence of initial coin offerings and 2018 has been the year of regulatory uncertainty around those ICOs, then 2019 will belong to the security token. So far, security token offerings make up only a relatively small percentage of ICOs. But that will soon change. Security tokens, not utility coins, will attract significant amounts of Wall Street money next year. Why is this shift expected to occur, and how can you prepare for it?

Security tokens combine the characteristics of utility tokens and venture capital

We believe security tokens act as a natural bridge between traditional finance like venture capital and Blockchain and benefit both equally. Utility tokens, akin to loyalty rewards points given by credit cards, have dominated ICOs. However, in some cases, owners cannot use the tokens beyond the issuer’s platform. As for venture capital, most private assets are relatively illiquid, which means investors face a difficult and costly time trying to convert them into cash. Security tokens solve both fundamental problems.

Security tokens digitally represent ownership in any asset, such as a piece of a tech startup or a venture capital fund and can provide investors with various rights to that company or fund. Furthermore, Security tokens provide liquidity to investors, access to compliance features to issuers, and a framework for oversight to regulators.

Traditional VC Utility Tokens Security tokens Issuer-Investor Alignment X X Investor Liquidity X X Access to Expert Networks X X Community Development X X KYC-AML Compliance X X Regulatory Oversight X X

Crypto regulatory environment remains blurry but forward progress in sight

Cryptocurrencies have attracted a flurry of negative headlines about fraud and non compliance with laws. Although companies have been able to raise significant amounts of capital through ICOs, the lack of regulation has created significant volatility and pricing pressure in cryptocurrency markets this year. As a result, it has become riskier to launch an ICO.

However, regulators around the world, as summarized below, are starting to develop a framework to oversee cryptocurrencies. The U.S. Securities and Exchange Commission recently appointed Valerie Szczepanik to a newly created position that will coordinate the agency’s approach to cryptocurrencies and ICOs. And last month, the SEC launched HoweyCoins.com to educate investors about how to spot fraud. The agency named the website, which features a bogus coin offering, after the Howey test, a method developed by the U.S. Supreme Court to determine whether a transaction counts as an investment contract.

We ultimately expect a more stable regulatory environment over the next six to twelve months. Global regulators are taking healthy steps towards ensuring safety and security of investors in this new asset category. These actions can also reduce volatility and help unlock significant amounts of smart money.

Source: SharesPost Research; Various media articles

Crypto ecosystem developments hint at a security token tsunami

As the regulatory environment for cryptocurrencies improves, we believe the broader infrastructure to help connect issuers and investors is starting to take shape. In the chart below, we list industry developments and emerging projects designed to boost the prominence of the security token market. The people behind these projects clearly believe that security tokens could soon attract the interest of businesses and retail investors. Furthermore, the market forces that drove the evolution of the digital currencies - democratization, globalization, transparency and liquidity – could prompt a flurry of private tech firms to raise money through security token ICOs .

Innovative startups and opportunistic, institutional crypto investors will position themselves to benefit from the growing secular trend of security tokens.

Date Company Event Description Nov 2017 FunderBeam Raises $5.8 million for early-stage startups through its Blockchain Jan 2018 Securitize Launches a “ICO in a Box” platform Feb 2018 Causum/BITE Sells equity via Blockchain for a cleaner power grid Mar 2018 Overstock/Tzero Cancels planned ICO; Plans to launch security token exchange platform Mar 2018 Securrency Plans to maximize payment flexibility through security tokens Apr 2018 Open Finance Plans to launch a security token trading platform Apr 2018 Harbor/R-Token Raises $28 million to “re-engineer” private securities for Blockchain May 2018 Elephant Announces a tokenized secondary market through in-house token May 2018 Polymath Plans to purchase a stake in a traditional securities exchange May 2018 Templum Raises $10 million for a security token platform; Acquires broker/dealer May 2018 VrBex Plans to raise $100 million to launch a security token trading platform May 2018 SharesPost Announces launch of a trading platform for secondary security tokens Jun 2018 Coinbase Acquires SEC regulated entities; Plans to enable security tokens trading

Source: SharesPost Research; Various media articles

Conclusion

Though early, security tokens are enjoying significant momentum thanks to the emergence of compliant ICO platforms and exchanges that offer liquidity for buyers and sellers. Regulators seem to have adopted an open minded approach to cryptocurrencies that does not stifle innovation. Although the SEC will increase the number of investigations and enforcement actions, organizations that issue tokens in a compliant manner will not suffer, but thrive and grow.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.