Is Security Token Infrastructure on track for mainstream adoption?
While investors in cryptocurrencies and blockchain look to Security Token Offerings (STOs, or what some refer to as ‘programmable securities’) as the successor to ICOs, the mid-2018 reality is slightly different.
Unlike blockchain ETH-funded ICO protocol projects — where investors often piled-in before a single line of code was written — potential retail STO investors may be less likely to join the party before they know what track conditions look like.
Some commentators have made the mistake of comparing the development of Blockchain infrastructure to railway lines. In the case of protocol ICOs (unique coins built for unique chains) the argument made by Jeff Garzik might make sense:
When it comes to adoption of Security Tokens, substantially complete build-out of compatible ‘rolling stock’ is a pre-condition for systemic success, where success means the promise of liquidity. The liquidity requirement makes Security Token Infrastruture challenges different from those of rail systems.
Railway lines do not to be fully built-out to be successful, just standardized and accessible. Even a one-mile long rail line is useful if the passengers know where it begins and ends.
Security Token Issuances demand a racetrack.
There are many kind of racetracks — horse, dog, stock car, and Formula One, to name a few — But they share one thing in common: they go around in a circle. Unless a race track is a complete circuit, no one will race on it. It goes around in a circle.
Security Tokens — an ecosystem where the trains go round and round — need a completed circuit to enable liquidity. It can’t be ‘end-to-end’, it has to be circular. Liquidity in stock trading is circular in nature and driven by speed: investors buy, investors sell. If investors can only buy, and it is not clear how or when they can sell or there is a delay, it won’t attract much interest.
The reason that Security Tokens look for full build-out is directly related to why people are interested in STOs in the first place: Liquidity. Liquidity abhors incompatibility (one of the reasons that it will be so hard for decentralized exchanges to trade in regulated securities).
If a potential issuer of or investor in an STO does not believe that the ecosystem can provide future, post-lock up liquidity, there is no reason to issue using this mechanism, because the value-added element in STOs of private illiquid securities is confidence in those issues’ future liquidity.
This was not a concern of ICOs as (in that unregulated environment) exchanges such as Binance rose up and — not burdened by compliance and other restrictions imposed by securities law — were able to provide liquidity for ICOs on their first day of trading, for a fee of course.
By enabling easy trading of the hundreds of ERC-20 derived cryptocurrencies, sold in massive public crowd-funding campaigns — and devoid of any restrictions such as KYC/AML, jurisdictional or accredited status in the secondary markets — cryptoexchanges gave altcoin investors confidence to invest in more and more ICOs. The reason why altcoin investors were confident was because they knew that liquidity was a given.
With STOs, liquidity is not a given, but that’s not because there are’nt exchanges. There are exchanges for Security Tokens (OpenFinance, tZero, Templum and others coming online) and broker-dealers have ATS’s, but the requirements for trading a security token go beyond the mere existence of a venue for trading. The difference between secondary trading of altcoins — which require sellers to bring the private keys and the buyers to bring funds — and the secondary trading of a regulated security come down to presentation of eligibility and ownership credentials.
Trading Security Tokens in a secondary markets requires coordination of data between multiple parties: the Issuer, buyer, seller,the exchange / ATS, and the market as a whole .
- Buyers and Sellers need to pass a background check with a broker-dealer or a third party to show that they are not suspect form a Know Your Customer/Anti Money landering perspective but also that they “Accredited Investors” who can purchase and sell privately placed securities.
- ATS and so called exchanges that allow the trading of STOs need to know whether the tokens being put up for trading are still subject to a lock up — which requires them to be accompanied by legal opinions and consent of issuer to be traded — or whether they are past the lock-up period and can be traded somewhat freely under Rule 144 or similar resale rule.
- Once the trade is done and the STOs have changed hands the issuer needs to update its records to reflect the new owner.
- Moreover, the ATS or Exchange provider is subject to additional rules of market conduct that require reporting of such trades and pre-sale disclosure of bids and offers
Unless all of these players are working in concert, it is not clear whether compliant liquidity can occur. If they don’t work well together, they’ll work slowly. Slow is not liquid.
So while providers seek to advertise their services as ‘end-to-end’ it is important to recognize that in the world of securities there really isn’t an end, just another trip around the track.
At Vertalo we’re betting that, by 2019, the pieces will all be in place to facilitate liquidity for compliant securities token transactions. That is why we consider ourselves a ‘Liquidity Enablement Platform’.
