Security Tokens — The Players
While security tokens are disrupting a well-defined space, the platforms surrounding them are still nascent and are testing a range of business models.
As a reminder, security tokens are an electronically wrapped stake or share in a private interest like a fund or company. For more context on why security tokens matter and what they could impact, read on Part I here.
Technology: Harbor first launched the Regulated Token Standard (“R-Token”) to enable permissioned ERC-20 tokens. R-tokens allow for embedded logic around investor eligibility, total investor base and holding periods. By building upon the existing ERC-20 ecosystem, Harbor has pre-solved for wallet and exchange support.
Harbor is offering a full-suite solution, such that the issuer need not have any related functions in-house. They have outsourced most legal responsibility — investor logic will be established via a whitelist from a responsible outside law firm. Regulators can add general permissioning as well. Harbor is the initial permissioning enforcer — each transaction references Harbor off-chain, vetting KYC, AML and any other criteria before transferring the asset. All of these services come at a cost though, as the platform remains centralized for the time being. If Harbor shutters, the issuer’s token is frozen until they agree to a new way to reissue them.
Economics: Harbor has embraced a more conventional path on both fundraising and monetization. The team raised $40mm in venture capital in two rounds of funding this year. Harbor monetizes its protocol like software, focusing on upfront issuance fees and recurring administrative / secondary fees like cap table management and additional distributions.
Technology: Polymath has taken an open source, marketplace approach, embracing the decentralized ethos of crypto. Their platform emphasizes a simple security token registration flow on it’s homepage, with hooks into KYC, legal providers and smart contract developers. Polymath has partnered with security exchange tZero as their ATS, allowing issuers to easily divest full whitelist control to a qualified exchange. Via all of these ties, Polymath avoids any legal responsibility, dispersing that amongst the vendors and the issuers — this is by no means a comprehensive solution.
Economics: Polymath conducted a ~$59mm private token sale of POLY out of Barbados in 2017. With POLY at an implied market cap of $400mm, the core team has retained a large stake and will monetize from token appreciation from network adoption. Polymath relies on a vibrant vendor base, and POLY reinforces that effect as they are early holders. They conduct all business in their ERC-20 token — providers bid and issuers and investors pay in POLY for services. Polymath will also sell value add consulting services via a separate Canada-based advisory entity.
They are also going after “Security Token Offerings” (STO), focused on raise caps and holding periods.
Technology: TrustToken began with a proof-of-concept in TrueUSD, using a network of escrow accounts and trusts to regulate the underlying asset (USD) and administer secondary trading. Now, TrustToken is ready to scale that model with a protocol for asset-backed tokens that relies on “SmartTrusts”. Upon issuance, the owner adds logic to their SmartTrust smart contract around usage and rights. The issuer also chooses a representative from TrustToken’s market of vetted fiduciaries to manage the assets based on those smart contract rules. TrustToken’s protocol specifies how the smart contract and fiduciaries communicate, and creates trails for regular audits.
Economics: TrustToken’s path looks like a middle ground between Harbor and Polymath. Like Polymath, TrustToken is raising via a token sale — TrustToken recently announced their first round of funding from the likes of a16z crypto and Blocktower Capital. They reopened their token sale in July to accredited investors. Their token will be used to pay fiduciaries, to stake on and collateralize assets. However, TrustToken also offers a more full-stack solution, and thus will likely monetize directly via issuance, secondary and advising fees. They currently take a small (<1%) transaction fee on deposits and withdrawals,
They are likely going to build upon their stablecoin success and expand into other currency bases first a la TrustEUR and TrustJPY.
What these models mean for e-securitization
It’s important to note we’ve focused on projects that move the ownership and compliance rules to the token level rather than exchange level. Given three likely trends, platform / protocol players are better contact points than exchanges:
1. Decentralized exchanges will grow stronger
2. Centralized exchanges inevitably become commoditized
3. Issuers who want a more comprehensive solution will enter
That said, which model will win?
The trustees of hard assets — including developers and high net worth individuals would likely find Harbor’s full suite and fee structure appealing, as they will want low barriers to entry and liability exposure. That said, Harbor’s reputation will have to supersede the centralized risks of a young platform owning the liquidity and compliance of an issuer’s ownership & financing.
For companies and funds who were never going to access illiquid capital — like many of the crypto entities created today — Polymath’s DIY approach and decentralized ethos will resonate.
TrustToken hints at the link between security tokens and stablecoins — another area I’ve written about. Real world assets could ultimately underlie a stablecoin, widening the opportunity for both these tokens and crypto adoption overall. If TrustToken proves their model is replicable with another asset beyond USD, they could dominate the global digital money arena, creating network effects before any other stablecoin truly takes hold.
Both Polymath and TrustToken rely on outside vendors accepting their tokens. Thus, in addition to functional technology, both companies need to manage their investor base and keep their tokens on a generally upward trajectory. Here, TrustToken’s more centralized org seems better suited for that role — it’s likely a full time comms / investor relations function that entities like this must build out.
Ultimately, we’re talking about capital formation, ownership and exchange across a range of assets — there are infinite nuances in needs and thus varied but large opportunities ahead of each of these.