Tokenized Securities: The token economy and future of ICOs

I’ve had an active interest and have been trading the capital markets since 2004. I was also a Series 7/63 (stockbrokers license) in another life. I get asked all the time- “What do you think of [insert coin symbol here]?” Although I have an active interest in blockchain tech and the token economy, I’ve decided to stop following crypto prices in general.

Here is why — I believe most crypto tokens in the current marketplace are going to $0. There I said it. This is not a popular opinion amongst people I know. The truth is, crypto is extremely popular in the poker community and I have a lot of friends in that community as a former professional poker player. So it brings me no pleasure to rain on the parade. I also want to note that this opinion doesn’t have anything to do with my views on the viability of these projects or blockchain technology in general. It has everything to do with the law and future landscape of the token economy.

Bullish on the blockchain. Bearish on (most) utility tokens

I am hugely bullish on blockchain technology. There are so many obvious use cases for blockchain technology to improve the lives of every human being. There are use cases we haven’t even thought of yet. Democratizing access, promoting transparency, and removing unnecessary middle men from transactions in sectors like banking, real estate, health care and others is a net win for all of us. My company Documo is currently building a product using blockchain tech.

There are a lot of great projects out there utilizing the blockchain to solve these problems, many of which have launched ICOs. The problem is, whether the project is legitimate or not (and there are a lot of projects that are not), just about every ICO is breaking securities laws in the US and elsewhere. In short — they are not legal.

Regulation is an ugly word to many. In a perfect world its not needed because people won’t lie, cheat or steal. In reality, when there is a lot of money at stake, bad actors emerge that have proven to be incredibly cunning and resourceful at figuring out ways to separate money from wallets of those who don’t know better. So like it or not- regulation is needed. These laws didn’t get written by accident. Nearly every rule and regulation was written as a result of people taking advantage of others.

Everybody knows about the obvious bad actor scenarios. Just yesterday it was reported that $660 million was raised as an ICO scam and the “founders” simply pocketed and disappeared with the money. Its hard enough to separate scams from legit projects. Nearly impossible for people that are not technical or in the tech community. The problem extends far beyond scam artists though.

In an effort to bypass US regulatory laws, just about every ICO in existence is claiming to be a “utility token”. This means these coins are not tied to equity, revenue or debt of these companies. So even if the company succeeds, that does not necessarily mean the token succeeds. What if the company is acquired and the token subsequently retired? What if the company pivots and decides that the utility of their token is no longer needed? What happens if the company decides to IPO and is now selling equity in the business? Will “investors” in the token get consideration? Basically, token buyers are relying solely on the secondary market for these coins to get a return.

That brings up another problem. According to the chairman of the SEC Jay Clayton-“I believe every ICO I’ve seen is a security”. If that is true, then not only are the issuers of the ICOs out of compliance, but the exchanges that facilitate the secondary market for these coins are also operating illegally as they are not registered broker-dealers of securities.

So I believe we are headed for a major regulatory crackdown in this space. We will see projects get shut down. Coins will go to zero. Exchanges might be shut down. Bad actors will be exposed and some people will likely be headed to prison. Liquidity and prices of tokens will most likely be very unpredictable as we wait for the dust to settle. Its unfortunate for the projects (and their investors) that are doing great things and simply saw a cool new way to raise money as they will have to work backwards to figure out how to get compliant.

Enter Security Tokens

There is light at the end of the tunnel though. I don’t think the token economy is going anywhere. Tokenization and decentralization of financial instruments is the future. I’m actually very excited about what I see as the evolution of the token economy — Security Tokens. Projects like Polymath and Securitize are helping companies compliantly raise funds using Security Tokens- coins that are registered securities and tied directly to company equity or debt.

Yes I know, this could effectively bring an end to the days of pre-product companies getting $100m in an ICO for nothing in return. A real travesty to be sure. Issuers will need to be more transparent and actually give their investors skin in the game. Truthfully, its a win for everyone. Making the companies accountable will aid in the success of these projects. Raising more realistic amounts of money at reasonable valuations is a good thing for them. It will force them to build real businesses and to think about releasing product and making money sooner while still democratizing access and providing liquidity for investors. In short, Security Tokens are awesome.

Think about it. Currently, most tech companies fight to raise money from a tiny group of people (venture capitalists) who mostly reside in one city in the world. Its incredibly hard and sometimes painful to raise venture funding. Most companies don’t even have a chance. If you have not previously started and sold a company or you don’t have VC contacts in Silicon Valley, your odds of getting a venture check are close to zero. You might not even get a real meeting.

There are problems on the VC side of things too. Recent stats are showing that Venture Funds are making fewer deals but investing more money in those deals. So they are making bigger and bigger bets that these companies will be the next Uber or Dropbox. The problem is the bar is set so high that for these huge bets to be considered a success, that means the companies need to be acquired for a ton of money or raise an IPO, which fewer companies are doing these days. In between these events, there is little to no secondary market for these securities…

…until now. Security Tokens can open up a secondary market for nearly any kind of security almost immediately. This is a huge win for everyone. Investors will be less inclined to rush founders to the next round of funding and companies can focus more on building sustainable businesses instead of trying to hit funding milestones VC firms set for them.

New regulated exchanges will open up (there are already some in the works like tZero, OpenFinance and Circle) that will be able to facilitate trading and liquidity of these new tokens. This means a safer, regulated trading environment and opening up access to those who previously had to wait for a company to go public before being able to buy stock- a game that has been rigged against the Average Joe forever. Want to invest in Facebook before they are valued at $100B? No problem. Find their token and buy it. Personally, I can’t wait to have a crypto portfolio of tokens that represent actual equity in startups I believe in.

More posts coming on this topic as well as some company news.