Token Economics — A Deep Dive (I): The Basics (2) Securities Token

Photo by PEIPEI

A story re Warren Buffet on Bitcoin and Cryptocurrency
Here is an interesting story I have read from CNBC. When it comes to bitcoin, billionaire investor Warren Buffett wants to make one thing clear: Unlike buying stocks, bonds or real estate, buying bitcoin is not an investment.

That’s because it lacks intrinsic value, Buffett says.

“If you buy something like bitcoin or some crypto-currency, you don’t have anything that is producing anything,” Buffett says in an interview with Yahoo Finance. “You’re just hoping the next guy pays more. And you only feel you’ll find the next guy to pay more if he thinks he’s going to find someone that’s going to pay more.

“You aren’t investing when you do that, you’re speculating.”

“The idea that it has some huge intrinsic value is just a joke in my view,” Buffett said.

The full story could be found at the end of this post.

The reason for me to share this story here is NOT to argue whether Warren Buffet is right or wrong, or how he has been wrong about backing new technologies before. He missed opportunities to invest in Google and Amazon, decisions he now calls mistakes. It is just an appetizer to start our session today — what would be the underlying value driver of a token?

A quick recap:
In the last session we discussed that a token has two cohesive characteristics — operational and financial, as focused on the first part. Before going to the details on the second part, here is a true story I would like to share first.

A couple of years ago, there was news on Bloomberg and other financial media regarding the “unstoppable Chinese aunties who are actively buying gold and chasing the gold price up”. And yes, my mum is one of those Chinese aunties. When I asked my mum “why are you buying gold?” “Well, it is good wedding gifts to my friends’ children who are getting married, or birth gift to my dear grant daughter (my daughter Liai, who was not yet born). And I believe the value will increase over time too.”

The answer is quite simple and straight to the point, addressing two essential questions on why people are buying something. And the same thing applies to tokens/crypto-currencies too:
• Why is this useful to me? — utility, operational characteristics
• What return can I get from buying this? — value, financial characteristics

The second one on value or price driver of the token is equally, if not more important to an investor or an early supporter of an ICO. There are a number of ways in which issuers try to drive the value of their tokens, namely:
• Buyback and burn
• Repurchase according to certain criteria
• Payback investors, in the way similar to dividend or interest
• And etc.

This is how the second part; the financial characteristics comes to the stage.

Securities Token
By definition, a security is a tradable asset, representing ownership (equity), creditor position (debt) or the right to ownership (option) of the holders who receive a dividend or coupon (return), which is what I call “financial characteristics”. Fundamentally, the financial characteristics are what drive the value of a token. But the legal definition varies by jurisdiction. So is the definition of a securities token. Thus, the securities tokens we discuss here are defined as tokens with financial characteristics and might NOT be securities tokens from a legal and compliance perspective. There are generally three types of securities tokens: equity tokens, debt tokens and asset-backed tokens.
Figure 1: Types of Securities Tokens

Source: Qeelyn Analytics

Equity token: This is pretty straightforward and refers to tokens with equity characteristics, including:
• tokenized equity, namely mapping equity ownership to tokens, with or without voting rights;
• dividend: profit sharing from projects
• revenue sharing, providing some value driver while avoiding the situation of been categorized as securities token by regulators
Figure 2: Examples of Equity Tokens

Source: Whitepapers and Qeelyn Analytics

Debt token: a token with debt nature. It could be a token with access to loan agreement, like in the case of BlockHive, or a buyback based on certain formula. Among all the debt token cases, the most interesting one to me is BlockHive.

Figure 3: Examples of Equity Tokens

Source: Whitepapers and Qeelyn Analytics

BlockHive is an Estonia-based incubator, which introduced an Initial Loan Procurement (“ILP”) and Future Loan Access Token (“FLAT”).
• ILP is a loan agreement structure that enables the company to procure loans to expand its ecosystem, while allowing Creditors to earn interest on the funds they lend to the company
• Loan agreements are digitally signed
• Creditors lend in Ethereum (“ETH”) and receive interest in ETH
• FLAT is an ERC20 token issued on Ethereum blockchain
• FLAT is issued to Creditors in an amount corresponding to the principal amount they have lent
• ILP Creditors who receive FLAT can use it for two things. They can transfer loan agreements to others, and they can claim loan transfer and sign loan agreements with the loan issuer

Figure 4: Initial Loan Procurement and Future Loan Access Token

Source: BlockHive whitepaper and Qeelyn Analytics

In the case of HIVE token launched by BlockHive, here is how it works:
• Creditors will make loans to BlockHive and digitally sign loan agreements
• For this, they will receive “Hive tokens” issued by BlockHive, which are FLAT
• The ILP will entitle Creditors to receive, as interest on the loan, 20 percent of the operating profit generated by BlockHive
• Interest will be paid on the balance of the loan, not on the balance of Hive tokens

Figure 5: HIVE Token

Source: BlockHive whitepaper and Qeelyn Analytics

Figure 6: BlockHive Loan Agreement

Source: BlockHive whitepaper and Qeelyn Analytics

There are three interesting things that I would like to point out: -
• The token itself is an access to loans, but not a loan itself. Once the token is transferred to a new holder, the new holder needs to register to claim the loan. This is for KYC and compliance purposes.
• The interest payment is actually based on 20% of operating profit, this is greatly reduces the burden of interest payment by BlockHive, and at the same time gives the creditor equity-like upside, very much like a preferred equity. [And despite being a debt security could be construed as being Judaic/Christian/Islamic in that interest is linked to a share of profit and not a fixed interest rate]
• Given it is a digital loan agreement assigned to the token, we would assume that in the case of liquidation, the seniority of payout would be higher than equity, a downside protection, which is better than nothing

Finally this is an asset backed token (“ABC”): this is becoming popular in industries like real estate, utilities, mining and etc., where traditionally it requires large upfront investment. It could be mapping a certain unit of asset or return of a project into a token. Compared to most other ICOs, which are mainly based on a great dream, an ABC provides a value driver of an underlying asset, leading to a lower theoretical volatility. An ABC is the crypto version of an Asset Backed Security and thus may be regulated in many jurisdictions.

There are two interesting cases that I have been following: -
• On March 22, a guest co-host on CNBC’s “Squawk Box”, Kevin O’Leary, the famous “Shark Tank” investor, explained that he’s currently working on a unique and first of its kind affair. The deal involves a “very prestigious brand hotel” in New York, and O’Leary is working to allow them to sell ownership in the company through a $400 million cryptocurrency offering instead of a stock IPO. This could be the first case that set the milestone and reference case for SEC to regulate crypto-currencies. Please see the link at the end of this post for more details.
• Element ASA, a Norway based Iron-ore company is evaluating to become a key issuer of Tokens in the Iron-ore industry, potentially supported by several Iron-ore producers around the world. The IRON Tokens will be issued by a new issuing subsidiary called Element IRON. Element will be the manager of Element IRON. The IRON Tokens will be established as digital token on the Ethereum platform, eligible for use to acquire goods or services from market participants who wish to use the IRON Tokens as means of payment. Token holders owning a defined minimum quantity of IRON Tokens may request delivery of Iron-ore through an exchange of IRON Tokens for Iron-ore on the further conditions set in the Whitepaper, due to be published. This caught my attention given 1) traditionally mining industry requires heavy upfront investment, and thus heavily depends on debt with very high leverage; 2) if this works out, it is an innovative financing structure that turning the tokenized inventory/reserve to help reduce both leverage and dilution for shareholders.

In the next section, we will discuss the single currency vs. multi-currency strategy.

**Recommended further readings: **

About the Author:
Telegram: yqguo

Thanks to my friend Iain Reed for the editorial work.
Iain Reed (LinkedIn):
Telegram: reedi

ETH: 0x0CDE176370145679391b3fB10f9CcB1CdEf7571B




An investor, an entrepreneur and a trail runner

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YQ Guo

YQ Guo

An investor, an entrepreneur and a trail runner

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