The State of Security Tokens 2022 — Market Appetite
Understanding the Security Token Investor Audience
The security token investor is an interesting blend of what exists in the markets today. It’s not necessarily someone fully fixated on decentralization or four-digit yields. But it’s also not necessarily someone interested in generating 4% annually that could be achieved elsewhere. Given this, it’s important that issuers of security token offerings understand the market in which they seek traction — essentially, a blend of cryptocurrency and real asset investors.
Many security token enthusiasts understand that tokenization is only plausible via all the blockchain progress that has engulfed the markets over the past decade, with an emphasis on the past 3 years. Companies like PGIM, KPMG, and Fidelity have been discussing tokenization since 2018. Although the infrastructure likely wasn’t capable then (and the infamous crypto bear market put a damper on tokenization for some time), the use case of blockchain technology for security tokens was nonetheless projected into the universe and put onto the radars of numerous “crypto people” ever since.
That is important to understand and to absorb because “crypto people” are one class of investors who follow security tokens. They understand the nature of the underlying blockchains but also wish to grab some intrinsic value that can be found within the assets that back security tokens. This asset-backed feature enables investors to tap into true value rather than banking on network effects and growth of the underlying blockchains. It is simply another “safer” avenue.
On the other side of the coin (but on the same coin, nonetheless) are the traditional investors who heavily desire intrinsic value within their investments. Investing in blockchains directly via utility tokens may be a bit too intangible for this investor class’ taste. Instead, this class particularly loves the concept of fractionalization and real-time liquidity for their pre-existing and comparable investments (i.e. real estate, illiquid funds, stocks, ETFs, and other tradable baskets). The only thing “crypto” about security tokens to this investor class is the fact that the wrappers are blockchain-based. As general cryptocurrency prices fluctuate, security tokens should theoretically be unaffected given they are backed by real assets and not by supply and demand of an underlying blockchain such as ETH, ALGO, AVAX, or SOL.
Successful security token issuers must study the market landscape before issuing tokens, as seeing comparable token offerings will help when structuring the “tokenomics” of the asset offering. Ensuring a unique and proper blend of features for both “crypto people” and traditional investors will likely lead to the sweet spot necessary to fully-subscribe an offering.
“Tokenizing Assets” vs. Security Token Offerings
There are two distinctions that can be made in the security token space — “Security Token Offering” and “Tokenizing Assets.” This isn’t a well-known or common demarcation, although it should be considering how the industry will grow going forward.
In short, a security token offering is a new equity/ debt/ revenue share/ profit share agreement to raise funds from investors to THEN deploy into some new business line. I see this as more of a Venture play than anything. Which is fine — but as we know from historical venture capital, the offering needs to be enticing enough to fully collect investors.
The other half of the industry — although “half” is used lightly considering I believe this side of the industry will account for the vast majority of assets — falls under “tokenizing assets.” Existing assets. Not a new offering to raise funds to then deploy, but an offering that enables current investors to sell and new investors to join, usually for recapitalization purposes. This is likely seen as a “safer” or more predictable offering since prospective investors (such as the “crypto people” and traditional investors) have some insight to the assets in which they are purchasing tokens in. This is simply the act of converting pre-existing assets to a digitally-traded and managed form via the blockchain. Take a look at the long-form report we published in December 2021 detailing how this can be broken down.
When I think of “launching a real estate security token offering,” I think of raising funds for brand new development. There’s no guarantee that this building will be successful or will even be developed and operational on time. The STO’s terms and return potential better accommodate that risk.
When I think of a company “tokenizing a real estate portfolio,” I think of buying into a piece of an existing, fluid, and cash-generating portfolio while certain investors exit early. That seems more predictable and tangible from the surface. The offering terms should also match that narrative.
Flop Case: Spencer Dinwiddie’s Tokenized NBA Contract — Debt Offering
As a sample of an offering that was ahead of its time but unfortunately aimed at the wrong crowd, take a look at Spencer Dinwiddie’s fixed income security token offering in 2020. First, Spencer Dinwiddie is not only an NBA player, but more importantly a trailblazer in the Web 3.0 space. He’s working to pioneer the “fan token” business model, and it’s likely that his foray into the space with this security token offering will provide him with valuable lessons for platform improvement. There is no Spencer Dinwiddie hate here! Only knowledge takeaways.
Dinwiddie structured his tokenized contract offering as a fixed income product available to accredited investors in the US (via Regulation D). With a contract value of $34 million and a fundraise goal of $13.5 million, Dinwiddie raised just $1.35 million with the help of Tritaurian Capital (Full Coverage).
This underwhelming subscription amount points towards a lack of product-market fit (P.S. that phrase isn’t just for startups). While not publicly disclosed, the interest rate on the tokenized contract was likely unappealing to… you guessed it… the unique blended investor base that comprises security token investors. Anything less than 10% was most likely not enough to move the needle without some sort of future equity inclusion or participating rights in future endorsement deals, and this truth came out in the end.
Full Case: Exodus $75 Million Reg A+
On the other hand, Exodus showed the industry just how powerful a community can be when it comes to fundraising. Under the “Mini IPO” provision that is known as a Regulation A+ filing, Exodus raised $75 million from a combination of institutional, accredited, and retail investors. While it is not disclosed the exact breakdown of the pie, Exodus certainly made use of its dedicated user base that’s been growing since Exodus’ inception in 2015 as a trusted digital assets wallet provider gave the company something very powerful — a dedicated digital assets community (aka, “crypto people”).
When it came time to raise funds in mid-2020, Exodus had a solid 5 years in the industry and an even more solid user base, which made it a prime candidate for a retail-enabled private placement, facilitated by digital assets of course. Working with Securitize, Exodus issued over 2,000,000 shares of Class A common stock (called $EXIT tokens) on the Algorand blockchain, totalling $75 million in proceeds.
The security token industry lives by the pinnacle of “raise from the public while staying private,” and that’s exactly what Exodus made use of here. Now not only are its users staying loyal to Exodus’ product lines, but they are also participating in the upside associated with the very services they’ve been using for potentially years.
It’s a great way to align interests, and Exodus can run another Regulation A+ offering maxing out at $75 million if it wishes in 2022. Current investors would gain the opportunity to purchase additional private shares (similar to early VCs getting the “right of first refusal”) and Exodus could continue to privately fund its growth through its own user base and network.
To revisit the unique blend that is a security token investor, Exodus captured both the crypto side by nature of its business and the traditional investor through its financial history and growth projections (see Regulation A+ Filing) for a successful and fully-subscribed offering.
Case in Progress: Security Token Market’s Own Crowdfund Offering
Stepping down a rung on the retail ladder from Regulation A+ to Regulation Crowdfund (Reg CF), Security Token Market is actively raising $5 million from its user base and industry colleagues — taking a page out of the Exodus playbook. As of mid-February 2022, Security Token Market has over $6.2 million pledged in its “Test the Waters” phase which technically makes the offering oversubscribed. Of course, this won’t be official until the offering goes live in Q1 2022 and pledges convert into successful investments, but this factor just reiterates the product-market fit associated with a security token offering.
Security Token Market embodies the blockchain-agnostic “all roads lead to Rome” approach by aggregating data and media from all aspects of the security token industry. Doing so presents value to nearly all blockchains that enable tokenization, nearly all investors in blockchains that enable tokenization, nearly all asset owners who seek to issue security tokens or tokenize assets, exchanges and marketplaces that offer security tokens, and of course security token investors themselves. The firm understands that public and private assets will continue to “digitize” on blockchains and eventually will become tradable on various venues.
Being the one-stop-shop for data associated with these fragmented and dispersed security tokens provides tremendous value to both “crypto people” and traditional investors, as both are used to their respective interfaces (i.e. CoinMarketCap, Messari, Bloomberg, CNBC). Check out full coverage on the Security Token Market Crowdfund.
Next week’s edition will cover Liquidity Overview & Analysis.
Important Disclosures:
- No money or other consideration is being solicited, and if sent in response, will not be accepted;
- No offer to buy the securities can be accepted and no part of the purchase price can be received until the offering statement is filed and only through the platform of an intermediary (funding portal or broker-dealer); and
- A person’s indication of interest includes no obligation or commitment of any kind.
