The State of Security Tokens 2022 — Tokenization in Public Markets
ArCoin — Arca US Treasury Fund
Rather than issuing a security token for fundraising purposes, Arca took the operational route to show the power of blockchain-settled funds. After 24 months of product development and regulatory review, Arca’s US Treasury Fund ArCoin received its SEC approval in July 2020 to be the first blockchain native closed-end fund under the Investment Company Act of 1940.
The fund, which aims to hold a minimum of 80% of assets in US Treasury securities, is designed to eliminate intermediaries and reduce risk through the digitized shares, which is a model that can be rolled out across future products. Given the immediate settlement nature of blockchain transferred funds, an individual ecosystem may rely on its own blockchain-settled asset as a medium of exchange to match this speed. ArCoin’s makeup of treasury assets and cash, in addition to its NAV of $1.00, makes it a very liquid and feasible “stablecoin” of sorts, in order to properly facilitate digital asset securities transactions and distributions.
INX Limited (INX)
As a publicly-registered competitor to tZERO and $TZROP, INX Limited issued its own $INX token that amassed an initial investment amount of $85 million across 7,200 investors through its Ethereum-based IPO with TokenSoft. Since INX raised traditional funds earlier, this brings their total funding to around $125 million. Per TokenSoft CEO Mason Borda, “Token holders receive 40% of distributions from the company with no voting rights, while equity holders will receive 60% of distributions with voting rights.” Officially, this is a profit-sharing token and provides distributions with the company net cash flows. Additionally, INX Limited redistributes profits to an ever-diminishing supply of INX tokens, as every token that gets used as a utility for reduced commission fees gets transferred to the INX Limited treasury reserve.
El Salvador’s Bitcoin-backed Bonds
Shortly after the announcement making Bitcoin legal tender in its jurisdiction, El Salvador announced a tokenized Bitcoin bond offering. The 10-year 6.5% bond offering would raise funds to purchase $1 billion worth of Bitcoin in an effort to boost the country’s treasury of its new official currency, and reduce the circulating supply to external bitcoin buyers. The bonds will be issued on the Liquid Network, which is a bitcoin sidechain that supports tokenization — a play straight out of the Blockstream playbook.
Franklin Templeton’s Blockchain-Settled Mutual Fund
Taking aim at the mutual fund industry, $1.5 trillion asset manager Franklin Templeton announced a blockchain-based fund that holds government money in December 2021. Called the Franklin OnChain Government Money Fund, $1.85 million worth of underlying holdings and shares are settled on the blockchain as a pilot program. Franklin Templeton is still maintaining records the “old school” way in conjunction with the blockchain-based shares per the SEC’s guidelines, but notes that blockchain approval only takes about 10% longer than a traditional filing. This should set a timing precedent that decreases with an increased volume of similar blockchain filings, and eventually eclipses traditional filings.
Motivations behind this initiative include a reduction in manual expenses and resources, global trading, and real-time settlement. In fact, the 24/7/365 tradability of blockchain-based mutual funds goes against the current mutual fund settlement structure of once per day — which may stand to disrupt the entire industry. My favorite quote from Timothy Spangler is, “If you see it as just the next tech upgrade, it’s not nearly as frightening in that sense. I don’t think any of this is flying cars. Every year from now is going to be marked by a step change in the permeation of blockchain in financial services.”
Securitize x Dow Jones Funds: Alternatives to a Crypto ETF
The main institutional bottleneck for direct cryptocurrency investment exposure centers around a crypto ETF approval. The sentiment is that exchanges like Coinbase and Gemini aren’t secure or scalable enough to handle the capital size that Nasdaq and NYSE are capable of. This delays true institutional entry until a “traditional market” fund is approved which would enable institutions to invest in the underlying crypto asset class without changing behavior with a new exchange provider. This is also why Grayscale has been so popular and has captured so many institutional investments — it is simply the closest match out there.
When looking at tokenization and all of the backend work that supports a tokenized product, there is a limited argument against it. Rather than going through a Coinbase or Gemini, wrapping a basket of cryptocurrencies in the security token structure provides all of the safekeeping and management benefits that have been covered in this publication — namely, proper KYC/AML, Transfer Agent capabilities, redemption functions, and a global reach. Rather than waiting on stringent SEC approval for a spot ETF (would allow something like Grayscale to convert from a premium-driven trust to a physically-delivered ETF), companies like Securitize are partnering with incumbent index providers to launch tokenized cryptocurrency index funds.
Through Securitize’ two new funds — S&P Cryptocurrency Large Cap Ex-MegaCap Index and S&P Kensho New Economies Composite Index — institutions gain access to a basket of respective crypto assets per the index. Pending a successful track record, this initiative may pave the way for additional institutions to either:
- Develop their own widespread indexes for funds to issue on,
- Develop tokenized products based on existing crypto indexes (such as Bloomberg Galaxy Crypto Indices), or
- Compile fragmented indexes into one global tokenized product (see ‘Tokenized ETF’ segment in the below section)
The security token breakthroughs will usher in a new product line that greatly unleashes new pools of stagnant capital outside of the traditional Equity, Mutual Fund, ETF, and Trust selections. Given the capacity to “wrap” nearly all sorts of assets in a security token, expect to see new product issuances including any and all of the asset classes covered in this publication.
SWIFT — Tokenized Asset Pilot
“In the first quarter of 2022, payment network SWIFT plans to run innovation pilots to explore interoperability in the tokenized asset market. Participants include Clearstream, Northern Trust, Citi-backed enterprise blockchain firm SETL, and other industry players. These will encompass securities market infrastructures, local custodians and global custodians.” Ledger Insights breaks down SWIFT’s proposed upgrade to its many-decade old infrastructure and financial plumbing that was mentioned earlier in this piece.
Working in tandem with SIX Digital Exchange, who was responsible for facilitating a $162 million tokenized bond with Credit Suisse and UBS, SWIFT hopes to find interoperable capabilities across different blockchains as it understands the necessity of “providing the glue” for cross-border payments and transactions in the digital world, much like it has done in the traditional world.
STOKR’s High-Yield Stablecoin Fund
December 2021 was a powerful time for the industry as STOKR announced support of the Aquarius Alternative High Yield Fund, an Algorand-based fund that takes advantage of the “growing imbalance between borrowing and lending rates in the $100 billion stablecoin market.” Since stablecoins are the most direct exposure that institutional investors can get to digital assets (given the stable price), stablecoin DeFi products have risen in popularity and in volume over the course of 2021. Hands-off investors may be looking at this space hoping for an opportunity to get involved, and SICOS Securities is offering a compliant solution to that through its available listing on STOKR. The offering is reminiscent of the Securitize Yield Funds covered above, and parallels the numerous Mutual Funds and ETFs that grew over the past couple of decades in competition. Given this, stablecoin fund sponsors are likely to build out multiple services to differentiate themselves from others as the market matures this coming decade.
Next week’s edition will cover Sample Tokenization Cases.
