Blockchain: A Game Changer for SME Financing!?
Two weeks ago, Kapilendo launched its first tokenized bond for one of its SME customers, the gastronomy franchise FR L’Osteria SE. L’Osteria has collected over 1.7 million euros from retail and institutional investors for this financing campaign. We have a closer look at this first “Mittelstand STO” with Christopher Grätz, CEO of Kapilendo.
Enjoy the Interview
Can you briefly explain your journey towards issuing blockchain-based securities?
We kicked off this project one year ago, realizing that the issuance of securities using a decentralized ledger might be a game-changer for SME financing because it considerably reduces the cost of financing compared to traditional capital markets.
We briefly considered other jurisdictions which were developing a legal framework favourable for the development of crypto assets. However, early on, the German regulator signalled that the regulation of crypto assets would be implemented and adopted quickly. At the same time, the BaFin approved the first prospectus of a tokenized bond (Bitbond STO).
From then on, it was clear that the choice of jurisdiction would be Germany. Besides, our clients are German SMEs that have much more confidence in the German jurisdiction, which was another factor that influenced our decision.
Then it was about selecting the blockchain infrastructure we would use in our project. Given its focus on use cases in the financial industry, Stellar was a natural choice. The set of functions or compositions used in a Stellar Smart Contract is less complicated and less error-prone than other blockchains. Also, Stellar’s flexibility like the separation of on-chain and off-chain operations was something we considered appealing, not only in terms of security but also for our relatively conservative customer groups.
What are the technologies that you have developed yourself?
We have developed an in-house issuance protocol and a non-custodial wallet, allowing our customers to manage their digital securities securely. These products are built on top of the Stellar network.
For our existing investors, the investment process remains almost the same as that from our previous, not blockchain-based, SME financing campaigns. The only difference is the input of a PIN, which is necessary to open the wallet. The whole process takes less than 20 seconds if the investors have previously carried out the legally required identification of their identity.
The emission you have structured for L’Osteria has the particularity to split on-chain operations (asset issuance, asset ownership) from off-chain operations (coupon payments) can you explain why do have decided to structure the emission as such?
Kapilendo has an established customer base of 35 000 customers. Most of our customers seek positive yields from interest rates and have no particular affinity with the blockchain or crypto ecosystem.
While considering this aspect, we realized early on that we would have to compromise to maximize the conversion rate from our customer base. The digital bond which we issued for L’Osteria is a standard fixed income product. The only change is the way it is structured: it relies on decentralized infrastructure instead of the existing centralized and siloed infrastructure.
Therefore, the product is targeted towards yield-seeking investors, just like the other crowdfinancing projects on our platform. For these investors, we believed that the option of using a stable-coin and on-chain payment would have been too technical and overwhelming, which could potentially curtail the conversion rate for our customer base.
However, we are closely monitoring the different experiments going on from the government as well as corporations using stable coins or “fiat on a ledger”, as they will gain some legitimacy in the next few months and might be relevant for us soon.
It is the fifth regulatory approved token-based issuance this year in Germany. The German regulatory authorities are also pushing for the adoption of blockchain technology in financial services with a new license required for the custody of crypto assets. What is your take on the current regulatory environment?
It is extremely positive that these new technologies and services are being directed towards higher levels of professionalization. While the transposition of the AMLD5 in the local law might make cypherpunks who were early on involved in bitcoin scream, it also actually represents an acknowledgement that blockchain technology is relevant, here to stay and will contribute to greater efficiencies for financial services.
It’s great that Germany is implementing a clear framework, starting with the regulation of the functions of custody and administration of digital assets. With our newly launched digital assets entity, Kapilendo Custodian, we will strive to obtain this license and develop our digital assets product offering.
It is also noteworthy to highlight that Germany’s progressive approach towards digital securities and crypto assets makes a lot of sense for such a new industry. In the absence of regulation, five digital bond offerings have been approved by the BaFin in 2019 following a case-by-case and gradual approach.
At the same time, the German government has been continuously consulting various industry players of all sizes to translate the European AMLD into German law in a comprehensive manner to allow the ecosystem to grow.
What makes Kapilendo unique if compared to other infrastructure providers?
On one hand, our network encompasses the German Mittelstand. Since 2015 our team has been on the ground, meeting, discussing and addressing the challenges that German SMEs face in terms of banking services. On the other hand, our customer base of more than 35,000 retail and institutional investors are looking for attractive fixed income opportunities.
Combining our deep knowledge of the Mittelstand market with our customer base, technological and regulatory expertise makes Kapilendo market position unique.
Why should I invest via an STO? What are my advantages and potential disadvantages as an investor?
The same rules for any other investments in financial securities applies to an STO.
A possible disadvantage is that a lot of the STO projects didn’t seek approval from the supervisory authority and are coming from companies with a limited track record. The risk is high and almost similar than a venture capital investment in start-ups, which is not suited for everyone.
However, we can observe that the 5 STOs with regulatory approval in Germany all issued a tokenized bond. In the future, investors might have a broader choice of tokenized financial instruments.
The advantages are that as an investor I get the chance to invest in projects that I usually do not have access to. This is particularly applicable for SMEs who were not open to private investors but rather only limited to corporate banks or private equity offices. We are experiencing the democratization of investments and especially of the so-called alternative investments, which is only positive because it allows investors to diversify their portfolios in an even broader range of financial products.
Diversification is critical for investing; financial securities and more generally digital assets built on a decentralized ledger will allow investors to gain access to new assets classes which were until today inaccessible (art, oldtimer) or non-existent (crypto networks).
In your experience, what is the biggest misconception people have about Security Tokens?
The term security token is sometimes misleading; we instead prefer to use the term digital securities. Maybe the token component of it leads people to associate it with cryptocurrencies (or ICOs) which are viewed in the mainstream to still have a negative image or associated with get-rich-quick schemes and market manipulation.
Digital securities are existing financial instruments built using the latest technological standard. They have nothing or little in common with crypto tokens which are usually associated with crypto networks and as such are a completely different asset class.
In your opinion, what are the biggest challenges that the whole Security Token ecosystem needs to overcome, so as to thrive?
As for anything new, we think education is a challenge. Most of the investors still lack comprehension of what crypto assets are, such as their differences and standard features in comparison with other asset classes. But that is normal for any new technology; on top of their novelty, blockchain and DLT have the great merits of challenging the status quo and bringing people to ask themselves fundamental questions. Of course, people will have differing understandings of these technologies and their benefits.
Adoption always takes time, having a regulatory framework around the custody and management of digital assets will enable the growth of the ecosystem.
This idea of a regulatory framework to ensure trust might be counter-intuitive for supposedly trustless technologies. However, we think it is an iterative approach that makes sense for this young industry. Also, as mentioned earlier, the industry remains associated with the negative image from the past years. Thus, such regulation will have a positive impact.
What is the most exciting happening you are waiting to see in the Security Token Ecosystem in 2020?
The first regulatory approved tokenized profit participation rights (Genussrecht).
Who do you follow to improve your learning curve?
Thankfully our product and IT teams are curating content for the whole Kapilendo team interested in the topic. Cryptoassets written by Chris Burniske and Jack Tatar is a good starting point for someone seeking to learn about this new asset class. The book not only focuses on what crypto networks are but also provides relevant insights to investors on how to apprehend this new asset class as part of a portfolio allocation.
Otherwise, The Basics of Bitcoins and Blockchains from Anthony Lewis is also very good at breaking down key concepts and provide a better understanding of what digital assets are.
Finally, I find the podcasts from a16z on the blockchain topic enlightening.
Why is there is no secondary market for Security Tokens available to offer (enough) liquidity? When do you think this will change?
We believe it will be one step at a time. Secondary markets for security tokens are coming. Börse Stuttgart is paving the way with the launch of their digital exchange, and I’m sure that other projects have a plan to provide solutions for the secondary markets liquidity issues.
But again it’s one step at a time. This year in Germany, the five regulated STOs are for tokenized bonds. The total issuance volume remains under 10 million euros.
Once we reach 50 or more STOs, including the issuance of equity-like products, we’ll then witness the first steps of a secondary market for digital securities. Also, future precise regulation and appropriate infrastructure will enable the development of specialized services providers.
Furthermore, in 2020, Central banks will start experimenting with stable coins or Euro-on-ledger, which might contribute towards the gearing up of STO.
Thank you for the Interview!
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