Highcastle: Talking about Equity Crowdfunding and Security Tokens

Interview with Ulyana Shtybel — Vice President of HighCastle

1. Which problem is HighCastle trying to solve?

The rise of the Initial Coin Offerings (ICOs) has shown that the traditional exchanges and crowdfunding are unable to cover the demand from SMEs amongst new early-stage issuers and global investors. In fact, the crowdfunding market is undeveloped — less than 5% percent of alternative finance in the world belongs to equity-based crowdfunding with 95% of activity taking place at p2p lending platforms an annual turnover of $ 145 bn . The reason for such a uneven split is due to the absence of a secondary market for crowdfunded equity.Both p2p lending and the ICO market do have a secondary market with a moderate level of liquidity.

Aiming to address the liquidity problem for private equity, HighCastle has created a platform where innovative companies and traditional businesses can undertake the offering of tokenized securities — STO (Security Token Offering), and investors can tokenize existing private securities and alternative investments to re-sell and trade them on the secondary market.

Tokenization is the process whereby an asset is transformed into a digital token, representing its accounting, settlement, and management and held securely on the distributed ledger register.

With blockchain technology, companies’ securities are tokenized to facilitate their smooth cross-trading against fiat/cryptocurrencies with a much deeper pool of liquidity.

2. What is Equity Crowdfunding?

Equity Crowdfunding for the last decade has been used by startups to raise funds in exchange for their equity via a sale of shares or convertible notes to a crowd of investment professionals, sophisticated investors, and high-net-worth individuals. Contrary to private equity and fixed income investing, such startup investing is rare about potential dividends, but trying to achieve a subsequent sale of shares for 5–10x the original investment. But why would you invest in startup equity with no opportunity to exit your investment? For this reason, equity crowdfunding is $3 bn and is dwarfed by comparison with $142 bn p2p lending and $10 trillion in alternative assets invested offline annually.

3. Where do you see the biggest advantages and risks using Security Tokens for Equity Crowdfunding?

Primary and secondary markets of private securities alternative investments traded on a blockchain based platform in the form of Security Tokens will disrupt not only the market itself but the whole way the investment banking industry currently operates. Meaning that access to capital will become much simpler for companies. This, in turn, will create broader opportunities for investors, investment banks and advisors. Already now we can see some of the traditional crowdfunding platforms are considering migration to the blockchain, adapting to a new token ecosystem..

The risks associated with the use of tokenization in equity crowdfunding primarily are coming from the regulatory complexity that presents itself. STO platforms are required to provide non-misleading information about the projects, conduct Know Your Client (KYC) and Anti-Money Laundering (AML) checks, have the custodian bank or permission for holding clients’ money, and most importantly — make sure that the company is eligible to sell securities to different type of investors. Has it issued and registered the prospectus or does it comply with the existing regulatory exemptions, as for example is required in the United Kingdom:

the total amount being raised from investors in EEA states is less than €5,000,000 (calculated over a period of 12 months); the offer is made to or directed at qualified investors only (e.g. venture capitalists and business angels and other persons regulated by the FCA); the offer is made to or directed at fewer than 150 natural or legal persons, other than qualified investors, in each EEA state; or the minimum consideration payable by any person is €100,000.

4. How expensive and time consuming is it to do an Equity Crowdfunding with a Security Token?

The cost associated with the issuance and listing of Security Token on the platform is around $15–20K. Issuance of securities in accordance with the regulatory exemptions wouldn’t involve excessive legal costs, but when a company is raising over $5–10 ml, then the necessary registration of the prospectus will cost around $20–50K in each country where the company wants to attract non-professional investors. The other cost consideration factor is the readiness of the project itself. To offer securities to investors, a company needs to provide a comprehensive pitch deck or so-called information memorandum and calculations of financial projections. In case the company doesn’t have a financial director and qualified team members to do it, they need to hire financial (corporate) advisers to do this work for them. Additional legal costs may apply to register actual shareholder/s and transfer the final investment into the company.

5. For which kind of security/asset class tokenization brings the most benefits, for which the least?

Tokenization will bring the most benefit to the market for private securities and alternative investments, publicly-traded securities would be impacted less.

The current stage of development of the blockchain technology has limitations related to its scalability and speed. Distributed registers with one operator are much faster than public blockchains, like Bitcoin or Ethereum. HighCastle has chosen a Stellar-based distributed ledger for its platform, as it is capable of supporting up to 5000 transactions per second, enabling fast and responsive trading environment for the private securities market.

In the next years we will see how blockchain technology will disrupt the private placement market as it finally makes the creation of a secondary market for private securities possible as liquidity continues to build. In a couple of years, blockchain could also begin to disrupt the existing incumbent stock exchanges. However, this will not happen until at least a ten-fold increase in the speed of blockchain as public securities are highly traded instruments and in many cases comprised of high-frequency trading participants. Even now the leading international stock exchanges like the London Stock Exchange, Toronto Stock Exchange, Australian Stock Exchange existing capacity suits just their alternative SMEs markets.

6. What would you recommend projects considering doing an Equity Crowdfunding with a Security Token?

As for any other type of private placement, traditional or tokenized equity crowdfunding, I’d recommend projects considering Equity Crowdfunding via issuance of Security Tokens to have at least a MVP product, completed team, advisory board, registered legal entity and first customers in place. If you don’t have customers yet, you should have a very strong, unique and innovative (meaning game-changing) technology. A company needs to be attractive and mature from the investment perspective. When you start your fundraising make sure you already maintain good communication with journalists to help raise the profile and awareness of your brand.

Be prepared to invest in the marketing of your company, especially if your company has no unique characteristics which helps to distinguish it from its competitors.

Mature startups and operating companies will benefit from fundraising via an offering of their tokenized securities (shares, bonds, loan certificates), but like in any other form of financing, investors will look to the economics of a deal, the intended use of funds and structure of present and future revenues.

7. What was the biggest learning you made during the last year?

The exchanges or crowdfunding/STO platforms as infrastructure providers can’t take the role of financial, corporate and legal advisers. You don’t want a market of tokenized securities without the necessary regulatory requirements and offering rules, which exist to protect the investors’ rights and protect unprofessional investors from fraud and misleading information. The blockchain is just a good technology, economic equations are still the same.

8. Where do you see the Security Token Ecosystem in 5 years?

We will see a majority of crowdfunding platforms trying to migrate to blockchain technology and create blockchain-based secondary markets. Many crypto exchanges will try but fail to meet regulatory requirements in order to be able to trade security tokens. The Ethereum public blockchain will not be applicable for issuance and trading of Security Tokens, so the permissioned blockchains, like the HighCastle blockchain, will spread amongst regulated exchanges, investment banks, and brokers to record the securities transactions. In five years we will see an evolution in blockchain technology speed, enabling public stock exchanges to start to migrate to distributed ledgers and trading platforms will be able to execute high-frequency trading transactions, or at least at human trading speed.

9. Who is your favorite super or real-life hero?

Real-time hero-entrepreneur, smart man and innovator Peter Thiel, author of “Zero to One”, co-founder of PayPal.

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Note: This interview was conducted on 01.10.2018