The good old days when crypto companies used security tokens to raise capital are now gone. Entrepreneurs can no longer sell tokens that have no payment obligation or dilution effect on the company.
Back in the day, companies would raise millions without any responsibility to the investors. Thousands of utility tokens were offered to the public, but most of these have lost their value or their liquidity.
So what happened?
The ICO fever
The ICO fever started with Mastercoin in July 2013. Ethereum followed in 2014, raising about 3700 BTC in the first 12 hours of its presale. This was approximately 2.3 million dollars. By the end of the ICO, Ethereum had raised more than 18 million dollars.
By 2017, it was clear to entrepreneurs that they could conduct ICOs through the Ethereum Blockchain and the sale of ERC-20 token. They took the opportunity to raise billions, as the prices of Ethereum and Bitcoin soared. This deluge of ICOs created numerous new millionaires who sometimes reinvested part of their newly found capital in new ICOs.
It turned out most of these ICOs were scams raised by fraudulent founders who did not uphold the US security laws and did not even intend to launch a business in the first place. Entrepreneurs had assessed the situation, and they were convinced they had finally found a way to raise capital without taking on debt or giving equity. ICOs provided them an avenue for free money. Who would resist such an opportunity?
Those who founded such ICOs are now placing the blame on SEC’s rules, citing them as unclear even though some of them came after SEC issued its first bulletin on ICOs in July 2017.
This tragedy saw retail investors lose millions, but something positive came from the experience: we learned a new way for entrepreneurs to raise capital.
It is possible for entrepreneurs to raise capital legally through the use of cryptocurrencies while at the same time offering investors protection for their money. This method of raising capital ensures that the entrepreneurs are not at risk of being sued by SEC or asked to refund all the raised capital to their investors.
This method of raising capital is now known as Security Token Offering.
Security token offerings work like traditional methods of raising capital except for a cryptocurrency twist. Although investors receive their securities in the form of tokens or smart contracts, the securities themselves are similar to what investors used to receive before cryptocurrency came along; debt, equity, convertible note, revenue share or more.
Advantages of Tokenizing Securities
Public View of the Capital Table
Each shareholder will have a public address on a Blockchain. Every address will contain a number of securities. These on-chain tokens are not the actual ownership; they only represent it. This means that if an investor lost his tokens, they could get them re-issued similarly to how you could get a new title deed to your house if you lost the old one.
Investors like it when there is transparency on the number of shareholders and securities out there. In the security tokens space, the Dole Foods case in which it was discovered that the cap table did not account for all the investors is often used as an example of why this is important.
Access to Liquidity
As of now, most investors who buy securities in a limited partnership or private enterprise cannot have the liquidity until the partnership dissolves, or the company is sold or goes public. Rich investors might find this arrangement favorable, but for the general public, a capital lockup of 7–10 years is far from acceptable.
Tokenization makes it possible for securities to be traded on Alternative Trading Systems in small trades that do not require an attorney for every transaction. As long as all the investors have the same agreement and they don’t have additional restrictions except the SEC mandated ones, the ATS can handle these trades. Participants who already have cryptocurrency but they are non-accredited can now purchase security tokens in a regulation crowdfunding or regulation A+ offering.
Reconciling the numerous standards offered in the market
The next challenge that needs to be overcome when dealing with security tokens is reconciling the numerous standards being offered in the market. Some of the major players here include:
This is a standard developed by Smart Engine. The proposed ERC-1450 is simply a digital stock certificate. The investor is allowed to possess their tokenized certificate but they are not allowed to transfer the ownership.
The ownership of the certificate is also stored offline with a registered transfer agent. Once a trade is completed on an ATS via a broker-dealer, the registered transfer agent initiates the transfer of the certificate. This process goes a long way in ensuring trade transactions observe Regulation A as well as Regulation Crowdfunding.
DS token is a standard developed by securitize. This company deals with the primary issuance of securities. The standard can therefore, handle voting rights, issuance and paying dividends. To ensure that secondary trading is compliant, Securities DS protocol breaks the peer to peer function of ERC-20 requiring that all trades must be approved by their compliance service.
Before you can buy or sell DS tokens you have to be on-boarded on the DS protocol and have an identifying hash in the registry.
This is a project developed by Polymath. Their goal is to tokenize all assets that are given to accredited investors. ERC-1400 operates as an umbrella that works with other digital asset standards to deal with non-fungible and fungible trading regulations.
Dealing with prevalent fragmentations
Even though the digital securities market has generated strong investor interest, it has been greatly hindered by prevalent fragmentation. There are numerous projects that support token issuance but the tokens often have nowhere to trade due lack of a compliant security token offering (STO) exchange.
This ceases to be a problem anymore thanks to the merger of Katalyse.io, CEZEX, and Formosa Financial. The merger creates a complete digital asset ecosystem that covers token listing, issuance, trading, and treasury management.
Formosa financial aids Blockchain innovators and digital asset holders in solving several of their major pain points by providing a one stop platform for their financial services and needs. Clients are able to access customizable suites of treasury management tools under one roof therefore helping to minimize friction, time delays and costs involved in critical financial task.
CEZEX is a next generation exchange that comes in handy in direct trading of digital assets. They offer a regulated marketplace where companies and projects list asset based security tokens and investors trade these security tokens with other investors in the security market. CEZEX is responsible for safeguarding security and transparency throughout the process.
Previously known as FundYourselfNow, Katalyse.io is a renowned crypto token sale listing platform in Asia. The platform has completed over 60 private and public placements for ICOs in more than 25 countries. The companies listing platform makes it easier for projects to manage their client onboarding process and tokenization of assets.
Combining Formosa’s financial treasury management platform with CEZEX’S digital asset exchange makes it possible for issuers and other companies with digital assets to manage their corporate accounts smoothly and in close proximity to the exchange, providing liquidity for the assets they offer.
With the merger, it is possible to issue a security token and then make it possible for the token to be traded by a global marketplace of investors and traders. All this is done in a compliant manner and the entire process consumes lees time than it did before the merger.
The merger expects to generate a steady demand from clients as they continue to grow the scoop of their service offerings and as the need for high quality infrastructure services in the security token space expands.
CEZEX also has a long list of deal flow from companies that would like to be listed on the exchange. All companies that are interested in raising capital through regulated asset-backed STO (security token offerings) are free to list on CEZEX as long as they meet customer due diligence requirements. The first batch of STOs is scheduled for listing in June.
The future for security tokens is bright. We already see standards transform from proposals to implementations in issuance and trading infrastructure. Some of these security token standards are already emerging as market leaders, and this will cause a major shake-up in the blockchain and digital assets industry.
We hope to see more fresh initiatives such as the merger of CEZEX with Formosa’s well established and professionally set up treasury management company which is bound to revolutionize the traditional digitization process. Soon or later, conventional financial securities such as stocks, bonds, and many others will also be tokenized.