Security Tokens: The Blockchain’s Coming Of Age
How the blockchain went from being a libertarian dream to becoming the future of capitalism, by Vincent Trouche CEO of Tokenestate.io
The rearview mirror: how did we get there?
The blockchain, with Bitcoin as its figurehead, emerged in the United States in the wake of the 2008 financial crisis and in times of great distrust with financial institutions. It was conceived as a solution for people to take back ownership of their currency, enabling them to sever the link with widely criticized institutions largely responsible for bringing the world to the brink of economic collapse.
The blockchain is thus, at least initially, a technology that comes baked in a libertarian and crypto-anarchist ethos. It was to financial institutions what punk rock was to classic music: a loud, fast, and deliberate offensive on the establishment supported by a small and fervent fanbase.
In the ensuing decade, the world slowly realized that the blockchain is much more than a currency used by darknet websites and ransomware — even if laggard pundits still view it through that lens. It is a revolutionary technology enabling the disintermediation of trust, on which most economic activity is based.
‘Crypto-whales’ and the ICO craze
Since ‘base’ blockchain applications such as Bitcoin or Ethereum exhibit strong economies of scale and do not require much capital to develop, it’s inceptors, early backers and users became millionaires or even billionaires — the famed ‘crypto whales’.
They used their newfound wealth to finance the emergence of an entire industry of crypto startups which went from inception to hundreds of million dollars in valuation in a matter of months. The ‘ICO-craze’ took the world by surprise in late 2016 and lasted till early 2018.
Drawing inspiration from the resounding success of early blockchain startups, hundreds if not thousands of ‘me-too’ startups sprouted overnight and started raising funds by mean of a cryptocurrency or utility token offering (i.e. ICO) with the promise of creating new economies from scratch, and enshrining economic relations in immutable blockchain code.
The business model of the average ICO startup typically consists in massively issuing a cryptocurrency or utility token, with the objective of creating a community of investors/users to disintermediate a particular industry or set of economic relations. This could be freelance work, wealth management, data-storage and even adult movie production and consumption.
Such ICOs where typically supported by faith in this new found economic ‘community driven’ business model, and more importantly by the massive economic valuation of crypto currencies. Bitcoin, which became a shortcut for investing in all blockchain related things, rose from a market capitalization of $15bn in late March 2017 to a peak of $325bn in mid-December 2017.
This ‘crypto-wealth’ fueled the raise of other cryptocurrencies and utility tokens, pretty much as a bubbling real estate market finances the construction of new apartment complexes — even if there is no fundamental demand for housing.
The end of the cryptocurrency party
The wheels fell off from the crypto market in early 2018, with Bitcoin valuation coming down 50% in a matter of weeks.
The economic rationale of the ICO driven business models started being questioned. In most instances, the cryptocurrencies or utility tokens issued by the startups could be effectively replaced by an existing cryptocurrency, such as Ether, and its blockchain by an existing blockchain, such as Ethereum. Crucially, most cryptocurrency or utility token business models create a central counterparty risk which is the issuing startup itself, while providing literally no recourse for injured parties to enforce their rights.
Another factor contributed to the demise of the ICO driven business models: national regulators took notice. Around the world, regulators ruled that most utility tokens were in fact securities, regulated instruments that most ICO startups cannot deal with.
The way forward: high stake ICOs
The ICO model is not over, but it is becoming an increasingly high-stake game. It is legitimate only for the few blockchains companies that have the potential to build cutting-edge and polyvalent blockchain-based solutions and payment networks, and, crucially, to finance their adoption at scale. Such companies are few and far between.
For new ‘infrastructure’ blockchains, the task is even more daunting because of the network effect and first mover advantage of existing contenders. 80% of all crypto startups are using Ethereum. Creating an alternative blockchain ecosystem will require massive resources. Telegram’s recent raise of $1.7bn by means of a cryptocurrency offering makes it a formidably contender.
Down the road one can expect only a handful of public blockchains and cryptocurrencies to survive and become the substrates in which the future crypto economy will growth its roots.
Blockchain-agnostic applications
While the blockchain is increasingly becoming accepted as the new normal, there are surprisingly a small number of applications which are effectively in production, besides cryptocurrency exchanges and wallets.
What the world needs now are blockchain-agnostic applications. To use the operating system analogy: Windows alone is useless. What makes it useful are the applications enabling its user to be more productive, from crunching number with Excel, sending messages using Slack or taking notes on Evernote. In turn, such applications must support different operating systems: an app which doesn’t work on my windows laptop, on my iphone and android tablet simultaneously is useless.
One key area of growth is the development of blockchain-agnostic — and cryptocurrency agnostic — applications to deliver the operational efficiencies promised by the blockchain. For example: the management of land registries, the securitization of assets, the management of intellectual property or being able to transact in ‘fiat’ currencies using the blockchain, to name but a few examples.
Security tokens: the blockchain’s coming of age
The increased regulatory oversight surrounding all things crypto has a silver lining to it: it is now possible to operate lawfully and to represent existing securities — such as share or debt instruments — by using a blockchain token.
In its landmark ‘Guidelines’ published on February 16th, 2018, the Swiss Financial Market Supervisory Authority (FINMA) stated that ‘If (…) FINMA comes to the conclusion that the tokens of an ICO constitute securities, they fall under securities regulation. Under the Stock Exchange Act (SESTA), book-entry of self-issued uncertificated securities is essentially unregulated, even if the uncertificated securities in question qualify as securities within the meaning of FMIA.’ Essentially, Swiss-based actors have now the possibility, under certain conditions, to represent the ownership of a security by using a blockchain token.
So the blockchain revolution has come full circle: from its humble beginnings as a crypto-anarchist pipe dream, it is now being integrated into our economies and regulatory environment. And that is a good thing, because regulation, in a democratic environment, has an overwhelmingly positive impact. Fair jugements cannot be made on the blockchain alone: they need to be enforced by a trusted ‘real-world’ 3rd party, the judicial system.
The laws and courts constituting the backbone of any democracy enable the peaceful resolution of conflicts. Few people would argue that it is better to resolve arguments at gun-point if granted the possibility to having a fair judgement in court.
The problem with existing regulation, and in particular securities regulation, is that it creates too much friction. If a company is willing to go public, the costs are typically prohibitive. Security tokens hold the promise to take the best of both worlds: the investor protection granted by the existing financial regulation, and the operational efficiencies made possible by the blockchain.
We see security tokens as the dominant way to raise capital for businesses in future. It is our expectation that they will become an investment vehicle to perform investments in real estate, treasury bonds and represent a trillion-dollar market in the years to come.
