As Bitcoin continues to wildly fluctuate, going through boom-bust cycles far faster than traditional markets, the speculation around crypto continues. President Donald Trump came out against cryptocurrency and — love him or hate him — I believe he made several valid points. Primarily, crypto is largely unregulated, and efforts to regulate pseudonymous cryptocurrencies almost inevitably fail. This message may have caused the crash in the price of Bitcoin from roughly $10,500 to $9,500 in just a few minutes. A 10% drop in the value of the U.S. dollar in this time frame would have dramatic implications, but 10% fluctuations are business as usual in crypto. (Full disclosure: I am a Bitcoin holder.)
Essentially, what we have is a volatile and difficult-to-regulate digital asset. That’s hardly the basis for a global currency, or for the future of the financial industry. However, an important technology was created as a response to the ICO scams of 2017 and the crypto crash of 2018, called “security tokens,” which are securities on the blockchain. The blockchain is the underlying technology of crypto, one used to distribute trust and remove intermediaries, while securities are tradeable financial assets — everything from equity, debt, real assets and more.
One of my organizations, the Security Token Alliance, is working to unify the industry. By onboarding and working with around 80 companies in the space, we’ve seen firsthand the great potential of tokenizing securities. Even more importantly, we’ve also seen the struggles and barriers to successfully tokenizing assets.
The point of many cryptocurrencies is to evade regulating and taxing intermediaries, like governments, while the point of security tokens is to make it easier and more efficient to comply with government regulations. This is important in a world that rests on the stability and protection provided by authorities like governments.
While crypto continues to be denounced by government officials and enterprise executives, I’ve seen a clear shift toward security tokens. Players like NASDAQ, JPMorgan and Overstock have entered the space — NASDAQ funded a security token platform, JP Morgan launched a digital currency and Overstock CEO Patrick Byrne shared his opinion that 100% of Wall Street stocks and bonds will be tokenized in five years. Infrastructure is also being built for new projects with regulated players like Bakkt and Swiss Digital Exchange.
Major industry leaders are starting to see the benefits of security tokens, which center around greater operational efficiency. Because security tokens act as a digital wrapper for securities, they can speed up the typically slow and expensive KYC/AML and accredited investor procedures. You can now create legal digital assets and raise capital on the blockchain. However, being compliant with the law is by no means a given with cryptocurrencies, for several technical reasons. Most importantly, typical cryptocurrencies have no functionality built-in for “transfer restrictions,” which means that cryptocurrencies can be sent to anyone, anywhere.
The reason that’s a problem is that governments naturally regulate who trades securities, and the people behind securities pick certain jurisdictions for the trading of their securities, or they pick where trading will occur. However, since cryptocurrencies don’t have restrictions built in, there’s a huge mismatch with government regulation. You could send a cryptocurrency to an unaccredited investor, to a minor, to an ex-convict or any number of entities where it wouldn’t be compliant.
This is why the United States Securities and Exchange Commission is fining the Canadian company Kik $100 million for their ICO. Because the Kik crypto-token, called KIN, does not have any transfer restrictions, it was available to U.S. investors, where Kik was not allowed to trade securities.
Security tokens set out to solve these problems and enable real, legitimate and credible blockchain use cases. Given the Kik scandal, the crypto bust and the SEC’s moves against other illegal ICOs, it’s hard to imagine enterprises seriously considering ICOs as a capital raise option. However, security token offerings (STOs) compete against IPOs, or initial public offerings, and security tokens compete against securities.
This is not to say that security tokens are a magic bullet for the crypto industry. Security tokens face many barriers to mass adoption, not the least of which is that the financial industry is typically wary of new technologies that promise disruption. Further, industry professionals who were burned by the ICO industry may be hesitant to give a “second chance” to blockchain.
In fact, a security token offering is not the only way to do a compliant blockchain-based capital raise. Utility tokens, which give streamlined access to a company’s products or services, have been around for longer and can be sold in the same regulated fashion. For example, Mandala Exchange sought to file for a Reg A+ offering in the United States, though it deems its token to be a utility token.
It’s also important to remember that most traditional asset managers in charge of real estate, derivatives, debt and so on haven’t even heard of security tokens yet. Given the benefits security tokens provide, I believe that’s set to change, but it won’t happen overnight. We need greater collaboration between stakeholders to clear up this uncertainty, as well as greater education across the board.
For starters, leaders in the space need to spread awareness that security tokens intend to be similar to securities, and not to crypto. This means that security tokens need to have functionality like transfer restrictions and trade halts built in. Further, since security token offerings seek accredited investors, the process of marketing an STO should look a lot more like marketing an IPO than an ICO, which is open to non-accredited investors. It’s also important to remember that STOs aren’t for everyone — if a company has the money for an IPO, that may be a better option for now.
It’s not as exciting as the crypto world had hoped. Security tokens are a far cry from the original decentralization ethos laid out in the Bitcoin white paper, but from my perspective, they’re a lot more feasible. Maybe this “boring” reality is exactly what crypto needs.