The current crisis caused by the pandemic has increased the need for accelerated automation that would lead to increased efficiency, lowered costs, and counterintuitively increased revenues. This can only come from a paradigm shift.

Distributed ledger technology (DLT) is undoubtedly revolutionising capital markets. It is, however, important to cut through the hype and bluster of misinformation, causing misadvice, and promote the use of blockchain in value-added ways. We believe that security token offerings (STOs) could be one of the more significant ways of using DLT in FinTech, both in scope and in social impact.

So, the questions we seek to address here are whether security tokens are a multi-trillion dollar opportunity, and how can they be made more trustworthy for investors and at the same time lever on crisis induced opportunity.

What are STOs?

A STO is the process of raising finance by way of selling issued security tokens to investors. Simplistically, a security token is a cryptographic representation of a (or a fraction of) traditional share of a corporate entity. There can, of course, be many variants to the rights and obligations packaged in a security token, associated with the underlying traditional share. The security token’s presence on a blockchain gives it many more features than a stock certificate. Smart contract systems can incorporate regulations within the token itself. Know-your-customer rules can prevent someone who isn’t qualified from buying the token.

Are STOs really gaining traction globally?

 There is exponential growth in the digital assets market. A World Economic Forum survey predicted that 10% of Global GDP will be stored on blockchain technology by 2027 @ USD 24 trillion.  In March 2019, Cisco published a report predicting that 10% of global GDP will be stored on blockchain by 2027. Deloitte also tweeted in May 2017 that 10% of global GDP will be on blockchain by 2025. Given the vast potential of the STO market, it is good to consider why such a stellar rise is predicted.

What opportunities do STOs provide?

Here are the key opportunities that are going to power this ecosystem when undertaken on a regulated exchange:

• Blockchain-based: The exchange will be built on a blockchain. Thus, all trades will be transparent and ownership can be traced;
• Fewer intermediaries: A digital market in which security tokens and cryptocurrencies are traded brings issuers and traders directly together. Fewer intermediaries mean lower costs and higher liquidity;
• Real-time settlement: Digital markets can operate 24/7 and offer real-time settlement, which eliminates huge inefficiencies of daily market closures;
• Programmable: Digital assets are programmable, and, through smart contracts, help include corporate events like ex-dividend and cum-dividend date and proxy voting; and
• Custody services: Such an exchange will offer its own or third party trusted secure custody services for cryptocurrencies, security tokens, and other digital assets.

What are the key facets of this trusted environment?

The primary benefits of STOs are greater liquidity, reduced transaction costs, smoother issuance, and greater flexibility to buy, sell, borrow, and lend assets. The key implications of the trusted environment enabled by STOs are:

• Increased tradability: Liquidity makes the asset more accessible. It is faster to trade and settle, allowing for a 24/7 trading environment in a global market, and provides the option to list on secondary exchanges set up to offer digital asset trading. Thus, companies will be able to conduct fundraising with STOs and their tokens can be tradable in the secondary market;
• Lower costs: A typical Initial Public Offering (IPO) on a leading exchange might cost circa US$1.25 million when factoring in various costs. By contrast, a high quality STO might cost as little as US$25k;
• More institutional acceptance: Liquidity on new digital exchanges is allowing the market to become more institutional e.g. ICE’s Bakkt, SECDEX Exchange, Swiss Digital Exchange and others announced by Fidelity Investments, Standard Chartered Bank and others;
• Instant settlement: STOs are light, agile and inexpensive, allowing for instant settlement, with institutional-grade third-party custody services starting to emerge;
• Asset swapping: In the future, digital exchanges will offer access to every type of security. This will allow for the exchange of historical asset classes for new esoteric ones – e.g. World of Warcraft tokens for Rolls Royce shares – through the use of smart contracts, which facilitate asset swapping;
• Virtual trading of immobile assets: STOs will be collateralised through digital and crypto exchanges, and immobile or illiquid assets will become virtually traded;
• Personal data will have monetary value: Our personal data has value and so why should we not be paid when this is utilised? Why can we not sell our own future potential now for a percentage of future value, much like equity in a company can yield a return based on performance? Tokenisation makes this possible.
• Digital futures and options: Futures and options can be determined by smart contracts – e.g. if a predictable event happens, sell Ethereum (a popular cryptocurrency) at USD 10.22! 

What top 10 benefits do STOs provide?

 In this modern era of digitalisation, tokenisation offers many advantages to companies, the most important ones being:

1. The possibility of creating a cryptographic token that is unique and immutable, through the use of blockchain technology;
2. It allows traditional share ownership of a company to be reflected digitally in a blockchain registry with ease of access for shareholders;
3. The use of blockchain reduces administrative inefficiencies and settlement delays by allowing the almost instantaneous transfer of tokens and therefore renders secondary trading, through the speed of transfer, more secure;
4. It promotes cost effective secondary trading, through a flattening of the structure, as fewer intermediaries are required to facilitate the movement of tokens;
5. The tracking of movement of tokens becomes much easier and more reliable through the use of blockchain technology, as there is no need to trust one centralised party;
6. It allows wider syndication of investors through fractional ownership and therefore increases liquidity;
7. It promotes administrative efficiency through automation of processes relating to corporate actions, KYC and AML/CFT;
8. It enables people to be more creative, in terms of what can be tokenised, to allow capitalise raise or to create value. E.g. it is possible to bundle rights and perks within tokens that have no or low intrinsic financial value, but would have a high value to potential shareholders such as fan tokens;
9. Tokenisation presents opportunities to unlock value from traditionally idle or illiquid assets such as real estate; and
10. Finally, we should not forget the marketing benefits of tokenisation, which demonstrates innovation.

How can STOs realise their potential?

In light of the surge in STOs, numerous jurisdictions have introduced a legislative and regulatory framework for digital assets – Seychelles being one such example. This makes for a promising start to help STOs realise their potential. Regulation is key to unlocking their potential and protecting investors so they can invest with trust and confidence, which unregulated exchange offerings cannot achieve.

When choosing the right digital securities exchange or marketplace, issuers and investors should look at four key aspects:

• Great technology, that is both traditional and digital so that it bridges the gap between the centralised current financial world and the decentralised finance (DeFI) opportunities;
• An experienced legal and compliance team and associated framework;
• Extensive capital markets experience; and
• Great products.

With the above in mind, regulated STOs offered on regulated exchanges should be better structured, with more opportunity and with much lower costs than traditional Initial Public Offerings (IPOs). Unfortunately, in many cases, that is not the case because services such as legal, finance, technology provision, and issuance activities are all carried out in a disparate fashion, therefore, leading to increased cost and even more intermediaries than there are in traditional markets. Exchanges and digital custodians need to offer an all rounded regulated solution to cover all elements of the value chain; with token issuance capabilities, legal structuring, financial valuations through state of the art technology, as well as the opportunity to safely keep the tokenised assets within a secure digital custodian as part of a cohesive single aggregated service offering.

Moreover, with asset tokenisation increasing, the capital market has shown a booming appetite for integrating digital assets into the wealth management portfolio. Institutional investors are increasingly investing in digital assets and require custodians to deliver exchange custody, self-custody, or third-party management of digital asset accounts. The new regulated cryptocurrency and digital asset exchanges are looking to expand liquidity and attract new participants. For this, they require custodian partners who are able to scale technology to meet the needs of the institutional market. Also, the rapidly increasing value of digital assets demands better security. The likes of Fidelity Investments, as well as numerous leading investment banks such as Goldman Sachs, have digital assets teams with actively developing offerings in this space, as has been publicly announced or reported over the last 12 months.

Changes in the world over the past few decades have warranted a change in how digital assets are defined. Ten years ago digital assets stood for images and documents, but now potentially represent entire financial systems and information oceans. Individuals and institutions, therefore, need trusted solutions and the market is starting to respond to this.

One thing is clear; we are only at the start of the 4th industrial revolution. The road to discovery and innovation lies ahead of us to create positive change and democratise the way that we do things.