If 2017 marked the emergence of initial coin offerings and 2018 has been the year of regulatory uncertainty around those ICOs, then 2019 will belong to the security token. So far, security token offerings make up only a relatively small percentage of ICOs. But that will soon change. Security tokens, not utility coins, will likely attract significant amounts of Wall Street money next year. Why is this shift expected to occur, and how can you prepare for it?
We believe security tokens act as a natural bridge between traditional finance like venture capital and Blockchain and benefit both equally. Utility tokens, akin to loyalty rewards points given by credit cards, have dominated ICOs. However, in some cases, owners cannot use the tokens beyond the issuer’s platform. As for venture capital, most private assets are relatively illiquid, which means investors face a difficult and costly time trying to convert them into cash. Security tokens solve both fundamental problems.
Security tokens digitally represent ownership in any asset, such as a piece of a tech startup or a venture capital fund and can provide investors with various rights to that company or fund. Furthermore, Security tokens provide liquidity to investors, access to compliance features to issuers, and a framework for oversight to regulators.
Cryptocurrencies have attracted a flurry of negative headlines about fraud and non compliance with laws. Although companies have been able to raise significant amounts of capital through ICOs, the lack of regulation has created significant volatility and pricing pressure in cryptocurrency markets this year. As a result, it has become riskier to launch an ICO.
However, regulators around the world, as summarized below, are starting to develop a framework to oversee cryptocurrencies. The U.S. Securities and Exchange Commission recently appointed Valerie Szczepanik to a newly created position that will coordinate the agency’s approach to cryptocurrencies and ICOs. And last month, the SEC launched HoweyCoins.com to educate investors about how to spot fraud. The agency named the website, which features a bogus coin offering, after the Howey test, a method developed by the U.S. Supreme Court to determine whether a transaction counts as an investment contract.
We ultimately expect a more stable regulatory environment over the next six to twelve months. Global regulators are taking healthy steps towards ensuring safety and security of investors in this new asset category. These actions can also reduce volatility and help unlock significant amounts of smart money.
As the regulatory environment for cryptocurrencies improves, we believe the broader infrastructure to help connect issuers and investors is starting to take shape. In the chart below, we list industry developments and emerging projects designed to boost the prominence of the security token market. The people behind these projects clearly believe that security tokens could soon attract the interest of businesses and retail investors. Furthermore, the market forces that drove the evolution of the digital currencies - democratization, globalization, transparency and liquidity – could prompt a flurry of private tech firms to raise money through security token ICOs .
Innovative startups and opportunistic, institutional crypto investors will position themselves to benefit from the growing secular trend of security tokens.
Though early, security tokens are enjoying significant momentum thanks to the emergence of compliant ICO platforms and exchanges that offer liquidity for buyers and sellers. Regulators seem to have adopted an open minded approach to cryptocurrencies that does not stifle innovation. Although the SEC will increase the number of investigations and enforcement actions, organizations that issue tokens in a compliant manner will not suffer, but thrive and grow.
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Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative, involving a high degree of risk, and investors should be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and investors should conduct their own, independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or investment advice.
Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment.
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