A Year Ago

In a recent report from Blockstate, in Switzerland, it revealed that so far in 2019 there are over 120 planned or launched Security Tokens Offerings (STOs).

These STOs have already raised over $1 billion, compared to 2017, when there were only 5 STOs which raised $67.5 million. STOs are set to replace Initial Coin Offerings (ICOs) as a method to raise capital and, because they are subject to much greater regulation and typically backed by real assets such as bonds, equity, commodities, property, etc., they ought to perform in a much less volatile manner. Given the higher regulatory bar that a STO has to comply with, STOs are likely to be much more attractive to institutional investors and will be traded on regulated exchanges across the world. The Blockstate report highlights that five countries are dominating STOs - Estonia, Germany, Switzerland, UK, and USA - who between them, account for 75% of the STOs issued to date.

The infrastructure to offer more STOs also continues to develop, as seen by the announcement of the tie-up between Globacap and Archax this week, both of which are regulated by the FCA in the UK. Globacap is a platform that has been built to be able to issue Digital Assets/STOs and is similar to Tokeny (which has just had €5 million invested into it, as detailed above by Euronext) and also has a partnership with Archax to use its exchange.  In 2018, Globacap tokenised its own shares. Then, in 2019, the platform tokenised two UK-based companies, helping them to raise capital, with Globacap serving as the custodian. The purpose of the platform is to provide built-in compliance to properly transfer ownership from traditional assets to Digital Assets.

Archax is looking to officially launch its exchange, which is intended to trade Digital Assets later this year. It will be using Blockchain technology to reduce costs and offer more transparency, both of which Archax believes are of great interest to the institutional investors that it is targeting.

The first STO in Germany, which was authorised by BaFin, took place in March 2019, raising €3.5 million for a company called Bitbond, a business that offers loans to small companies. Therefore, there is plenty of evidence that not only are STOs gathering greater traction but as we see more infrastructure in place it will enable asset managers and banks to be further engaged with Digital Assets. We have already seen the likes of Goldman Sachs and Fidelity offering custody solutions and Avia providing STO insurance, so all that we really need is evidence of good liquidity for STOs. If we see attractive trading volumes in STOs, Digital Assets really will be able to give their analogue paper-based alternatives a real run for their money!


Security Token
Last year, the European Union agreed on new prospectus regulations which will come into force on July 21st and will give clarity as to how much capital a company is able to raise when doing a securities offering in each member state.

It will be possible to raise up to 8 million euros within any 12-month period from the general public, without the need for a prospectus.

The image shows the different amounts that each country will be able to raise before a prospectus is required.
This new regulation will be of great assistance to firms which intend to launch a Securities Token Offering (STO), in particular, those STOs that wish to raise a small amount of capital. STOs will also benefit as more Digital Exchanges are launched, which themselves will list these newly created securities.

Digital Asset Exchanges are where you can trade Digital Assets for others, or fiat currencies, such as £, US$, Yen CHF or Euros. If you need access to technical analysts’ tools, stop losses, profit targets, etc, then you are likely to have to open an account. However, if you just wish to make the occasional trade, there are Exchanges (often referred to as platforms) which you can use that do not require an account to be opened. There are typically three types of Digital Exchanges:

• Trading Platforms – connect buyers and sellers and take a fee from each transaction.
• Direct Trading – these platforms offer direct person to person trading where individuals from different countries can buy and sell. Direct trading exchanges don’t have a fixed market price, instead, each seller sets their own price that they wish to trade at.
• Brokers – anyone can use these to buy Digital Assets at a price set by the broker and are similar to foreign exchange brokers.

In the UK and many other jurisdictions, pension managers, mutual fund managers, and many private client portfolio managers are often restricted by their investment mandates and client agreements, to hold but only a small percentage of assets in securities that are not listed on a recognised exchange. There are many exchanges/platforms around the world that are able to trade Digital Assets - such as Coinbase, Kraken, Binance, Poloniex - and you can find a list here that gives a brief summary of ten of the better known Digital Exchanges.

It is not just new exchanges, but we are also seeing traditional exchanges entering this sector, such as the London Stock Exchange, which has recently listed UK’s first Digital Asset (2030) and has even licensed its technology to the Hong Kong Stock Exchange AAX. The world’s largest operator of Stock Exchanges, Intercontinental Exchange (ICE), is active in this space. ICE is a Fortune 500 company which owns the New York Stock Exchange (which is the world’s largest).

We have just seen new legislation being introduced in Europe, the 5th Money Laundering Directive (5MLD), which will bring it in line with the US. The 5MLD will impact Digital Assets which are involved in the provision of two different services:

• Digital Asset Exchanges – where one can buy and sell Digital Assets and traditional fiat currencies.
• Custodian Digital Wallets - firms which hold private keys

European members will now have 18 months to implement...

Capital Markets
Financial Regulation
The London Stock Exchange (LSE), which is one of the largest regulated exchanges globally, has issued an STO worth £3 million on the LSE’s Turquoise platform.

This is the first STO, or as some are calling it an Equity Token-Offering (ETO), for The LSE, and has been carried out within the Financial Conduct Authority’s (FCA) Fintech Sandbox for a company called 20/30.

Nivaura helped with the 20/30 issue, and had previously been involved in launching a bond on the Ethereum network, claiming that by using Blockchain technology the costs of issuing a bond could fall by as much as 65% to 80%.

Nivaura recently raised over £20 million from Linklaters, Allen Overy, and the LSE to develop their business as they believe that Digitising the issuance of bonds and equities for private and publicly quoted businesses is here to stay.

No doubt other exchanges around the world will be keeping a close watch on the LSE, as they will not want London to steal too big an advantage in this sector, which is attracting considerable institutional interest around the world!

Digital Assets
In 2014, Mastercoin launched the first Initial Coin Offering (ICO).

It took nearly three years for this capital-raising mechanism to really take off, which subsequently created over 5,000 tokens raising over $22 Billion on a global basis.

As regulators turned their attention to ICOs, arguing that many of them ought to be treated as securities attention has Increasingly focused on the development of Security Tokens (STOs).

STOs are often asset-backed and are subject to security regulations in the jurisdictions in which they are launched and marketed. Making global offerings onerous and practically impossible.

STOs are usually backed/pegged/linked to an asset, examples include private or publicly traded shares, bonds, property (residential and commercial), commodities (gold diamonds), foreign exchange ($, Yen, Euro, £) and even exotic investments like wine, violins, art and other collectables.

STOs, being Digital Assets, mean that they can be listed on Digital Exchanges, which in turn enables them to be traded 24//7 as well as enabling enables smaller investors to buy and sell these assets.

Historically some of these assets, such as real estate and collectables, have proved to be illiquid, and the preserve of the wealthy and institutional investors. However, STOs ought to be able to widen the number of investors who can gain exposure to these previously illiquid assets in the future.

More recently we have seen organisations that want to raise capital by issuing tokens using one of the 300 digital exchanges to launch Initial Exchange Offerings (IEOs). These IEOs are very similar to an ICO, but by being listed on an exchange hopefully have greater liquidity.

Potentially they offer investors a degree of comfort because a third-party (the exchange they are to be listed on), has carried out a degree of due diligence. If the token meets all the tests - including that the company that is creating the it is not intending to use any capital raised to build its infrastructure, IT, or platform etc. it may be classed as an exchange or utility token, so outside of the regulations that capture STOs.

Some exchanges have decided to call their IEOs Direct Premium Offerings (DPOs), usually designed to offer investors access to a cryptocurrency at a discount to the market price. In traditional stock exchanges these are called “rights issues”.

More recently we’re seeing Token Curated Registries (TCR), which are designed to replace centralised lists, eg. a list of the top ten hotels or restaurants in a City. TCR is like an incentivised voting game that creates lists which are maintained by the people who use them. Users collectively vote (using tokens) to decide which submissions are valid, which should be included in the list, and where they will be ranked.All of the above typically use Blockchain technology as part of the process of bringing a company to a wider audience, apart from Direct offers, which simply look at raising capital (much like an Initial Placing Offer (IPO)) but do so without the costly underwriting fees of investment banks.

As Slack have announced they are to launch a Direct Offer, will Pinterest, Zoom, Uber or AirBnb also use Direct...

Capital Markets
This was the message reported from China this week as they confirmed that they are cracking down on organisations raising capital via Initial Coin Offerings (ICOs) and Security Token Offerings (STOs).

It was only in December 2018 that Beijing’s Municipal Bureau of Finance said “The ICO (initial coin offering) model is getting left behind for a new concept called STO. I want to issue a warning to anyone considering running an STO in Beijing,” Xuewen said. “Don’t do it in Beijing – it is illegal. You can only engage in such activities with the approval from the government.” Government approval, what does this mean?

This is at odds with recent promotion of a
book on Crypto assets on a Chinese state-run TV last month that reportedly has an audience of one billion. The presenters telling viewers that Crypto assets could be one of the best investments they could ever make.

It was only in December 2018 that there were rumours that the People’s Bank of China was looking at ways to create its own cryptocurrency. It apparently thought this type of digital asset could replace Bitcoin and perhaps even the U.S. Dollar.
Given these conflicting messages, we spoke to GlenBit in Edinburgh that owns a Digital Asset platform powered by Japanese technology, as they have close contacts in China. GlenBit looked at various Chinese government websites and national publications and could find no mention of this ICO/STO ban. They did find an article on a well known Chinese website that follows Crypto news, called ‘Bi Hu’, which using Google translated this article https://bihu.com/article/1601678341 which said “After the ICO foam was broken, many countries began to ban ICO… Thus, a new form of new currency, STO, was born that will become the main mode to raise money for Chinese blockchain project”

Time will tell the actual stance the Chinese are taking…

Digital Assets
AXA XL, Europe’s second-largest insurance company, who made $2.6 billion profit in 2018, has announced that it is partnering with New York-based Assurely, an Insurtech startup, to offer insurance cover for firms that are involved with Crowdfunding and or Security Token Offerings (STOs).

The new product is called CrowdProtector and provides issuers protection against investor complaints and lawsuits so investors may get their principal investment returned should the issuer misuse the funds, purposefully misrepresent information in their offering documents, or steal the money.

This is significant as institutions, as part of their due diligence process, look for issuers to have insurance arrangements in place prior to investing. Historically investing in small businesses and start-ups had largely been the preserve for wealthy investors and specialist funds. However, with the advent of Crowdfunding and now STOs smaller investors are able to get access to what are often start up companies, so this insurance cover is welcome to potentially offer protection to these often less sophisticated investors.