Overstock.Com Inc, one of the first of many publicly listed companies globally to do an Initial Coin Offering (ICO), now via its subsidiary tZero — which is a crypto exchange trading security tokens — has announced a tie-up with the Boston Stock Exchange. This will help tokens to comply with some of the SEC regulations and is a very positive move for tokens, as well as a healthy sign that the ICO market is maturing. After all, many people have believed that in reality a significant majority of cryptocurrencies are not utility tokens, but are security tokens, and need an exchange to be listed on. To date, crypto exchanges have not been keen to list security tokens, as this could have potentially meant the exchange itself would have needed to be regulated. It would also have meant that potentially the firms issuing the tokens would have to comply with regulation, and so significantly increase the costs of doing an ICO.
It has been a little like the emperor who has no clothes, or the analogy that “if it looks like a duck, swims like a duck quacks like a duck…it is probably a duck”. If you are raising capital using an ICO for a company that it is going to build/create a business and turn it from an idea to something tangible, then it is likely the token you create will be a security. Although it is ironic that once the ICO has raised capital to build software or some type of organisation, many will need a way to access/power the organisation i.e. a utility token. So, there is a body of evidence to argue that many tokens initially need to be treated, listed and traded as a security token, and then potentially will become a utility token.
However, if you are doing an ICO and create a security token, you immediately need to look at the regulatory hurdles and significant potential costs of promoting or, in some cases, even allowing investors to participate in your token sale. In effect, you will need to comply with security regulations from the likes of SEC in the United States or FCA in the UK, as you could find yourself carrying out an Initial Public Offering (IPO) and being like Apple, Google, BP or Facebook, a publicly listed security.
It is likely we will see many more exchanges offering to trade security tokens going forward. Indeed, recently the CEO of NASDAQ said that they would consider becoming a digital exchange. Meanwhile, the OTC market is very active as an alternative way for institutions and HNW sophisticated investors to trade cryptocurrencies’ tokens. It has been reported that some organisations are seeing trading volumes of $100 million of trades a day. One of the best-known firms in this market is CircleInternet Financial Ltd. This company is owned by Goldman Sachs Group Inc, another sign of how institutions are embracing the new asset class that ICOs have created.
A regulated exchange, which can trade security tokens, could act as a possible gate keeper and offer global regulators some comfort, but only if the exchanges allow clients to use the exchange, provided they have completed appropriate KYC and AML checks. The next challenge is, how can you make the whole user experience of buying tokens more user friendly, without the need to have private keys and hot and cold wallets? Then the industry needs to address the issues of custody that is, who and how, can a third party hold digital assets which is vital for crypto funds to be able to evolve. While the technology of blockchain that powers many tokens was designed to decentralise the economy, the ability to have an organisation to look after your tokens that can be trusted is still appealing for many.
A fund can offer one the ability to have a true spread of managed or index tracking crypto exposure. There are attempts to offer investors a spread of exposure to different cryptocurrencies from Circle Internet Financial Ltd, a subsidiary of Goldman Sachs Group Inc, and while there are hedge funds and other specialist vehicles being created, these are typically not available for the public.
Currently, it is not possible to offer a regulated mutual fund/OEIC/Unit Trust to the public, as these vehicles need to have the majority of their assets invested in “recognised securities”. These recognised securities need to be traded on recognised, therefore regulated, exchanges which ideally are able to provide fair prices, liquidity and the ability to buy and sell these securities, so the asset managers can value the funds they are managing. While all of these regulations have been created to try and protect investors, in reality there are many securities/equities, particularly quoted smaller companies, that have a listing which have very little daily liquidity and arguably offer little comfort that the price which is quoted, is the price that can be traded at.
There are many cryptocurrencies that have a far more daily turnover i.e. people buying and selling, than many, many publicly listed companies, and furthermore, rather than being listed on one stock exchange which is the norm, cryptocurrencies are often traded on multiple exchanges globally. Even for the most valuable companies, by market capitalisation, in the world such as Amazon, Apple, ExxonMobile, Microsoft, which may be listed in NewYork, Tokyo and London, every Friday evening in New York the stock exchange closes and one has to wait until Monday morning in Tokyo the stock market to open before you are able to start trading again. Contrast this with crypto exchanges, where you have the ability to trade 24/7, and often by using several different exchanges that are located across the world.
So tZero’s announcement with the Boston Stock Exchange is a significant step forward.
It potentially will allow cryptocurrencies to be traded on a regulated exchange, which in time may be recognised, and so allow institutions who are currently managing over $80 trillion according to Goldman Sachs and heading to $100 trillion, start moving some of this capital into cryptocurrencies. What impact will this have on the crypto market and ICOs as more institutions embrace this new asset class?
Jonny Fry is the co-founder and CEO of TeamBlockchain Ltd. He is a Blockchain, crypto economics, ICO and funds specialist, with over 25 years’ experience as CEO of an asset management business which he floated in London with over £1 billion under management.
2 June 2018
This article was originally published in 2nd June 2018 edition of The Sunday Guardian. Read the original edition here