Share this Post
For purposes of this writing, let’s talk about security tokens alone (vs. utility tokens), and let’s assume that issuers want to comply with both existing and evolving SEC regulations. Here is how I think it plays out.
First, let’s understand the three blockchains you should care about today — the three major projects. First, the Bitcoin blockchain, designed singularly to support the bitcoin cryptocurrency transactions, is not directly relevant to this discussion so we’ll ignore it for now.
The second is the Ethereum blockchain powered by the cryptocurrency Ether. Ether (like Bitcoin) has just been deemed “not a security” causing a collective sigh of relief in ‘hodl-world.”
Ethereum (the blockchain) has the largest number of nodes, and as such has been the go-to protocol for security tokens based on two standards, ERC-20 (I’m tokenizing a pool of real estate) and ERC-721 (I’m tokenizing The Plaza Hotel). The Ethereum blockchain processes transactions faster than Bitcoin, but the need for speed is driving the development of several new projects that we’ll be seeing later this year.
The third main project is Hyperledger. Originally designed for Enterprises who are pursuing non-crypto, permissioned blockchain projects, Hyperledger has become the home for several notable crypto projects that need more specialized technical underpinnings. IBM leads the Hyperledger coalition, and as such is driving the consortium with certifications and developer communities till hell won’t have it anymore. Hyperledger is promising, but currently not as appealing as Ethereum for security token issuance.
As the choir currently singing “we already have plenty of financial vehicles, why do we need tokens?” is being replaced by the hot, new “it’s the liquidity, stupid!” rock band, many existing market participants will be forced to reinvent themselves to remain relevant.
The Financial Services Players
Issuers who, might have issued stock or other instruments in the past, will instead issue security tokens. They will file a registration statement (S-1, Reg A+, etc.), write a white paper that endeavors to describe the monetary policy of the token, and commence with some sort of offering online or through a private placement. Token investors will need to submit to a KYC/AML verification just as they would when opening a brokerage account, and a new genre of KYC/AML APIs are struggling to add throughput to handle the volume.
Broker-dealers continue to get squeezed. If security tokens replace traditional securities, traditional brokers will see a continued decline in relevance and margin as clients seek specialized professionals to execute token transactions and reduce the friction experienced by the DIY cryptocurrency investor.
Traditional broker-dealers will experience further encroachment as the new breed of broker-dealer assembles itself out of existing machinery to offer “one-stop-shop” capabilities that help pave the new token highway. We are already seeing new securities exchanges register themselves with broker-dealers attached, and utility exchanges like Coinbase are starting to offer custody services in order to entice institutional investors.
Given these moves, I believe we will see new crypto-centric B/D’s that a) issue tokens b) are Licensed transfer agents c) can be token custodians d) and support tokenized private placements. Snappy!
Brokerage accounts in the new paradigm are replaced by wallets. Instead of KYC (Know your Customer) at the BD level, KYC will happen for wallets that are later whitelisted as suitable vehicles authorized to purchase initial token offers and in some cases in secondary market transactions.
Transfer Agents are in a bind if they choose to pursue the “I wish it wasn’t so” strategy. Instead, transfer agents can leverage the security token stampede to expand their roles and relevance in the eyes of their customers beyond token issuance to services that might otherwise have been offered by traditional ecosystem participants.
For example, transfer agents can offer 1099 reporting, automate the payment of token dividends, issue periodic statements of account holding, and even provide applications to help investors track their cost basis across their entire portfolio of holdings.
Transfer agents can also play a leadership role in making sure that token issuers have a valid “checklist” of features that are baked into the smart contract code to make sure that downstream compliance is frictionless. The services offered by transfer agents can evolve to very elegantly support cryptocurrency on a broader level than exists in traditional securities.
Exchanges will bloom like flowers. Due to the hostile regulatory environment, the bulk of growth for crypto exchanges is happening outside of the United States. There is heavy anticipation around the launch of tZero, widely believed to be the first live exchange in the US that will allow trading of security tokens.
There will be more exchanges to hit the U.S. market in 2018. These exchange will compete on the basis of a) their listings, b) the trading interface, which will be aimed at the segmented trader personas and financial institutions and c) their downstream services (e.g. paying dividends, issuing statements, tax reporting).
Clearing Firms = Dead technology walking. Clearing happens on the blockchain. If clearing firms decide to evolve, they will quickly need to augment their traditional services with blockchain equivalents and look to displacing some of the other ecosystem participants.
Blockchain technologies, fueled by cryptocurrency and self-deterministic ecosystems, are causing an upheaval that doesn’t mandate adoption for everyone, but cannot be ignored by anyone. Above all, there is a new playing field for financial services. With intellectual perseverance at the forefront, combined with common sense regulatory adherence and a brush of bravery, anyone can field a winning team.
Grace Schroeder is the CEO of SLINGR.io, the Inventor’s Low Code Application Platform. SLINGR Blockchain Solutions range from smart contract development and deployment to development of integrated on/off-chain solutions for issuers, brokers, transfer agents, and custody solutions providers.
Share this Post