There has been a lot of talk in recent years about crypto, tokens, blockchain, ICOs, STOs, Digital Securities, etc. What does it all mean and why should you care? In order to navigate the new financial digital world, it is important to first understand the terminology. Below, I have broken down the typical terms being used in this current digital environment. In certain sections, I have provided the example of the USA, and its primary regulator, but this is globally applicable.
Distinguishing the types of secondary markets or exchanges where you can trade digital or traditional assets also seems to be confusing. I have created the following chart to try to distinguish these.
Now, why should you care? What does this mean to you? Despite what some people say in the press, blockchain is here to stay. So understanding the types of digital assets that it hosts is going to be important in making business and investment decisions.
As a co-founder of a company that is focused on revolutionizing the private capital markets, I am not going to get into cryptocurrencies as this is not my area of expertise. This is for currency experts to discuss. Similarly, while I know the public listed markets well and how they operate, there are plenty of people who know these markets far better than I.
My background is geared towards the issues faced by private companies. Thus, I will elaborate on the fragmented ecosystem of the private capital markets that sorely need solutions.
Since the SEC and other government regulators around the world started stepping in to ban ICO’s, other alternatives have evolved. The security token offering or STO is one such term that got some wings in 2018. However, the institutional and traditional investment communities were still leary of the idea of a token or blockchain solution being provided by people without an appropriate understanding of the entire market they are trying to disrupt. Many people from the ICO space were just changing the name and using STO as a new hype to sell the same ideas.
Many of the players (intentional choice of word) in the ICO space were trying to circumvent securities regulations saying they know better how the ecosystem should work. After decades of scams, the securities regulators know that the current system has built-in checks and balances for a reason. We all understand there are issues and inefficiencies in the private capital markets, but in order to change securities rules you better have a big budget and strong case for it. As an example, the JOBS Act took well over five and likely closer to ten years to come into place. The use of blockchain has valuable applications that can certainly provide more efficient and cost-effective solutions to current private capital markets, as long as you work within the existing securities regulations.
There is a lot of exciting stuff being built with blockchain technology. I believe that if you are looking at this as a solution to the private capital markets, you need to consider a few things if you are looking at public chains as a potential solution:
- Use of private wallets for sole custody of financial instruments will not work. Securities law requires the use of transfer agents in many situations and transfer agents need to have custody of assets in order to manage them. If the digital securities are being held by individuals in their own wallet, there is no way the transfer agents can have custody of them. Think of public markets: you do not hold the securities (share certificates) yourself, they are digitally represented in your brokerage account and held by transfer agents.
- Mining of securities: It is generally not acceptable for unknown miners to verify transactions; even known miners must be eligible to perform business validation of a transaction either because they are parties to the transaction, have fiduciary responsibility, or certified subject matter credentials or otherwise registered and regulated entities.
Gas prices are not acceptable when it comes to securities. In order for a token to move on some blockchains, a gas price needs to be paid to miners. Transaction fees must be contractually fixed in advance and cannot be uncertain or subject to an auction style of payment (which leads to a form of ad-hoc discrimination). For individual investors, transaction prices need to be certain and follow execution guarantees.