6 May 2020

Why tokenisation and STOs are changing the investment world for the better6 min read

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The widespread international adoption of blockchain technology has the potential to fundamentally change the finance industry. Lending, payments, remittances, identity management and the investment industry all benefit from a massive boost in innovation – with the tokenisation of assets contributing its part. In this light, the character of Security Token Offerings (STOs) has to be emphasized. 

Global spending on blockchain technology and solutions is expected to reach USD 15.9 billion by 2023, with the financial sector accounting for over 60% of the worldwide market value of blockchain since 2018.

Tokenisation has opened a new world for investors by offering fractionalised investment opportunities for many assets and commodities. Over the past decade, we’ve seen a steady evolution from crowdfunding platforms, through to Initial Coin Offerings (ICOs), and more recently, Security Token Offerings (STOs).

Due to the lack of global regulation for cryptocurrencies and blockchain, STOs were a natural progression for ICOs, as tech-savvy entrepreneurs and businesses wanted to utilize blockchain technology to raise funds from accredited investors.

What is tokenisation?

Tokenisation is the process of converting a unit of asset ownership or rights into a digitised token on a blockchain. The concept of tokenisation can be applied to financial instruments under regulatory assets such as bonds and equities, and tangible assets such as precious metals, real estate, artwork or copyrights.

As tokenisation is adopted globally, the Liechtenstein government became one of the first governing bodies to implement official regulatory laws, with Prime Minister Adrian Hasler stating: “Thanks to the TVTG, a key element of the government’s financial center strategy will be implemented and Liechtenstein will be positioned as an innovative and legally secure location for providers in the token economy”.

What are Security Token Offerings?

Similar to ICOs (Initial Coin Offerings), during an STO process investors are issued with tokens or crypto coins that represent their investment when they purchase tokens. However, unlike an ICO, security tokens represent investment contracts in assets such as stocks, funds, bonds, or real estate.

Security tokens area backed by real-word assets such as properties or companies and therefore must comply with KYC and AML regulations. Depending on the underlying financial instrument, they can be only available to accredited investors.

How do ICOs differ from STOs?

STOs have to comply with regulatory governance, whereas ICOs offer their coins as utility tokens, thus offering users access to decentralised applications. Therefore, a significant difference between these two processes is that ICOs offer coins for ‘usage’ rather than investment.

In the past, ICOs managed to avoid legal frameworks and strict governance from regulatory bodies. With little upfront compliance work necessary for an ICO launch, ICO creators could offer their coins (raise funds) to the general public.

STOs are much more difficult to launch as these offering processes must comply with relevant regulations such as AML and KYC before they offer an investment opportunity. Additionally, they can typically only raise funds from investors that have sufficient accreditation and have passed certain regulatory compliance.

Why is tokenisation good for investors?

As we enter a new decade, asset tokenisation has quickly become an emerging trend for investors and entrepreneurs which is based on several key factors.

Broader investment base:

When it comes to real-world assets, there is a limit to levels of fractionalisation that is possible. Selling 1/30 of an apartment building or a small fraction of a company share is not practicable at present. That said, if the asset is tokenised, these financial limitations are removed, making it possible to purchase or sell tokens that represent fractions of ownership. This allows a much broader investor base to participate in a purchase.

Faster Settlements:

Tokenisation has the potential to drastically reduce transaction times due to the availability of 24/7 trading. Smart contracts can be automated to complete transactions instantaneously and reduce settlement times significantly. This reduces counterparty risks and limits the possibility of trade breaks.

Robust security:

Regulators are currently developing regulatory tokenisation frameworks in developed markets. These frameworks will improve levels of protection and transparency for investors due to the immutability of data stored in digital ledgers via blockchain technology. This increased transparency gives investors more opportunities to manage risks through accelerated transactions.

In Liechtenstein, the Blockchain Act (TVTG) was enforced in October 2019. The act included the creation of the TVTG, which is the ad-hoc FMA supervision and registration of ten new service providers that use trusted technology systems such as blockchains to provide their services. This law implements FATF recommendation, providing supervision under the Due Diligence Act (DDA) for these services.

Increased liquidity:

By making fractional ownership possible, tokenisation allows investors to buy shares in assets that are not liquid. For example, if a piece of land is tokenised, it can be purchased by a large number of small investors, allowing the market size to expand by increasing liquidity.

Why are STO’s good for investors?

A versatile range of investment opportunities:

Before ICOs and STOs, investors were left to choose stocks from the market. However, the stock market offers limited investment opportunities because only a small percentage of companies can go public. STOs are disrupting the industry by allowing smaller companies with proven financials and solid business foundations to seek investment. As a result, investors no longer have to rely on IPO announcements to expand their portfolio.

Fewer middlemen involved:

As an improvement to traditional financial models, STOs give investors the chance to cut out the middleman. The need to purchase a stock or a share through a broker or dealer is eliminated by STOs, helping investors to pursue a range of lucrative opportunities without paying multiple advisors for the liberty of access.

STOs are well-regulated from the outset:

STOs are treated as securities as soon as they are created and therefore governed by regulations at all times. Each country enforces different regulatory standards to make sure that companies launching STOs are held accountable to their investors. Additionally, unlike ICOs, investors are placing their money into tangible assets such as company shares when they purchase tokens and buy into an STO. This makes STOs more credible and potentially rewarding for investors.

STOs are becoming increasingly successful

In July 2019, BlockState published the results from an investigative study that investigated over 100 completed, running, or planned STOs. The results suggest that this growing industry, which included just 5 STOs throughout 2017, had raised over USD 1 billion with only five jurisdictions representative of three-quarters of all issuances.

The primary findings of the study revealed:

  • Adoption is more prevalent in five countries with Germany, the USA, the UK, Switzerland, and Estonia representing 75% of all issuances.
  • STOs are multiplying in number: In 2017 only 5 STOs took place, with a total issuance volume of USD 65.59 million. However, 2018 saw 35 STOs totaling USD 434.95 million in volume.
  • The most common asset class is equity: The most significant part of finished issuances were conducted for company equity as 46 equity tokens were issued with a total volume of USD 622.9 million. 
  • The financial sector dominates the tokenisation market: The financial industry was responsible for 77% of all STO funds raised, making the industry a clear leader in the market. Real estate was a close second, accounting for 11% of all funds raised.

The World Economic Forum has predicted that 10% of the world’s GDP will be stored on blockchain technology by the year 2027. Based on this prediction, Finoa has estimated that the market of globalized tokenization could reach USD 24 trillion in financial assets by 2027.

Although the tokenisation of assets represents an industry that is still in its infancy, this radical evolution from traditional investment processes could significantly improve the lives of investors across the globe. Using tokenisation and STOs to their advantages, tech-savvy investors can expand their portfolios, increase their dividends, and spread their wealth across new global ventures.

Author(s)

Max J. Heinzle

Max J. Heinzle is the founder and CEO of 21.finance AG which operates area2invest, a marketplace for securitised and tokenised assets. He studied Business Management and Global Banking & Finance in London and gained extensive capital market experience at one of Austria’s leading Venture Capital firms and as Head of Investor Relations of a listed German technology company.

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