The digital currency ecosystem continues to evolve, and projects are now looking to introduce its functionality to retail investors through security tokens. These tokens serve as an evolution of crowdfunding attempts where teams reach out to the public as a way of funding their projects and distributing tokens without the need for traditional intermediaries.
Today, these crowdfunding projects are commonly referred to as Initial Coin Offerings (ICOs), and in the first two months of 2018 alone, they purportedly accounted for a total of over $2.5 billion CAD in pledged funding. According to TokenData.io, this figure is spread across over 250 projects.
The popularity of ICOs continues to garner attention from both regulators and pioneers operating in adjacent industries. In a race to invite retail investors to benefit from this crowdfunding venue, security tokens are emerging as a way to allow businesses and investors to capitalize on of the industry’s features. Now, proponents suggest that security tokens could become the industry’s next big movement.
The origins and appeal of the ICO movement
Initial Coin Offerings can be traced to the launch of a project formerly known as Mastercoin, which debuted in July 2013. Now known as Omni, the project launched a fundraiser in the hopes of obtaining the funds it needed, without requiring the backing of shareholders or a financial institution.
To do so, the project invited the public to contribute through bitcoin payments, in exchange for a stake in the project known as Mastercoins. The incentive for the public was that they would not only be helping Omni sustain itself during its preliminary development but that they would also hold tokens which could increase in value and later be sold for a profit.
Purportedly, the project raised over $640,000 CAD worth of bitcoin, and several ICOs attempted to replicate this success in the months that followed. The following year, Vitalik Buterin announced the launch of Ethereum’s crowdfunding attempt, called the “Ether Sale,” which raised over $23 million CAD in four weeks, breaking previous records at the time.
Many ICOs have since eclipsed this figure, yet the unpredictable nature of these public offerings continues to spark red flags for regulators, and historically many failed ICOs have left investors with next to nothing.
By their nature, Initial Coin Offerings do not guarantee investors anything more than the tokens they choose to purchase, and both malicious and inexperienced actors continue to over-promise in terms of scope or financial return. As an example, a recent report published by Bitcoin.com stated that 46% of the ICO projects that launched in 2017 have already collapsed, in spite of over $133 million CAD in funding.
Security tokens cooperate with regulators
Securities can be difficult to define, particularly through the different regulatory lenses from which they are considered. Generally, the term refers to tradable financial assets. An emerging group of proponents believes these assets can be better served through tokenization due to its increased global access and liquidity,
Unlike traditional ICOs which offer “utility” tokens or coins, security tokens function in direct cooperation with regulatory bodies. While this has historically limited the availability of security tokens on the market, companies like Polymath and its contemporaries believe that this is a new billion dollar craze that is just around the corner.
As Polymath’s CEO, Trevor Koverko, explained in a discussion with CNBC, the line between utility tokens and security tokens is often blurred. Generally, he explained, utilities should exist to serve a purpose, whereas security tokens should exist for the purpose of investors receiving a financial return.
According to Koverko, security tokens currently represent an extremely small portion of the overall digital currency market. Purportedly, both ICOs and digital currency exchanges are particular in avoiding security token classification and association due to costs associated with regulatory compliance.
However, emerging projects like Polymath and platforms like tZERO, Equibit, and Poloniex seek to increase the prominence of the security token market. Here, advocates believe that the prospect of tokenized asset ownership could soon entice businesses and retail investors.
While traditional stock markets abide by opening hours, proponents believe that there is an opportunity for financial markets to operate with the same worldwide, around-the-clock reach that currently makes the digital currency market attractive to the public.
The case from both sides
Initial Coin Offerings are often viewed as a ‘double-edged sword’ as their public and largely unregulated nature makes them a target for actors who operate with bad intentions or are otherwise unable to deliver on their promises to investors. While ICOs continue to grow, some view failed projects and the risk of fraud as detrimental to the industry’s appeal to traditional investors.
Security tokens counter many of the issues present in ICOs. This is because working in cooperation with regulators allows them to be under further oversight from bodies like the Securities and Exchange Commission (SEC), which functions to protect retail investors.
However, there is a philosophical division, as many of the potential vulnerabilities that exist within the current ICO framework are praised by digital currency advocates. While the open nature of these offerings has historically placed investors at risk, this is conversely seen as a facet of the rebellious nature of the industry, and proponents praise the industry’s ability to exist without significant oversight.
While this divide is unlikely to reach compromise in the near future, security token proponents believe that 2018 will observe a significant rise in the number of prominent security tokens. Here, figures like Koverko believe that the industry can grow to accommodate new investors arriving from the traditional financial market without requiring a fundamental change of heart from the industry’s current proponents.