Regulators Are Slowly Starting to Get It: Utility Tokens Are Real
“I want to quash this false narrative that’s been going around for the past two years that you can separate blockchain from crypto. You can’t.”
No, that’s not a bitcoin maximalist, a HODLer or a crypto-anarchist talking. It’s a regulator.
And Sopnendu Mohanty, the chief fintech officer of the Monetary Authority of Singapore, wasn’t preaching to the crypto-converted, either, when he issued this reminder that native tokens are integral to a decentralized blockchain.
Rather, he was addressing a room full of curious but wary central bankers and international development officials, all of whom were attending a G20 forum in Riyadh, Saudi Arabia on technology and financial inclusion.
It was refreshing to hear someone in the official sector take issue with the simplistic “blockchain without bitcoin” refrain that gets sold to corporate and government leaders who don’t always realize that their problems might be better solved with a less cumbersome distributed database.
That wasn’t only because it’s important for people to understand how native digital tokens are an integral part of the incentive and security models upon which open, permissionless and censorship-resistant transaction-recording systems are built. It was also because Mohanty’s intent was to help shape sensible crypto regulation.
He was urging regulators to adopt nuanced policies that recognize certain crypto-tokens belong to a new type of technology for improving economic coordination, one that can’t be jammed into a decades-old securities law framework. And it’s also encouraging to see evidence that he’s not alone in thinking this way.
Various regulatory authorities around the world are opening up to the idea that, when tokens have a clearly functional role within a blockchain network, it’s better to manage them with existing consumer protection and anti-money-laundering laws than with burdensome securities regulation.
To be sure, they’re doing so somewhat nervously; many are understandably concerned about investors being duped by scammy ICOs in Wild West token markets.
Nonetheless, their gradual yet earnest attempts to define these concepts open the door to blockchain technology’s more meaningful integration into the global economy.
Here, Singapore’s central bank is leading the way. In a March speech, MAS Managing Director Ravi Menon laid out a clear rationale for distinguishing “good” tokens from “the bad and the ugly.”
The Swiss Financial Market Supervisory Authority, or FINMA, has also been proactive. It came up with a useful taxonomy that divides tokens into three categories: payment tokens(bitcoin, litecoin and co.), utility tokens (ether and, in theory at least, various kinds of ERC-20 tokens) and asset tokens, with only the latter being subject to securities laws.
Other developed-country jurisdictions are also wading in. Both Malta and the U.K. dependency Gibraltar have shown an open regulatory posture toward ICOs and token exchanges. Meanwhile, Caribbean countries such as Bermuda are developing regulatory frameworks for tokens that would promote blockchain innovation while preserving their status as trusted domiciles for foreign financial institutions.
Governments are also taking action at the provincial level. Wyoming’s state legislature passed legislation defining utility tokens as a new asset class and exempting them from securities regulations.
Until last month, it appeared that the U.S. Securities and Exchange Commission was taking the exact opposite approach. In February, Chairman Jay Clayton, speaking before the Senate, said, “I believe every ICO I’ve seen is a security.” The implication was clear: most, if not all, of the hundreds of tokens already sold in this manner should have registered with the SEC and complied with related disclosure and compliance requirements.
In stoking fears of a dragnet approach from the SEC against all tokens, this statement prompted ICO issuers to ring-fence themselves from the U.S. markets. It also gave a boost to purveyors of “security tokens,” who don’t pretend to be inventing anything more than a more efficient means of selling securities to investors.
But since then, the SEC has also softened its stance. Clayton later told CNBC that bitcoin would not be classified as a security. And, then, in a landmark speech last month, William Hinman, the SEC’s director of the Division of Corporate Finance, answered a question that had been nagging the ethereum community. Hinman said that although ether was a security at the time of the ethereum proto-ICO in 2014, it no longer met that definition because of how it now functions within the ethereum network.
This was not as proactive as other jurisdictions’ moves to explicitly carve out the concept of a utility token. Hinman was merely defining what ether was not. But by coming to that conclusion, he had recognized the unique qualities of this particular token: how ether is a kind of “crypto fuel,” used to pay for the decentralized computation by which smart contracts are executed on the ethereum platform.
What’s important is that regulators are doing their homework and starting to recognize there’s at least potentially something different going on here from what they’re used to seeing. There’s a lot of learning still to come, but light bulbs are quietly going off in different corners of the regulatory world.
Whether you’re in the camp that welcomes regulatory clarity to foster public confidence in this technology or among those in the crypto community who see government engagement as anathema to a system of money originally designed to bypass the state, this emerging regulatory awareness represents a seminal moment.
The race is on
Clearly, many countries taking these steps have their eyes on the potential economic gains generated by the freewheeling ICO market, one that has raised $20 billion so far and which, with $275 billion in (admittedly poorly measured) market capitalization, has come to constitute a significant parallel capital market. There are tax windfalls to be had and there’s the real prize of attracting innovation to their shores.
They need to be careful, though, as this is an exceptionally fleet-footed form of capital. They risk encouraging global “regulatory arbitrage.” When a technology is as geography-agnostic as this, its users will often choose their home base depending on where regulation is lightest, stoking competition among jurisdictions. Given the inordinate number of scammers in the ICO business, the danger is that the worst players gain too much freedom and, by extension, too much influence over how this industry is broadly perceived.
In times past, U.S. regulators could rise above such problems. The sheer amount of money raised in the U.S. left global actors with no option but to comply with their rules just to ensure access to it. But with foreign capital markets deeper in the age of globalization, globally distributed blockchain development teams are deciding that the U.S. just might not be worth it. We are already seeing ICO issuers deciding that they can comfortably raise all they need from Asian investors.
Where this is all pointing, I hope, is to a coordinated international effort to better harmonize the regulatory approach.
Mohanty told me he sees six or so of the world’s more important regulators coming to a broad agreement on utility tokens and on what distinguishes them from payment and security vehicles. There’s a need, for example, to define pressing questions about what level of platform functionality, and when, a token must have to earn exempt utility status. And, beyond the securities laws exemptions, regulators should agree on strategies to apply existing consumer protection laws to ensure that ICO issuers are still held to account for the promises they make to people who put money into their token pre-sales.
Some have forcefully argued that carving out explicit legislative definitions of a utility token – a la Wyoming – overly constrains innovators to those definitions and creates contradictions across jurisdictions. Better to rely on existing laws than to add to the body of legislation, they say. But such concerns should not prevent regulators from creating clearly signaled guidelines to participants in the blockchain development community about how they will apply existing law to different scenarios.
There’s a still a lot of work needed to improve and scale blockchain technology and to foster broad confidence among future buyers of crypto tokens. Best practices among issuers, exchanges and investors/buyers need to be developed. But encouraging the expansion of utility token models is a worthy goal, one that’s much harder to achieve if the burdens of securities laws were to be imposed on all those who create them.
To understand this, one need look no further than the financial inclusion objectives of the Riyadh-based conference that Mohanty spoke at. Organized by the Global Partnership for Financial Inclusion under the leadership of Argentina, which holds the G20’s current presidency, the event explored, among other goals, how to encourage entrepreneurship in low-income, developing countries.
If we want the whole world, include enterprising people in such countries, to have access to the powerful economic advantages of decentralized, peer-to-peer applications and business models, regulatory barriers to entry must be softened.
This is, in other words, a cause for humanity.
Sunrise at Lincoln Monument via Shutterstock.
Written by CoinDesk.com
Less Than Half of ICOs Survive Four Months After Sale, Study Finds
Majority of ICOs Live Less Than 120 Days
Despite data from two recent studies suggesting that investors are still bullish on ICOs (Initial Coin Offerings), a research conducted by Boston College academics reveals that most crypto startups relying on crowdfunding have a pretty short lifespan. According to the authors – Hugo Benedetti, assistant professor at the Carroll School of Management and finance PhD student Leonard Kostovetsky – less than half of all new ICOs survive more than four months after launch.
The two researchers based their study on analysis of the Twitter accounts maintained by the projects, taking into account the intensity of tweets after the coin offering. They estimated that the survival rate of the startups, 120 days after the end of the sale, was only 44.2%. The assumption is that companies that are inactive on social media in the fifth month most probably did not survive. The report covers almost 2,400 ICOs completed before May this year, and examines over 1,000 Twitter accounts.
The survival rate has been calculated as an average figure for three categories of ICOs, Business Insider reports. The first group consists of projects that have not reported raising any money and are not listed on exchanges. Startups that reported raising capital but didn’t list fell in the second category. And the third includes the ICOs that list their coins on trading platforms. The statistics show the following survival rates – 17%, 48%, and 83% for these groups, respectively. The share of the projects that become inactive right after their token sales, or the potential scams, is about 11%.
Listing Increases Chances of Survival
Based on these findings, the study concludes that the sustainability of an ICO depends on whether the company behind it is able to list its coin on a crypto exchange. Investors who have supported a project during the coin offering enjoy greatest returns when the coin is listed. The researchers gathered data for over 4,000 ICOs, which raised $12 billion since January, 2017, and found that the projects generated an average return of 179%, accrued over an average holding period of 16 days from the last day of the ICO.
According to Kostovetsky, selling the acquired coins on the first day of trading is the safest investment strategy, when it comes to ICOs. In any case, investors should sell their holdings within six months, he added. “What we find is that once you go beyond three months, at most six months, they don’t outperform other cryptocurrencies,” Kostovetsky told Bloomberg. “The strongest return is actually in the first month,” he emphasized.
Benedetti and Kostovetsky explain the spike in the prices of many tokens after their listing with the underpricing during the ICO, as often they are sold to investors at significantly discounted prices compared to the open market rates. Despite that, the researchers also found that the returns are declining over time as companies have started analyzing prior sales by similar platforms to better determine the expected demand and the price of their coins.
Written by Bitcoin.com
UK Financial Regulators Are Preparing for a World of Crypto Assets
Blockchain crowdfunding ideas may be ten-a-penny these days, but seeing the concept tested out by a financial regulator and a major stock exchange is pretty unique.
Still, that’s what’s happening now in the U.K. where the London Stock Exchange Group (LSEG) and U.K. financial regulator, the Financial Conduct Authority (FCA), are working with distributed ledger technology startup Nivaura and 20|30, a UK company building a blockchain platform for corporate equity issuance.
One of the more exciting projects within the fourth cohort of the FCA’s regulatory sandbox (some 40 percent of the cohort use distributed ledgers), the project will target institutional as well as accredited investors using the LSEG’s Turquoise, the hybrid exchange platform for European equities that allows trading both on and off traditional exchanges.
The aim is to demonstrate for the first time in a live deal that equity in a U.K. company can be tokenized and issued within a fully compliant custody, clearing and settlement system.
As such, the first company to test out a primary issuance of tokenized stock will be 20|30 itself in September of this year, a launch to be followed by a one year lock-in period according to Tomer Sofinzon, co-founder of 20|30.
20|30 says that as soon as the first testing phase is complete, there exists a pipeline of dozens of young companies looking to try the tokenizing process out. These include medical device makers, firms in the pharmaceutical space, agricultural companies, and software providers.
Since the equity tokens being issued will be built on ethereum, trading of these will presumably start to happen, at least on an OTC basis, once the lock-in period has passed.
“That’s absolutely possible,” said Sofinzon. “After the lock-in period, we can begin the next phase, to really test the tradeability.”
The test follows a number of similar efforts to make more liquid markets for equity crowdfunding using blockchain tech, including the Korea Exchange which launched the Korea Startup Market for trading tokens on an over-the-counter (OTC) basis back in 2016.
The London Stock Exchange said in a statement to CoinDesk it is exploring blockchain as a way to help SMEs and to “innovate the issuance and tokenization of securities enabled for execution and settlement within the LSEG Conduct of Business framework.”
“This project with Nivaura is exploring tools to help companies raise capital in a more efficient and streamlined way,” said the LSEG.
But while a big step for incumbents, the project is also a boon for the startups involved.
Taking a gradual step-by-step approach Nivaura has shown that debt securities can be tokenized in a regulatory compliant manner and cleared and settled on a public blockchain such as ethereum. Nivaura has, in fact, executed three issuances in the FCA sandbox as a participant in two previous cohorts.
The ramifications of tokenized equity being distributed via an exchange are weighty, but the initial problem the project set out to solve is the inefficiency of equity crowdfunding, which essentially operates a bilateral relationship between the share issuer and the investor.
But, institutional investors don’t work like that. They require a trusted market infrastructure, supplied in this case by Nivaura, leveraged by the LSEG’s network and ability to generate sell orders and buy orders on a grand scale.
Speaking exclusively to CoinDesk about the project, Dr. Avtar Sehra, CEO and chief product architect at Nivaura, said: “Someone can use our technology to do all the legal documentation, tokenize these assets and execute them. LSEG has then been forward-thinking enough to help get these orders out to the existing market”
That said, tokenized equity is a tough nut to crack. Oftentimes, people talk about equity tokenization that’s just tokenized digital certificates which are not transferable, explained Sehra.
Debt is more straightforward, he said, because the token is the bond. “Equity is driven by legislation and the legislation makes it very hard for the token to be equity itself.”
Designing the legal structure around the equity token meant creating a legal markup language and ensuring compliance with Central Securities Depositories Regulation (CSDR), which Nivaura has been working on with law firms like Allen & Overy and, as part of the latest FCA cohort, Latham & Watkins.
Once there is a certain legal structure around the token, that gives the holder of that token the right to the equity and the right to all the beneficial interest in that equity, said Sehra, permitting a forward glance at the next possible phase of the project.
“If we can guarantee this is the most commercially viable way to do this, it will not only allow efficient primary distribution but it’s also going to potentially allow very simple secondary trading as well.”
“There is a possibility that we are going to be launching that next year.”
It’s worth mentioning that since the settlement layer is the ethereum public blockchain it would be bounded by a throughput limit of about 15 transactions per second, for the time being at least until the technology improves.
Sehra acknowledged that throughput and latency are huge issues for public blockchains, but said that for the purpose of this project over the next two to three years it’s sufficient.
“The industry is going to become a world of tokenized assets – that’s inevitable. We don’t really care if it’s ethereum or bitcoin, the underlying infrastructure isn’t that important. But it is going to be a blockchain.”
Bitcoin image via Shutterstock
Written by CoinDesk.com