NCFA Fintech Confidential October 2021 (Issue 4)

Why have security tokens been so slow to
catch on?
In order for security tokens to achieve their
full potential, they must fulfill their promise
of liquidity. Liquidity requires two things: a
regulated exchange and sufficient trading
volume. So far, neither of these requirements
has materialized.
Security tokens are subject to greater
regulatory scrutiny than utility tokens (like
Bitcoin or Ethereum) from the US Securities
& Exchange Commission (the “SEC”). Security
tokens require full SEC approval to be sold in
public offerings to non-accredited investors
or traded on secondary exchanges. This is
one of the many reasons their growth and
adoption has been more modest.
Most attempted security token exchanges
have floundered. In 2018, well-funded
companies like Templum, tZero, Coinbase,
Openfinance and Sharespost announced
that they would list security tokens on their
exchanges. Sharespost was particularly well
positioned to do so because they were an
existing broker dealer with ATS registration.
Three years later, the only exchange which
has succeeded even modestly is tZero.
However, even tZero, a passion project of
publicly-traded firm Overstock.com, only
offers two security tokens for public trading,
one of which is an affiliate of its parent
company. Openfinance, although still in
existence, offers securities with a combined
market cap of only around $50 million–a
mere drop in the bucket.
At the moment, no dominant platform for
trading security tokens exists. Furthermore,
the complex compliance issues have
largely discouraged new entrants. But
there is hope. Since security tokens are
programmable, compliance can be baked
right into the token which should reduce
compliance hassles. Compliant protocols
like Polymath and Harbor have figured
out how to collaborate with exchanges to
address these issues.
The SEC (once considered
an insurmountable obstacle
to compliant token offerings)
is finally starting to qualify
offerings. Nothing pours fuel
on a financial product’s fire
quite like transparency and
regulatory clarity, and it’s
happening now.
In July 2019, the SEC qualified the first
Regulation A token offering (a $23MM offering
for Blockstack) setting precedent for the
sale of tokens that are immediately tradable
to both accredited and non-accredited
investors. They also provided clarity around
secondary sales.
In July 2020, Arca Labs began trading its digital
security token, the ArCoin, which is registered
with the SEC and represents shares in Arca’s
U.S. Treasury Fund.
FEATURED
Trading volume has also been thin, but the
expectation that digital securities would
trade with the volume and frequency of
public equities or cryptocurrencies was
flawed from the start. Digital securities
represent private investments, an asset
class that has always traded infrequently.
Adding blockchain does not necessarily
incentivize owners to trade them any more
frequently.
Exchanges don’t exist and trading volume is
thin. Where is the silver lining in all of this?
In September 2020, the SEC finally registered
an $85 million security token offering from
INX, a foreign crypto trading company.
This became the first ever security token
IPO qualified by the SEC, marking a major
milestone.
In April 2021, the SEC qualified a Reg A+
token offering for Exodus, marking the first
digital asset security which conferred equity
in a US-based issuing company. Exodus
subsequently raised $75 million from 6,800
individual investors.
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