Love them or hate them, ICOs really stirred the pot. Did they stimulate global interest in blockchain technology? Absolutely. Did they represent an unsustainable speculative bubble which was bound to burst at some point? Absolutely.
In fact, the whole ICO craze is a bit of a Catch-22. If the markets had remained purely driven by utility they probably wouldn’t have been as popular. But the fact that they transformed into what we might charitably describe as ‘unregulated securities markets’ has had one very positive implication for ICO investors: they are in the best position to be first movers in the rapidly-evolving digital securities market.
As discussed in our previous article, the once scalding Initial Coin Offering (ICO) market has become frosty as 2018 continues to wear on. But as the ICO deal stream slows to a trickle, we are seeing the rise of the Digital Security Offering (DSO).
As we dive deeper into this transformation, it’s important to understand that the ICO and the DSO are fundamentally two different things, which happen to share a common denominator.
Moving from ICO to DSO
The DSO is, and was always intended to be, an investment and cap management vehicle that will mostly be used for private placements and other typically illiquid asset classes, as an Angel investor this made sense to me. There are a lot of features of digital securities that help them accomplish its goal, as a vast improvement over the tedious and expensive process of creating, trading, and managing private securities (more on that in a moment).
ICOs, on the other hand, were almost exclusively sold as utilities to incentivize communities building technology on a public blockchain. The “token” was intended to reward people working for the greater good of the community.
The ICO was not intended to be a speculative investment vehicle – at least, not in its original form. And although there are a few unicorns out there, many ICOs will fail. This is not inherent to the model they used – startups fail all the time – but the capital raised and the global excitement around tokenization has allowed the brunt of those failures to rest on the shoulders of the retail investor.
The inevitability of failure, and the reasons for success
So what happened, to create this speculation? Due to the frictionless nature of trading tokens on the blockchain investors began to do what they do best – they speculated, traded, and rode the wave all the way to the shore. Markets were born, prices fluctuated (artificially or authentically), trades were made, and for anyone with a background in securities, it became very apparent that the “utility” notion had transformed into a budding unregulated securities market.
Dana Farbo, COO of Augmate, puts it bluntly: “Regardless of whether this token is used as a part of the platform or not, a company that insists on going the route of a utility tokens with investors who hope to gain on the increasing value of the token is risking their business and possibly the livelihoods of its employees, business partners, investors, and others.”
I mentioned that the silver lining for ICO investors is that they are in a fantastic position to be among the first to explore the digital securities offering. And that’s true – the media they consume, their comfort with physically-intangible assets, their understanding of the technology underpinning many of the projects that are seeking crowdfunding – all of these factors are advantages that non-crypto investors do not possess.
But after the ICO model has gone supernova, what real benefits are there for retail investors? And what’s the safety net?
Let’s take a closer look at some key components for DSOs:
Digital securities, as issued and managed by reputable issuance platforms like Securitize or Polymath, apply global regulatory rules to the lifecycle of the digital share or token.
ICO tokens were often sold without regulatory clarity. There is, in many cases, nothing that legally protects the token owner from nefarious or ignorant acts committed by the issuer.
Digital securities are backed by an asset of value. This can be the equity of a company, fractional ownership in an apartment complex or the payout of dividends from quarterly profits.
ICO-acquired tokens usually have no assets backing their value. They are offered as a ‘utility;’ a means in accessing a service on a communication network. One pays money for tokens that grant access to the service.
Digital Securities are not Bitcoin-paired
Digital securities gain their value from the net asset value (NAV) of the asset backing the product, and can trade at a premium or a discount to their NAV. This is the expected behavior of any asset-backed security. Digital securities will be paired with fiat.
ICO acquired tokens that trade on exchanges are often correlated to the price of Bitcoin. This is a tricky situation. Very few tokens from ICOs have any dependence on the blockchain technology underpinning Bitcoin.
However, when the price of Bitcoin goes up or down, the value of ICO-based tokens tends to follow. The ICO cannot stand on its own, so true market value is distorted. If token projects had separated from Bitcoin and, to a lesser extent, Ethereum, the market might look very different today.
Digital securities have a reputable and qualified issuance platform to manage the complete, end to end lifecycle of the product and the code enforcing its compliance. Support for upgrades and changes to code according to the business or regulatory framework is part of the service.
ICO acquired tokens are managed individually by the ICO project owner. They are often ill-equipped to manage any change, even if there is any code to manage in the first place. The entity that originally issued their tokens may even cease to exist.
The transformation from the ICO token issuance to the market for digital securities is taking place for legitimate and important reasons. The ICO market saw massive growth and subsequent downfall within a short 18 month span. Since regulations were unclear (or even ignored) the buildup of infrastructure was quick and easy.
The digital securities market, on the other hand, is being built methodically and carefully. The regulatory requirements are lightly onerous, but not impossible. Code is created to fully support digital securities issuance, exchange, storage and management.
This is not an explosive boom that leads to a bust.
Rather, it is the intentional drive to create a regulatory-compliant ecosystem that will last for generations.
Patience is the friend of the fundamental investor: fundamentals are the past and future of long term investing.
This article is presented as part of the Crypto Briefing focus on Security Tokens and Digital Assets.
Crypto Briefing does not accept any payment or financial benefit from expert guest authors.