By Vanessa Malone
- A series of events from both the Wall Street and blockchain industries led to the emergence of digital securities.
- The infrastructure to efficiently and compliantly conduct a digital security offering (from issuance to secondary trading) is already here.
- Education should be the primary focus as we head deeper into the second quarter of 2019.
Digital securities are essentially the same as traditional securities that have been bought and sold for decades, just with a ‘digital wrapper’. Unlike cryptocurrencies or utility tokens, digital securities represent real ownership interests in an underlying asset or company. Using a smart contract, a type of self-executing contract operated on the blockchain, issuers can offer an array of financial rights to an investor including equity, dividends, profit share rights, voting rights, buy-back rights, etc.
When we talk about digital securities, commonly referred to as security tokens, we’re talking about the result of a head-on collision between Wall Street processes and blockchain technology. But this collision didn’t happen overnight. A series of events on both sides of the spectrum led to the emergence of digital securities and the technical evolution of today’s capital markets. So, how did we get here, and, where is the digital securities market going in 2019?
A Brief History
In just six years, we saw a drastic change in not just how companies raised capital, but in who invested in them. With the Jumpstart Our Business Startups (JOBS) Act signed into effect by President Obama in 2012, we saw the emergence of Rule 506(c) of Regulation D (Reg D) and Regulation A (Reg A) which came into effect in 2013 and 2015, respectively.
These regulations sparked an investing revolution. On one hand, companies were given the ability to utilize modern forms of communication and marketing (e.g. social media) to attract investors. On the other, investment opportunities typically reserved for high-net-worth individuals were now accessible to the general public, both accredited and non-accredited investors alike.
According to the head of the SEC’s Office of Small Business Policy, Jennifer Zepralka, since the new Reg A rules went into effect, 123 public offerings were completed raising a total of $1.3 billion through September 2018.
In parallel to these regulations, an even greater phenomenon was brewing on the opposite end of the regulatory spectrum. Initial coin offerings (ICOs) took the market by storm in 2016 and 2017, generating an estimated $20 billion in capital raised to date. Unfortunately, legitimacy for ICOs, as the market has come to know them, was short-lived. The majority of ICOs are now below their listing price or have lost all their value.
Amidst the scams, projects failing to deliver, and finally the SEC’s crackdown on ICOs, the market took a turn.
Many lessons were learned during the ICO-era. First and foremost, regulation and investor protection are necessary for the industry to mature and grow, and second, blockchain technology has the ability to automate and secure many of the processes involved with purchasing, transferring and owning securities and / or assets.
This coupled with the SEC declaration that most forms of tokens will be considered ‘securities’ forced the industry to pivot, and this pivot collided perfectly with the new Reg D and Reg A regulations. According to a report from MarketWatch in January of 2019, there has been a 550% uptick in exempt ‘ICO securities offerings’ filed with the SEC.
Where is the digital security industry headed?
While 2019 was deemed by some to be the ‘year of digital securities’, we all must understand that we are still in our infancy stage. Many factors are contributing to the slow adoption of digital securities in 2019. Among these include regulatory uncertainty, infrastructure and general education of the marketplace.
When it comes to regulation, the SEC is only beginning to provide more guidance to issuers, investors, and financial intermediaries. In addition to working with select issuers who came forward to get back into compliance instead of penalizing them, the SEC named digital assets as one of its 6 examination priorities for 2019. At this stage, we can all agree the SEC is acknowledging the benefits blockchain technology can have on improving current processes as long as issuers conduct their fundraising efforts within the existing regulatory framework.
Although some are waiting on changes to the SEC’s current stance, the players who want to get ahead of the market aren’t waiting for a step-by-step manual. Instead, they are innovating, funding, and developing technology built to both comply with today’s regulation standards and adapt to future changes.
As far as infrastructure, many companies are still discussing what they’re building and what’s to come but the tools to conduct a compliant digital security offering are already here.
In fact, what we’re seeing now is companies with live technology partnering with one another to fill in the gaps to better support digital securities offerings.
You’d think this gets tricky as many companies in the space offer more than one solution, especially when it comes to companies like ours, which covers everything from issuance, to KYC/AML, to custody for Transfer Agents, and secondary trading. But, at this stage of the digital securities industry, it’s not uncommon to see companies who may compete on one side but complement another form a strategic partnership.
Right now, there is a strong sense of camaraderie in the industry with companies working together to strengthen access to the infrastructure and lower the barrier for quality issuers and investors.
A major aspect of lowering the barriers to entry comes with educating the masses. DSO, STO, Reg D, Reg A, blockchain, etc.; all these phrases add additional layers of difficulty when it comes to the mass adoption of two relatively new concepts.
Regulatory direction, that will come. As we head deeper into the second quarter of 2019, the focus should be on strengthening the infrastructure and educating the market on the benefits and tools that are currently in place that will transform the securities market as we know it.