The Evolution of Security Tokens, Competitive Landscape, and the future ahead


The crypto economy has made rapid strides in just two years since the phenomenon of ICOs took off in 2007. A lot of innovators jumped on the ICO bandwagon in 2017 lured by the ease of fundraising. Sturdy demand outstripped supply of crypto goods ensuring an oversubscription of every ICO in 1H2017 notwithstanding the quality or absence of due diligence, though by 3Q2017 regulators started playing spoilsport and raising objections and demanding greater scrutiny and oversight, though most did not go as far as China, the hub of crypto financing, in outlawing ICOs altogether.

Most financial incumbents like Goldman Sachs, JP Morgan, Citibank were caught unawares by this massive phenomenon. Thus far, they had been giving press bytes on blockchain playing a neat, predictable, preassigned role in their business stack and the incumbents had been preparing well for this new . Just as they had paved way for previous stacks such as CRM, SAP and other such technological upgrades where incumbents were not disrupted, but rather went on to acquire an advantage over the upstarts However, cryptocurrencies and ICOs raised a specter they little understood and were much less prepared for.

Goldman Sachs, JP Morgan each have filed applications and even obtained patents for use cases such as using smart contracts, blockchain and tokens for issuing traditional Wall Street securities. They thought, just like in earlier tech advances like cloud, SAP, CRM, they would have an advantage in this scenario too. They would protect their fiefdoms with this intellectual property protection, strengthen their competitive positions and preempt upstarts from entering this space, this holy grail which constitutes $80 trillion of global securities. All the incumbents had their eyes firmly set on this long term trend. Several startups focusing on blockchain came into existence in 2014, with huge investments from Wall Street, like Digital Asset Holdings, Circle, Chain, Symbiont etc. Digital Asset Holdings was incorporated with the express purpose of catering to incumbent Wall Street firms, and to date has raised $115m funding from 15 Wall Street investors such as Goldman Sachs, Citigroup, Deutsch, ASX, JPMorgan, BNP Paribas. Symbiont intended to help Wall Street firms in upgrading their clearing and settlement firms and also to create private securities on the blockchain. Chain was founded in 2014 and raised $40m from NASDAQ, Visa, Fiserv, Capital One. ICOs continued unabated, but the early ICOs were mostly limited in their fields of application to the cryptocurrencies ecosystem, and the industries amenable to use of the crypto such as gambling, prediction markets, exchanges, wallets etc.. There was no ICOs targeting Wall Street – The bastion of the old guard.

However, what happened in 2017 was beyond what anyone ever imagined. No one had anticipated the upswell of crypto so soon. The upstarts were not playing to the script, nor by the rule book. Appalled, it was natural for the heartbeat incumbents to sing paeans of regulation and obituaries of ICOs in the same breath calling them frauds, scans, Investor inanity. No one listened, and it failed to quell the fervor for the ICO. ICOs continued unabated, but the early ICOs were mostly limited in their fields of application to the cryptocurrencies ecosystem, and the industries amenable to use of the crypto such as gambling, prediction markets, exchanges, wallets etc.

There were no ICOs targeting Wall Street – The bastion of the old guard. None of these ICOs posed a real threat to Wall Street, however. Bankers’ greed, fabled for smelling opportunities from afar, this time left them immobilized, as they did not know how to break ground in this new territory and the momentum of the $5.6 billion in ICO funding entirely bypassing the traditional fund raising mechanisms was too fast for the street. Then I wrote the first ever white paper detailing a process transforming the way for issuers to issue legally compliant securities, with no middlemen, and architected a whole new paradigm for modern-day capital markets. This was groundbreaking, and the world’s first ever crypto white paper. I had fun breaking this story to audiences around the world and got much carried away with my travels instead of staying put and doing our own ICO swiftly.

Prior to this, only Wall Street banks and the Big 5 consultancy firms had conceded that this could potentially be done, but not how. Certainly, none of the earlier corporate papers revealed that the very authors could be removed from the picture. Their illustrations, tellingly, very much had them intact in the whole new paradigm they were architecting, and in essence not saying anything new other than that they could upgrade their current databases to the blockchain, to continue to do whatever they weredoing. Either they had not understood the magnitude of this technology’s potential, or if they did, they were disingenuously keeping it guarded against the world.

The securities landscape has traditionally been a densely populated terrain with millions of intermediaries such as Broker- Dealers, Exchanges, Commission Agents, Custodians, Clearing & Settlement Agents, Allan providers against securities, futures exchanges, market makers etc. Then we started to see the first batch of ICOs targeting a Wall Street-related businesses. So the initial slew of ICOs related to securities industry was launched a good 6 months after my white paper.

These ICOs started taking aim at either:

• Very niche applications such as tokenized real estate, tokenized Assets such as Gold backed tokens, which were innovations hitherto unseen in Wall Street, and did not threaten the incumbents as these were new territory.

• Tokenizing existing walk street securities and derivatives instruments, as IOUs, thereby improving liquidity for existing owners of securities, enlarging the pool of customers, expanding the market for incumbents, and also did not threaten the incumbents.

• Creating new infrastructure such as a marketplace for these tokenized securities, which is a greenfield opportunity where Wall Street incumbents can also compete, but still does not threaten the existing market shares of incumbents. The ultimate promise of smart contracts to disintermediate, had by and large escaped these first crop of ICO innovators in securities space, despite my having publicly revealed the secret sauce – of architecting a crypto filled Wall Street, or democratizing capital raising by empowering small humble entrepreneurs to launch their public fundraising without having to incur the high threshold costs charged by Wall Street banks to manage an IPO – which is rent-seeking and a huge barrier.

On the other hand, dissecting the statistics of corporate IPO pipeline, private funding rounds are getting ever larger with $100 million + financing rounds now a norm, thanks to mega funds of $100 billion Size such as SoftBank which invested in 16 US companies totaling $10.8 billion in 2018. That pre-IPO private funding by a single megalith investor is close to the cumulative ICO & STO financings of an estimated $13 billion in 2018. Median amount of funding raised prior to tech IPOs has quadrupled from $64 million in 2012, to $239 million in 2018, meaning that successful companies do not face any challenges raising large amounts of private capital prior to IPO, and may even prefer to stay private because of interests of their share holders, as well as active ongoing M&A activity amongst tech startups. from Wall Street, like Digital Asset Holdings, Circle, Chain, Symbiont etc.

So IPOs as a fundraising mechanism can be exploited more and more by small & medium enterprises if the cost of going public can be brought down significantly, and IPOs can happen outside the precincts of stock exchanges and investment banks. This is the whole promise of HCX! The way IPO costs can be dramatically reduced is by rearchitecting the whole process with the use of technology and by bringing down the fees paid to middlemen. Though regulators never necessitated the role of investment banks in an IPO, few firms have taken the initiative of doing IPOs on their own, Spotify being a leader in this regard. Pages Jaunes had also explored trimming the role of banks, and had managed to change the process but stopped short of eliminating investment banks al-together. Daimler Chrysler issued a bond on the blockchain. London Stock Exchange is now exploring creating a direct issuance process on the blockchain. So rapid strides are being made in the direction of automating securities issuance.

However, going by developments at the intersection of crypto and Wall Street, not many have a solution to remove the biggest entry barrier, namely fees paid to investment banks. We are the first and only ones to propose an automated investment banking platform. This is the ultimate promise of smart contracts, that we wish to unlock for the benefit of the humble entrepreneur in any remote corner of the planet. This is the ultimate promise of smart contracts, that we wish to unlock for the benefit of the humble entrepreneur in any remote corner of the planet. Virtue signaling, quality stamping, and aggressive marketing, all necessary ingredients for any fundraising company, have significantly pushed up the costs of fundraising in the crypto verse today. Except that these functions are now performed by new crypto intermediaries and crypto marketers rather than Wall Street banks.

What are the pervasive problems here? Why have companies needed investment banks historically? – Lack of access to investors – Inability to handle tedious processes and the need to outsource – Inability to determine a reasonable valuation of the company equity on their own. – The absence of an independent entity to assure the quality of an issue: virtue signaling and quality stamping. Let us try to tackle each of the above limitations faced by entrepreneurs, summoning technology. Lack of access to investors It is true that intermediaries have over the decades kept a close guard on the investors. Even big companies like Facebook and Google whose brand strength is enough to have investors swarming to their IPO, do not dare to execute their own IPO (like Spotify did) because these are rich companies. They want to behave rich and have no need to skimp on fees, and they might want to outsource the investment management process. This is not a deal breaker for an established company at a mature stage.

However, it is for companies at a growth stage where timely funding can spell the difference between bankruptcy and survival. Initial Security Token Offerings Investors naturally want to get access to IPOs because IPOs are typically underpriced by banks so as to secure successful subscription. However, most retail investors lose out to institutional investors when it comes to IPO allocations as investment banks want to keep their regular feepaying clients (hedge funds) happy, and these banks keep hefty IPO allocations for their favored clients at the expense of retail investors who are nobody’s clients.

Technology can solve this problem of access to investors, even without having to use smart contracts. Platforms such as Linkedin and Angel List have all the Investor universe you can think of. So a digital platform that connects issuers with investors will solve the problem of access to investors if it succeeds in building traction by bringing high-quality issuers, building trust worthiness of the platform by keeping away bad actors and proving usefulness and ease of use. Inability to handle tedious processes Smart contracts will facilitate the handling of features such as shareholder voting, dividend distribution etc and make it more efficient for issuers giving them more control over the processes and catalyzing a more personal relationship with the investors, which may be a good thing in the age of Alexa. Inability to determine a reasonable valuation Though valuation is a science, in practice it is more of a process when it comes to IPOs. It is simply done by building an order book which algorithms can very well replicate, once investors are accessible on the platform and ready to put in their orders and reveal their price preference to subscribe to shares in a specific IPO. This is no different from online auctioned which are now all-pervasive, and the same behavior can be expected of investors too.

A major point of difference between crypto economy and the traditional capital markets is in valuation and pricing. While shares use metrics such as Net Present Value of future cash flows, Capital Asset Pricing Model, Discounted Cashflows, price multiples, public trading multiples etc, cryptocurrencies started with completely laissez-faire pricing. However, digitised Securities will once again take us back to a reasoned ground where initial issue price may be determined by demand but over time, it has to be sustained by fundamentals. A look below at the vast divergence between pricing models. Lack of an independent entity to assure the quality of an issue – Virtue Signalling This is a problem that can be solved by community governance, and market place rating mechanisms which have evolved well since Amazon and eBay. Dynamic and democratic ratings Where everyone can participate have become far more reliable indicators of quality, than privately guarded ratings such as by those of Moodys and Fitch which are known to have had agency problems or incompetence in predicting quality and consistency or lack thereof, as many blowups in the past indicate. All in all, with the right quality checks and institutional grade security, Smart Contracts may surpass investment banks in price, efficiency, as well as a superior personal connection with investors. We, therefore, believe HCX has immense potential as a pioneering innovator in the space of challenging the archaic systems.


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