Security Tokens – Are we witnessing the merger of crypto and traditional financial markets?

Initial Coin Offerings (ICOs), and their tokens, have changed dramatically during the course of 2018. Back in January, Blockchain events in London were full of millennials living off appreciating cryptocurrency assets, spending their days and nights trading utility tokens from the latest ICO to hit the chatrooms of Reddit or flash up on Telegram.

Nine months on, things have changed due to the decline in value of many cryptocurrencies and the market ‘wising up’ to the fact that anywhere between 75% and 95% of unregulated utility token based ICOs being a sham. The days of individuals living off the appreciating value of their crypto assets seem to be far behind us.

Shifting trends

The popularity of utility tokens has decreased in favour of security tokens, which are linked to the value of real world assets such as property, cars, paintings, equity in a company or future income. This compares to utility tokens which often just provide a ‘pass’ to use or access software with little or no real world value.

Conceptually, this shift makes a lot of sense as it allows security tokens to ‘bridge’ crypto markets with traditional financial markets.

The new secondary market

Security tokens have now made it possible to make illiquid assets, such as private limited company shares, liquid, through ‘tokenisation’ and trade on blockchain based exchanges.

These secondary market security tokens have legal rights attached to them linked to actual shares in private limited companies, often secured through Ethereum based smartcontracts. The owner of the security token often has the legal right to benefit from the increased value in the event of sale through an Initial Public Offering (IPO), merger or acquisition.

Companies such as ‘The Elephant’ and ‘Funderbeam’ have built blockchain based platforms allowing investors to access private limited company shares in unicorn and other pre-IPO companies where the existing shareholders have looked to liquefy proportions of their shareholding. Revenue is raised by the platforms through annual management and other fees where an IPO takes place or shares are sold as part of a merger or acquisition. The platforms themselves offer their own security tokens with rights to a share of this income (similar characteristics of a preference share).

The arrival of this new market could well be a reaction to the longer period between venture backed companies proceeding to IPOs which often takes 10 years or more, compared to the 3-5 year norm of the early 2000s.

What does the future hold?

Security token ICOs are beginning to move towards mainstream private equity fundraising, with greater regulation and legal rights attached to real world assets. The ‘wild west’ of unregulated utility token ICOs could well become a thing of the past as we move towards 2019.