State of the Security Token Ecosystem: Part One – Security Token Offerings (Q1 2019)

Introduction

The aim of this research is to provide a broad and objective overview of security token offerings (STOs) that have been conducted, are currently in progress, or have been announced.


As of March 31, 2019, we have identified 150 STOs in various stages of development. While not a comprehensive list, these 150 projects constitute a sample large enough to be representative of the STO industry as a whole. In order to examine this data-set accurately and efficiently, a simple random sampling technique was employed to ensure all 150 projects had an equal chance of selection.


For the purpose of this research, we have included EEP23 Investment tokens, based on the International Token Classification (ITC) framework devised by the International Token Standardization Association (ITSA). Under this framework Investment Tokens are divided into the following sub-categories: Asset-backed Tokens (EEP23A), Debt Tokens (EEP23B), Derivative Tokens (EEP23D), Equity Tokens (EEP23E), Fund Tokens (EEP23F), and Other Investment Tokens (EEP23Z).

What is a Security Token Offering?

A security token offering is the sale of tokens representing ownership of an asset in exchange for fiat currency, cryptocurrency, or stablecoins. Security tokens can represent equity, debt, a unit of a fund, real estate, and a wide range of commodities. In addition, security tokens and their associated blockchain smart contracts offer certain legal rights, such as voting rights or revenue distribution. Security tokens are considered as securities by most financial regulators around the world, and as such, token issuers must comply with all relevant securities laws of the country in which they conduct an STO and raise funds.


STOs often serve as a step towards an initial public offering ( IPO), but even if an IPO is not sought, they provide a level of legitimacy and safety lacking in the initial coin offering (ICO) model. The main difference between ICOs and STOs is that security tokens are backed by a tangible asset such as equity, debt, real estate or commodities.

Token Offerings by Country of Incorporation

This section will identify countries and regions that are hubs for blockchain activity and examine their approach to developing and implementing blockchain regulations.


To identify such activity hubs, we observed the number of STOs in a given country and monitored both existing and proposed regulations governing the legal status of STOs and the ability of market participants to invest in them.

Graph 1. Distribution of STOs - Country of Incorporation

The US emerged as a clear leader with 61 offerings, representing 40.6% of the 150 STOs covered in this research. The UK came in a distant second with12 STOs – representing 8% of the total. Switzerland came in third with 11 offerings, just one less than the UK. The European Union had a total of 39 offerings, including 12 from the UK and 27 from other EU member states. Among the other EU countries, Germany is also an active player, with 8 STO projects.


The Cayman Islands, where 10 companies choose to launch their offerings, is another notable player in the global STO industry. Despite its comparatively small population and economy, the Cayman Islands’ lack of corporate tax, along with other business-friendly finance and banking regulations, makes it an attractive jurisdiction in which to incorporate and execute an STO.


Despite the considerable advantages of launching an STO in the Cayman Islands, it lacks the stability and access to investment capital available in the major global financial centers. Furthermore, although incorporating a company in the Cayman Islands is relatively straight-forward, achieving tax-exempt status in the company’s country of origin requires careful consideration of the domicile county’s tax laws – which can significantly increase costs.


Another significant finding of our research was the lack of Asian representation in the sector, with Asian-based STO projects constituting just 5.3% of our survey sample. As mentioned in our previous article, the majority of business and investment activity in the crypto-sphere is based within Asia. In late 2017 and early 2018, the top crypto exchanges by market volumes were frequently Binance, Huobi, and OKEx, all of which are registered in and operate from Asian countries.


The failure of Asian countries, despite their advantages, to establish a stronger presence in the emerging STO ecosystem has several contributing factors. Our preliminary findings indicate that Asian countries have continued to focus on ICOs and investing in projects that classify their tokens as utility tokens. While our research did not reveal any clear evidence from which to predict whether Asian countries may pivot towards STOs, we believe it is inevitable that they follow the global trend of increased interest in the STO model.


With most developed countries heavily involved in the emerging STO industry, it would appear likely that the “Four Asian Tigers”, and in turn the rest of Asia, will change their focus from ICOs to STOs. The high number of security token alliances from Europe and the US is another sign that industry is developing momentum, and we can also see such alliances starting to form in Asia, one of the most prominent being the Asia Security Token Alliance (ASTA).


The increasing concentration of projects in certain regions is also evidence that STO hubs are becoming established, aided by the creation of the legal frameworks essential for STO’s to become a mainstream method of fundraising. It is no surprise that the United States, UK, and Switzerland appear to lead in the number of STO projects, as most investments in ‘traditional’ securities are from US investors in US-based entities. (http://www.oecd.org/)

Token Offerings by Sector

Almost one quarter (22%) of STOs are conducted by companies developing a security token ecosystem infrastructure.  Key players in the creation of such infrastructure include token issuance platforms, primary trading platforms, and secondary trading platforms. We identified two reasons for this. One is the current lack of infrastructure and the other is the increasing demand for infrastructure capable of processing the highly complex problems such companies are attempting to solve companies are solving.


Despite the existence of more than 70 token issuance platforms, and more than 70 security token exchanges (secondary trading platforms), no clear market leaders have yet emerged. This market will be examined further in Part 2 and Part 3 of Security Token Network’s “The State of Security Token Ecosystem” series.


We identified 13 fintech companies (9.3%) that are currently attempting to tokenize their assets, indicating the nascent state of the industry and the untapped potential for it to effect significant changes in the financial industry. Furthermore, the real estate, manufacturing, energy, and healthcare sectors have gained significant traction in asset tokenization, while other industrial sectors remain sporadically represented.

Token Offerings by Token Issuance Platform and Token Standard

Where a token created, and which token standard is used in its implementation, are the most important factors to consider in the STO process. The following section provides an overview of how STOs have been distributed thus far.

Graph 2. Distribution of STOs - In-house or Token issuance platforms

Firstly, let us examine the ‘place’ of token creation. Slightly more than half (52%) of token issuers have engaged token issuance platforms to create their tokens. The number may be higher, as this information is not always publicly available (due to non-disclosure agreements), and even when it is, it can be difficult to obtain.


The remaining 72 STOs are issuing tokens in-house, meaning that they have their own blockchain-capable development team building the smart contracts. Companies that would fall in this category include ConcenSys. 52% of STOs have decided for a more expensive, but much safer solution in this process which is having issuance platforms creating their tokens. The reason for this is simple – token creation is the point where companies must ensure that they are fully compliant with laws and regulations, or risk incurring significant legal and/or financial penalties.


Given the critical nature of the token creation process, companies deciding to engage a token issuance platform should consider several factors in their selection process. According to our research, the most-used platforms are: Securitize, Neufund, DealBox, Polymath and Swarm Fund. A key reason behind the success of these platforms is the interoperability of their token standards across multiple security token exchanges.


For example, OpenFinance Network is currently working with Securitize’s DS protocol, Polymath’s ST-20 token standard, Swarm Fund’s SRC-20 token standard is cross-chain protocol-agnostic security token and DealBox creates tokens on Stellar Lumens (XLM) Distributed Ledger. The platforms where STOs will eventually list their tokens will be more willing to accept token standards with which they are already familiar, rather than in-house created tokens.


Whether financial institutions will endeavor to construct their own protocols, or simply acquire one of the above companies as a ready-made solution, remains to be seen. The advantages and disadvantages for financial institutions, in terms of developing their own protocol versus acquiring existing protocols, will be examined in Part 2.

Conclusion

As our research has revealed, more than 90% of the 150 STOs we examined are based in North America and Europe. This indicates the market is currently highly polarized between these two continents – whether Asia will start catching up with these two activity hubs remains uncertain. The fact that infrastructure STOs are in the majority indicates the crucial role they will play in the development of this ecosystem.


Overall, the current state of the security token ecosystem looks quite promising, and we look forward to examining the results STOs report in the second quarter of 2019.


Stay tuned for Part 2 of Security Token Network’s “State of Security Token Ecosystem” series, which will bring you more insights into the current state of token issuance and primary trading platforms.


Please note that this research is done on a best-effort basis,
as such, we cannot guarantee that all information included in this report is current and valid.

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