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Token Sale

Asset tokenisation can disrupt financial markets

Introduction

Increasing use of asset tokenisation in financial markets will have many implications in the future: it can affect liquidity, trading, asset pricing, transaction clearing and settlement.

The issue of asset tokenisation and its impact on markets is addressed in the publication OECD (2020), The Tokenisation of Assets and Potential Implications for Financial Markets. Blockchain Policy Series.

When looking at the effects of tokenisation on markets, one has to differentiate between the following two situations:
– the tokenisation of securities that also exist off-chain, i.e., securities traded off-chain that are tokenized and transferred partially or completely on-chain;
– the issuance of securities in the form of tokens directly on-chain, thus native to the blockchain, i.e. without securities being issued in conventional form.

Asset tokenisation: trading implications

DLTs enable transactions in which trust is distributed among the nodes participating to the network, without the need for a central authority or intermediary to validate a relationship between two parties carrying out a transaction. Transactions are validated and confirmed by participants in the decentralised network in exchange for a certain transaction fee. On this basis, it is expected that with an increasing use of tokenisation, the market-making model will be revolutionised with consequences for market structure and the market-maker function.

Disintermediation and the impact on the market-making function

Market-makers provide the price of securities to investors who want to buy or sell them. The role of market-makers is usually crucial in markets with a limited investor base and the need to provide liquidity, particularly in contexts of market crises, when market-makers resolve orders in the absence of a true balance between supply and demand. In contrast, the matching of buyers and sellers in a decentralised market for tokenised securities is automatic and requires no third-party intermediation. In this context, the efficiency gain lies in the elimination of the intermediary.
However, it happens that asset tokenisation operators offer market-making services to clients even in blockchain-based markets, for instance, in cases where the DLT-based tokenisation network in use does not have sufficient liquidity; or that the platform provider has economic incentives that encourage to keep the broker model in a tokenised environment anyway: brokers may still be useful in decentralized environments for the execution of large orders.
A move away from a market-making model could have an impact on the smooth functioning of some markets and the redistribution of risks between them. The resilience of markets could be adversely affected by potential systemic effects due to situations of massive selling that could occur in the absence of market-makers holding traded assets on their balance sheets acting as ‘shock absorbers’ and thus mitigating the volatility that arises.
This risk will be higher for native on-chain securities, while for off-chain securities, the effect may be reduced by the presence of traditional parallel markets.
The presence of intermediaries in blockchain-based tokenised asset markets may cause the efficiency gains of decentralized DLT systems not to be realized to their full potential. The question of what level of disintermediation and decentralisation is actually desirable is still an open issue.

Liquidity implications and benefits

In a scenario of increasing diffusion of asset tokenisation, the number and diversity of assets that would be traded in the markets could increase considerably and consequently liquidity would increase. Platform providers already allow tokenisation of any asset on the same infrastructure, therefore the technology that enables tokenisation is easily available.
The tokenisation of assets such as small and medium-sized enterprise (SME) stocks or private equity/venture capital (PE/VC) funds can provide significant liquidity to nearly illiquid asset classes. Similarly, tokenisation of assets with limited liquidity, such as private placements of unlisted securities; limited liability company holdings; and small bonds, appears to offer a guarantee of improved liquidity for these asset classes as well. Some industry experts estimate that tokenisation could “unlock trillions of euros currently in illiquid assets, significantly increasing trading volumes”(Deloitte, 2019).
Secondary market trading for such assets, once tokenised, would be vital for the liquidity of asset classes such as those mentioned above, leading for example to greater availability of investment funds for SMEs. However, it should be emphasised that this development will only take place if the efficiency improvement brings economic benefits. In that case, it would generate enough increased demand to allow tokenised markets to acquire sufficient depth to allow the benefits described above.

Pricing implications

Trading in a tokenized environment would undoubtedly benefit from the increased transparency provided by DLT-based networks. An important benefit of increased transparency is the reduction of information asymmetries, and this, in turn, has the potential to improve the price discovery mechanism, providing investors with incentives to increase their participation and bring additional liquidity into the market, this would also improve the competitive conditions in the market. The key issue for the use of DLT in financial markets is related to the operational efficiencies provided by technology and disintermediation: cost efficiencies can reduce trading costs, costs for investors participating in tokenized markets, provided that the savings obtained are passed on to investors. This could, in turn, promote market participation and increase trading volume in tokenised markets with wider benefits for public markets. The connection between on-chain and off-chain markets for tokenised assets may have further implications for prices.

Market interoperability

Trading of tokenized assets in a decentralized world takes place 24/7 across multiple networks. In the absence of interoperability among the various blockchain-based networks and on-chain and off-chain markets, trading of tokenized assets risks to become fragmented with important operational consequences including the need for arbitrage.
On the other hand, the integration of on-chain and off-chain would create a dual listing system similar to the one that occurs when a security is listed on several markets.
The need for arbitrage can potentially occur even in native tokenized assets, when they are traded on different exchanges with limited or no interconnection. This may lead to inconsistencies in the way assets are valued, if there are discrepancies in prices across platforms.
Market fragmentation can also result in the price of the token being different from the price of the underlying asset in conventional markets. This could occur as a result of of the token being traded in multiple systems, or the types of investors participating in the respective markets. In a scenario where tokenisation is prevalent, even if such price dissociations occur for short periods, they could have an impact on the stability of some markets.
The issue of interoperability is not limited to the connection between the on-chain and off-chain worlds or between different blockchains; a further level of integration would be required in relation to links between the legacy infrastructure of financial market participants and blockchain-based infrastructure. Market participants would need to build DLT-based systems as tools on which asset tokenisation can take place.
Given the complexity of the internal and external networks of financial market legacy infrastructures and the multitude of actors, processes and interests involved in even a simple trade, such integration and interoperability may prove to be a challenge with possible consequences on the smooth functioning of parts of the markets.

Conclusions

As abstract as the benefits of DLT technology may initially seem, they become more tangible in the context of capital markets. The development of this technology in the financial universe offers numerous benefits: increased disintermediation and therefore fewer intermediaries and the consequent increase in speed of execution and reduction in costs, In addition, any investment opportunity can count on global market reach: in fact, anyone with simple access to the Internet will be able to take advantage of almost any investment opportunity and even those currently reserved for an élite will become available to everyone. Finally, DLT technology has the potential to significantly reduce market manipulation; every transaction is recorded transparently, in real time and shared, immutable, verifiable and always accessible to all interested parties. Analysts say that in the coming years, asset tokenisation will become the preferred method of generating value, and countries that choose this new option and democratise their capital markets will gain a strategic advantage over other States.

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Token Sale

What is tokenization of assets and why is it important?

Introduction

The spread of blockchain and Distributed Ledger Technology (DLT) applications and their use in financial markets facilitate the exchange of assets without the need for a central authority or intermediary.
The issuance of crypto-tokens is the best known application of DLT, at first in relation to tokens issued in Initial Coin Offerings (ICOs), initiatives aimed at financing start-ups.
However, the use of DLT-based tokens is also growing in other areas, and the tokenization of assets or the issue of Security Tokens (STO) have become one of the most important use cases of DLT in the financial markets. Such assets include securities, but also commodities and other non-financial assets such as real estate.

The theme of asset tokenization is handled by the publication OECD (2020), The Tokenisation of Assets and Potential Implications for Financial Markets. Blockchain Policy Series.

Tokenization

The tokenization of an asset is the creation of digital tokens on the blockchain representing that asset. The potential for asset tokenization is theoretically unlimited, as any real asset could be tokenized and stored on the blockchain. However, the tokenization of real assets involves much more than simply tracking data on DLTs, and the execution of a transaction on DLTs could have real-world legal effects, such as the transfer of ownership.
Asset tokenisation has potential cross-cutting implications for financial market practices and participants, market infrastructures and regulators.
Increased use of asset tokenization could have widespread potential benefits in terms of cost efficiency, speed, greater transparency and more inclusive participation of retail investors in markets. Although the use of tokenisation is currently limited, its potential is significant.

Tokenization of real assets that exist off-chain

Tokenisation of physical assets is the process of digitally representing an existing real asset on a DLT.
Thus, asset tokenization involves the representation on the DLT of pre-existing real assets by linking or embedding the economic value in digital tokens created on the blockchain.
The tokens issued exist on a ledger and also carry with them the rights on the assets they represent, acting as a store of value. The assets for which the tokens are issued continue to exist in the real world and, in the case of physical assets, these would typically need to be placed in custody to ensure that the tokens are constantly backed by these assets. Custody of assets therefore plays an increasingly important role in tokenization transactions.
Communication between the “off-chain” (traditional financial market infrastructures) and “on-chain” environments will be crucial for assets that continue to exist off-chain.
In theory, any asset can be tokenized and the rights on that asset be represented on a DLT.
Real assets for which there are pilot projects are real estate, commodities, such as gold, works of art or collectibles. Intangible assets, such as intellectual property, could also be tokenized, creating new types of assets and innovative digital markets.

Tokenization of native blockchain assets

There are important distinctions between tokenized assets that exist off the DLT and tokens that are native to the blockchain. Native tokens are born directly on the blockchain and live exclusively on the DLT. Payment tokens are examples of native tokens.
Tokens issued in ICOs are another example of native tokens: generated within the blockchain, they are not backed by an off-chain security or other asset. This has important implications for market structure and governance.

Challenges of tokenization

The adoption of asset tokenization of assets on a large scale requires to address a number of challenges related to the underlying technology: from scalability to interoperability, exposure to cyber risks, hacking risks and 51% attacks, as well as the business risks and costs associated with migrating to a DLT-based environment.
There are also governance issues related to the difficulty of identifying a single owner or node responsible for the entire network.
In addition, a potentially unclear regulatory and legal status for some tokenized assets is a risk for market participants, and should be addressed through clarity and interpretation of existing laws and regulations by financial regulators and supervisors.
Then there are questions about data protection and privacy, but also about data storage and the regulations applicable to data use, sharing and retention. This is particularly pertinent in jurisdictions with privacy regimes such as GDPR in Europe, which require very strict consent management processes, effective data rights management systems.

The legal status of blockchain, tokens, and smart contracts has yet to be defined in many jurisdictions, while countries such as Switzerland, Liechtenstein, and Germany have recently taken steps to implement a clear and favorable legal framework, opening the market to companies and promoting the growth of the new blockchain industry.

Benefits of tokenization: disintermediation

The application of DLT in asset tokenization can offer a number of benefits related to disintermediation:
– efficiency gains through the transfer of value without the need for trusted centralised intermediaries and/or through the efficient automation of processes, resulting in faster and potentially cheaper transactions
– the use of smart contracts can reduce the cost of issuing and administering securities, further reducing transaction costs, increasing execution speed and simplifying transactions.
– the use of smart contracts can facilitate corporate activities (e.g. coupon or dividend payments, voting) and collateral management (e.g. exchange of ownership interests).
– the automation introduced in the issuance, distribution and management of securities can reduce costs during the whole life of the securities, benefiting both issuers and investors.
– the distributed nature of the network with no single ‘point of failure’, the immutability of the blockchain and the application of cryptography can increase the resilience and security of the infrastructure.

A greater trasparency

In addition to the efficiency gains due to the disintermediation potential of DLT, asset tokenization can bring benefits such as increased transparency regarding transactional data, issuer information and asset characteristics through better record keeping and information sharing.
Financial markets can benefit from data integrity, immutability and security as well as the automated verifiability available in many blockchain-based systems.
Greater transparency can also be achieved in terms of compliance and interactions with regulators: as regulatory restrictions programmed into smart contracts are automatically enforced, the regulator can be automatically notified when restrictions are changed or deactivated. Regulators can also have near real-time information on specific on-chain events of interest to them.
The quality of the data that is fed into the blockchain is critical to the robustness of the recording and sharing of information.

Speed and wider participation

A wider use of asset tokenization may also benefit investors who would then have the opportunity to hold fractional ownership of an asset. Investors, particularly retail investors, may gain access to types of products that would otherwise be beyond their capacity, and may participate in capital markets with low investment or smaller portfolio sizes.
An indirect benefit of asset tokenization for market participants relates to potentially faster clearing and settlement due to the almost immediate transfer of ownership on the blockchain and the continuous reconciliation of the blockchain being updated at each transaction.

Conclusion

The application of DLT-enabled use cases is meaningful when there is:

– a sound business rationale for the application of DLTs, for example, the use of DLT solves a real business problem? Are there gaps in trust or security, is there enough space for disintermediation, are there measurable efficiency gains to be leveraged? How does the DLT-based use case compare to the traditional use case?

– a technical feasibility assessment demonstrating that the application of DLTs provides significant benefits over the technology currently in use, and also that the main technical challenges are overcome.

– an economic rationale for the transition to DLTs, i.e. a proven and measurable economic justification for the application of DLTs (for example measurable efficiencies and cost reductions to compare to the investment required to transition to a blockchain environment).

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Market Token Sale

The future of token issuance (STO, IEO & DAICO)

As everyone probably knows 2017 and early 2018 represented the ICO frenzy moment. Reminiscing those days we mostly think about how every new company had the best and most disruptive solution to X Problem, on (white)paper, and absolutely needed blockchain and a utility token to do that. Needless to say, most of these projects proved to be either impossible to implement or were outright frauds.

However, ICOs were not entirely bad, they were revolutionary as they democratised the access to early-stage investment; something that in traditional financial markets is mostly reserved to Angel Investors, Venture Capital Firms and Private Equity firms.
As the excitement for ICOs wanes and the flaws of this financing model become more evident, a number of contenders is emerging to leverage the untapped potential discovered through ICOs.
The most well known new model is the STO, but some new popular token issuance models are IEOs and DAICOs. So what are these new names and how do they stack against each other?

STOs

STO stands for Security Token Offering. After investing in the project, an investor receives a crypto-token (specifically a Security Token), just like in an ICO. However, an STO is different, because a Security Token represents an underlying asset, for example, the issuing company stocks (in which case an STO is similar to an IPO).
A company is not forced to tokenise its share, in an STO it could tokenise its revenue streams instead. In this case, the investor would receive a share of the company revenues proportional to the number of tokens they hold.

Compared to ICOs, STOs are heavily regulated. They are costlier, take longer time and are more difficult to launch; in exchange, they provide much more reassurance to the investor.

Another important difference is that ICOs required a company to have a blockchain-centred business model. In contrast, any company could potentially undertake an STO, even if its business model does not require the use of blockchain.

In turn, compared to IPOs, STOs give the company greater flexibility (as they are not limited to sell tokenised shares), while being more cost effective and less cumbersome. Of course, a traditional IPO usually offers a much larger liquidity pool.

DAICOs

The term DAICO was initially proposed by Vitalik Buterin in January 2018 as a solution to the dishonesty issues affecting ICOs. It stands for Decentralised Autonomous Initial Coin Offering.

It allows token holders to vote on the use of the capital raised by the DAICO.

For example, the token holders can decide to release the funds over time as the development team reaches certain milestones. In the most extreme case, the token holders can vote and decide for the project to shut down and return the contributed funds to the respective investors if they are not satisfied with the progress being made by developers.
Essentially, a DAICO makes the developer team accountable towards their investors.

IEOs

IEO is another form of token issuance that relies on Cryptocurrency Exchanges. The term stands for Initial Exchange Offering.

In this case a project partners with an existing Exchange (the partnership includes and goes beyond the simple listing). The project gets directly and listed on an Exchange. In order to participate in the IEO, an investor has to open an account with that specific Exchange.
The project team is no longer the direct counterparty for the investors. The Exchange acts as a trusted third party overseeing the operation and acting as the point of contact for the investors. The exchange also performs the necessary due diligence to protect its existing customers. The regulation level is similar to the one of ICOs.

One of the most notable IEO services is Binance Launchpad. Recently Bittrex responded to Binance by launching its own IEO platform.

The Bottom Line / The Verdict

One of the obvious questions that come to mind is “Which method of token issuance will eventually prevail?

Simply put there is no right answer as this is a complex matter, one can just try to make educated guesses. In my opinion, all of them will survive because they have different use cases and serve different niches.

STOs are more evolutionary than revolutionary and play an important role in bridging the crypto world with the classic finance world. Furthermore, they promote asset tokenisation, which is a use case with huge potential and implications.
IEOs are also revolutionary in a way, as they bring ICOs closer to IPOs (in a different way than STOs), as they also give more importance to the Exchanges as a key player.
For these reasons, I foresee a convergence of STOs and IEOs in the future.

The DAICO will probably be the best solution for pure-play ICOs that do actually need a utility token and who do not just use Blockchain as technology but also follow a decentralised philosophy in their business conduct. It will probably take longer for these projects to emerge compared to the two aforementioned methods.