5 Startups Creating Security Tokens on the Blockchain
Ilusory superiority refers to the propensity of humans to overestimate themselves when compared to others. Take for example the survey they did of Stanford MBAs, of which 87% rated their academic performance as above the median. While that sort of ignorance can be expected from people with MBAs, it’s actually a far more widespread problem. The truth that nobody wants to hear, is that there are a lot of dumb people out there. That’s why the Sakawa Boys in Ghana are thriving and becoming even more sophisticated. We’ve seen recent cases of older white dudes from Ghana, talking to wealthy older ladies in Asia, shortly after which comes the “I have a $4 million inheritance to send you” proposal:
White dude in Ghana chatting with a female mark – Source Nanalyze
Maybe its just true love and the inheritance is real, but we’re not convinced.
For further evidence of human stupidity, look no further than Initial Coin Offerings or ICOs. It’s mind boggling how very few people in the media call out this garbage for what it is, but instead they hem and haw about how ICOs “might be risky”. We covered this extensively in our article on Why ICOs are Not an Investment or an Asset Class, an article which talked about how your typical ICO simply offers you a worthless “token” or “cryptocurrency” that can only be used to buy a product IF the product is actually built. There is no equity involved at all, a fact seems to be all but ignored, even by those who condemn the ICO phenomenon. But what if someone could take the underlying blockchain technology and attach something that actually has value to it? It’s something referred to as tokenization or “security tokens”, and a number of startups out there think that tokenizing private securities on the blockchain may be the way forward.
Creating Security Tokens on the Blockchain
Founded in late 2017, San Francisco startup Harbor has taken in $38 million in funding from notable investors like Andreesen Horowitz and Peter Thiel’s Founders Fund which served as lead investor. All that money is being put to use developing a platform that uses the Ethereum blockchain to standardize the way securities are traded on the blockchain. The platform will automatically enforce any present security regulations like “accredited investor status” or “anti money laundering” and can easily handle the additional regulations coming down the pipeline as the SEC continues to crackdown on ICOs. While the platform could support all kinds of obscure assets like fine art, the initial focus will be on real estate.
Then there’s Prometheum, a startup that’s “creating the world’s first blockchain ecosystem for the fully compliant issuance trading, clearing & settling of tokenized securities”, but there’s one thing that makes them entirely different from Harbor. You see, Prometheum is ironically raising their money from an ICO. They’re called “Ember Tokens”:
The COO of Prometheum is Aaron Kaplan, a securities attorney at Gusrae Kaplan Nusbaum PLLC, where he was focused on blockchain and securities regulation. Let’s hope he’s making them eat their own dog food.
In a similar fashion we have another startup called tZERO of which Overstock.com has majority ownership. Sounds legit, right? Surely a billion dollar company wouldn’t fcuk things up. Don’t be so sure about that. It appears that a class action lawsuit has been filed against Overstock.com asserting that “Overstock’s coin offering was problematic and potentially illegal” and that the SEC is investigating the tZero coin offering which “could result in a delay of the tZero security token offering, negative publicity for tZero or us, and may have a material adverse effect on us or on the current and future business ventures of tZero.” It sure could.
If the SEC is always throwing a wrench in the works, why not just switch jurisdictions to somewhere where regulatory bodies are even more strict and consequently the people are boring as hell. That’s what SwissRealCoin decided to, when they opted to create Switzerland’s first commercial real estate crypto token. One look at their homepage tells us things aren’t going so well:
We are extending the reservation phase and moving the start of the ICO for SwissRealCoin 2-3 months back. In the meantime we’re Activating Plan B after the Swiss regulator FINMA missed the opportunity to provide clear guidance on the proper structuring of innovative security tokens.
Yes, the Swiss regulators definitely missed an opportunity here. Let’s hope the regulatory officials get their act together so we can all pile in on this exciting opportunity to own some real estate in a land which most Americans couldn’t point to on a map.
Moving back to venture capital backed startups, we have Templum. Founded around the same time as Harbor, this New Yawwk based startup has taken in $12.7 million in funding so far which included participation from Japanese financial services firm SBI Group. In February of this year, they acquired a firm called Liquid M Capital:
Liquid M Capital operates an alternative trading system (“ATS”) that plans to use Blockchain Technology as part of the operation of the ATS. Liquid M Capital is able to facilitate the primary issuance of ICOs as a securities. The approval was a result of Liquid Markets Group’s (the parent of Liquid M Capital) advocacy and petition for rule change to the SEC in late 2015 to amend regulation ATS for unregistered securities.
This raises an interesting question. Do all these startups have to petition the SEC for permission to issue ICOs as securities, or is this something that anyone who has an “alternative trading system” can do? Kind of important to know how many regulatory roadblocks these startups will need to face while the SEC tries to get this whole ICO mess under control. This is a good segue into talking about ICO 2.0.
ICO 2.0 – Security Tokens
An article by MIT Technology Review this week referred to ICO 1.0 as “tokens that don’t have any valuable underlying asset”. All they represent are future revenues for businesses, most of which won’t be likely to get off the ground. Now we have ICO 2.0 which is where ICOs now represent “security tokens” that actually have something of value attached to them. That sounds more like it, and now people can appropriately start comparing an ICO to an IPO.
Last week Fortune interviewed one of the PayPal Mafia, David Sacks, about how real estate will be the first application for security tokens which are expected to debut before year-end. The reason for that is that real estate asset often trades at a discount because there is no liquidity. You can’t just go buy a $1,000 stake in the London Shard and then sell it next month when you want your money back.
Of course the idea of crowdfunded real estate investing is hardly new, and it’s a topic we explored in our article on 10 Real Estate Investing Fintech Startups. Also backed by Andreesen Horowitz, startup Peer Street offers real estate investing to millennials by allowing them to buy small pieces of residential property they’ll never be able to afford. Mr. Sacks argues that blockchain provides the sort of transparency that’s needed for these types of platforms to ensure that you get what you pay for. Then there are the many REITs out there, some of which have excellent dividend growth records. REITs to look at for commercial property exposure include Realty Income and National Retail Properties (we’re long-term shareholders in both).
A Word of Caution About Security Tokens
As Mr. Sacks warned, just because someone tells you that your token is backed by some asset doesn’t mean you should believe them. That’s why you look for platforms like Harbor that use blockchain for transparency and are backed by sophisticated investors. Of course that also means very little because of one word that comes to mind – Theranos.
Any platform you choose to use has something MBAs like to call “systemic risk”. It’s like when your brokerage firm blows up Enron style and you’re told that all the securities that you thought were being held there have somehow disappeared. Good luck getting anything back in bankruptcy court. Then there’s the frenzy of stupid people that will drive the token price up, rapidly detaching it from the real value of the underlying assets – kind of like what you see with pump-and-dumps. As we often say, a conservative investment strategy like index trackers or dividend growth stocks are what have created the majority of sustained wealth – not the type of “ICO 1.0 wealth” that will evaporate as quickly as it was created – just like your relationship with that charming fellow in Ghana.