The definitions in this article are based on the latest Maltese regulation.
Much has already been said and written about the advent and integration of blockchain technologies in businesses and various areas of the global economy. The technology has many advantages that can significantly improve the processes involved in a vast variety of industries, ranging from insurance and legal services to logistics and finances.
The year 2017 saw the largest boom of demand for blockchain technologies and their related cryptocurrencies. Billions of dollars were invested in a broad spectrum of projects offering different services, platforms and even commodities. However, the experience of 2018 and the general trend of 2019 are still proving the thesis that no technology can ever become profitable until it becomes truly useful for the average user. The benefit average users have seen thus far is limited and is largely attributed to token trading on exchanges, a factor that cannot be called a success determiner for blockchain technology application as a whole.
Despite the market slump, blockchain technologies have not lost their luster and appeal. Vast corporations and service providers are considering the integration of blockchain technologies into their structures. SWIFT is already developing its own application for blockchain, while Facebook is actively buying up blockchain startups and projects that are considered to be useful in the development of a decentralized social network base.[
There are three main methods how blockchain can be integrated into businesses, but each has its own nuances, advantages and disadvantages. And each of these factors in itself is subject to a variety of aspects that can stop, impede or accelerate their integration into existing business processes. But one type of blockchain projects will still stand out from the rest in light of the recent market dynamics and is certain to attract far more attention than those that have dominated the market previously by virtue of their promises.
Each type of blockchain application in business projects has its own rules and principles of operation. To be able to fully understand the future potential of these applications, it is necessary to clearly divide blockchain projects and investments in them into 3 categories.
The most secure and transparent approach for investing in blockchain projects is the STO (security token offerings) or, consequently, ETO (equity token offerings), under which the token issued by the company is a digital equivalent of its shares and gives the same rights as those granted by shares. In this case, the application of blockchain makes it possible to issue shares in electronic form. The project itself can be anything from a regular startup or a startup using a blockchain, a recycling plant or, in theory, any kind of business that has something of value to offer. The STO is the only type of blockchain project that is showing promise under the current evolution of the blockchain market. From the very beginning utility tokens were not designed to become a financial instrument, however some people were speculating on those as if they were. The launch of tokens tied to real assets ranging from commodities to stocks is the logical evolution of tokens that will be able to grant their holders real value that will not be vulnerable to overall market conditions and will not suffer from the hyper-volatility suffered by other types of tokens.[
Of all the great variety of blockchain-based projects we can clearly differentiate between several types: for example, there is one linked to businesses, in which the blockchain is used to solve specific business problems. Usually, this involves the combination of a large number of players who do not trust each other at different levels and provide automated calculations within the ecosystem.
Another type of blockchain projects relates to those for which the release of native cryptocurrencies is not a way of solving a real business problem, but is in itself a certain value carrier. This relates to new cryptocurrencies, new protocols, or even new blockchain platforms like EOS and NEO. These projects are usually involved in hi-tech development and pin their value on the future demand for their technology and its unique characteristics.
Speaking of this type of blockchain projects, it is necessary to point out that platform protocols and new cryptocurrencies are still highly risky, as the ratio of capital allocated to this type of blockchain projects remains rather low. The reason is simple, because the venture fund model does not imply investment in tokens. Funds have a different investment policy, since the token asset class remains extremely volatile in its pricing and highly dependent on the market’s behavior in general.
So far, the main investors on the market are still crypto enthusiasts, crypto exchanges, crypto funds, and mining companies.
Unlike the STO, where investors have certain rights protected by smart contracts, owning the tokens of an operating company does not give any special benefits, except some control over the situation at best. As such, this type of transactions is not interesting for venture funds, because such projects do not generate profits, and the investor’s calculation is going to increase the growth in the value of the token. This class of assets remains highly volatile, and given the market situation, it is very difficult to launch such projects. It is just as difficult for a private, uninitiated investor to distinguish a good project from a bad one. Counting on investments from the likes of crypto-pools, exchanges and syndicates is the only solution for this type of projects.
Apples and Oranges
With the current situation on the market seeming like a breaking point in segregating quality projects from “wannabes”, the future of investing in blockchain is becoming clearer. The main reason why most blockchain projects may not not survive in the long run is the absence of funding available for everyone, but only for the select few.
It has become clear that the concept of utility tokens is dead, and the UTO, or Utility Token Offering, and ICO, or Initial Coin Offering, which in Malta is regulated by the MFSA and MDIA, as a way of raising funds, has not justified itself in the eyes of the vast majority of crypto market participants, including many of the project founders themselves.[
Its 2019, and at this point, it is very difficult to sell the issuance of tokens on the basis of valuation and a promise of future growth. A project seeking to attract a large amount of funds over $1 million has to turn to traditional venture financing. Venture funds evaluate projects in accordance with industry standards set for evaluating startups. Depending on the stage of the project, its prospects and risks, a certain assessment will be assigned to the project.
The ICO format of fundraising no longer applies to these types of projects, even if there is a working business, product and ecosystem in which tokens are used for some purpose.
Venture capital funds that have already invested in ICOs have long noticed that projects conducting large-scale marketing campaigns are the ones to be feared, as hype is a powerful weapon in inflating artificial value. Secondly, involvement with such projects creates unnecessary legal risks, as there have been cases of such projects committing illegal marketing acts and any involvement with them will cast unwanted attention on their counterparties.
The basic fact that all seeking to attract VC’s attention need to understand is that most venture capital funds are technologically agnostic and do not care about the technology behind the project. The fund’s main goal is to make money and there are few boundaries within legal limits that they would not consider in their search for profits. Given the new nature of the market, blockchain projects are gradually attracting rounds like ordinary startups and are raising from a few hundred thousand dollars to several million over the consequent rounds.
The most important factor determining whether a startup can attract the financing it needs resides in its ability to solve a real market problem. Given that funds are usually industry-specific, they will focus on a particular technology, for example, deep-tech, or projects that use deep technologies. It is therefore important for funds dealing with projects that the technological advantage be impossible to replicate.
The fact that a startup uses blockchain does not in itself increase its value, so it is especially important for project founders to center on and promote the solution they are offering to an existing problem for the market and what competitive advantages they are going to present as leverage instruments in generating profits.
Coming to a Market Near You
Considering the downfalls of the methods previously used by blockchain startups in their search for financing, projects and companies have started eying the STO model of fundraising as the next generation of blockchain market instruments. It would not be understatement to say that the entire world of blockchain, Venture Capital, institutional and angel investors are all eagerly anticipating the STOs and ETOs to emerge as a fully compliant, transparent and developed instrument.
The benefits of STO model are quite obvious: provision of security and transparency, compliancy to name a few. This also places a certain demand on high degree of responsibility and financial resources. Correspondingly, when we are talking about STO it needs professional investors and a very mature approach to planning, organizing and executing business models and leading them into solid ventures on good footing.
The STO can be safely drawn in parallel with IPOs, or Initial Public Offerings, as the similarities are many. Both are involved in the issuance of a company’s shares for public purchase, both have the intrinsic value of their shares tied to assets that have low volatility, and both have a large number of legal and financial requirements. However, the benefits of the STO largely outweigh those of the IPO by virtue of its lower entry threshold and the greater legal freedom inherent to it.
There are well-known jurisdictions that are not only encouraging the development of a favorable legal environment that would foster the registration of STOs but already allow the registration and the launch of STOs as is the case in Switzerland and Malta.
A new era of ICOs can be heralded when STOs become legally acceptable and affordable, but in a completely different format. STOs are being considered by many serious venture funds, because they solve a big problem of the venture market, namely, the problems of liquidity in shares. The essence of the problem is that investors cannot buy a share in a startup easily and will not be able to sell them with less difficulty. In fact, venture investors are engaged in investing in non-liquid assets, it is very difficult to withdraw acquired assets to the cash pool, and the process can take up to several years.
The tokenization of shares allows small investors to invest in startups with small amounts of investments, for shorter periods with different investment strategies, and to play on the stock price. In addition, it opens up new assets to the market, for example, offline enterprises, small production facilities, and a large number of other companies that have real value. Despite their value, it is simply impossible for such companies to issue and sell shares of their businesses. The solution is creating a “bridge” between the public market and the company, which will make such businesses liquid and will allow selling shares or borrowing against the security of these electronic shares. Going forward, this has the potential to change the structure of business financing.
The release of security tokens will change the financing world in principle. It will allow for an influx of an immense number of real value companies and will open up vast investment opportunities not only for large capital and funds, but for average people with small amounts of funds that they are willing to invest and use for generating additional revenues. Unlike utility tokens, which are applicable only in a limited number of situations and are constrained to their own platforms, security tokens are applicable in any enterprise that functions transparently.
Looking Forward 2019
2019 is predicted by many leading specialists in a large number of venture funds to be a booming year for STOs, as new regulations to govern the secondary market, the stock exchanges and new financial instruments are to be introduced. The necessary framework for the launch of STOs is already taking shape as many projects are developing platforms for launching STOs in a legal, compliant way. One of the burdens of launching the STO concept lies with the lack of interoperability of the crypto and stock exchange, where stock exchanges have the space to list the STOs.
Malta Stock Exchange has just inked a number of provisions aiming at enabling MSX, the fintech arm of the exchange, to launch a trading platform for tokenized securities. These provisions will see MSX partner with Neufund, a platform for the issuance of security tokens, to build a decentralized, fully regulated, stock exchange for trading of tokenized securities in addition to security tokens. The partnership is planning a pilot during the next few months, which will include an ICO hosted on Neufund’s primary market, and the ICO tokens will later on be listed and traded on Binance (via means of a separate agreement with Neufund).
MSX is working closely with the regulators in Malta to comply with the Malta Financial Services Authority Act. Malta has emerged as a haven for blockchain investors, with big businesses like OKEx and Binance relocating to the country. It’s not a coincidence that Malta has been referred to as the “blockchain island” during the past few years, we think it will stick, unless someone names it “STO land” – which seems to have even better chances of sticking.
2019 promises to be a truly revolutionary year based on all the precursors and announcements. But regardless of the overall sentiment, it is already clear that the STO will be the leading trend on the blockchain market, since it has proven to be the more viable option bereft of the uncertainty and volatility of its predecessors.
By Victor Michaelson