Security Tokens Must Be Driven By Demand

Innovation, Opinion, Regulation | January 7, 2019 By:

Finance has always been at the core of investments into tokens.  For the majority of people who put money into crypto, there is an expectation of money to be made, which makes them investors and the cryptocurrencies investments.  Therefore, the cryptocurrency space follows the concept of finance, leading naturally to a discussion of supply and demand. Fundamentally, the cryptocurrency markets are driven by this dynamic, and the success of security tokens going forward will depend on generating enough demand for such tokens.

Taking a look back from 2016 to 2018, the price of cryptocurrencies has largely been driven by supply and demand.  When there was not a lot of supply or demand, the token world was relatively quiet. Then demand picked up as a way for individual investors to invest into previously inaccessible early stage, private tech deals across international borders.  This demand certainly exceeded supply and the prices were driven up significantly. The skyrocketing prices also contributed to increased demand until 2018 saw a significant shrink in demand due to regulatory crackdowns and disappointing output from the projects versus unrealistic expectations.

As the next iteration of cryptocurrencies, security tokens are defined as regulatory compliant tokens that represent securities, typically taking on the definition by US regulators.  These tokens typically represent some assets, such as equity, debt, real estate, etc. They can also represent some utilities, which some may argue for a utility token status, but the Howey Test (and the interest from an investor to profit from the tokens) defines these tokens as securities. The bulk of the cryptocurrency industry has pivoted to security tokens in hopes of reducing regulatory risks when fundraising.

There is no shortage in supply of security tokens, as companies and projects are always looking for ways to fundraise.  The key for the growth of this industry is on the demand side.

Where can the demand come from?  

Due to the constraints of security tokens, the demand for security tokens will not come from the retail space that traditionally powered ICO’s, but rather from high net worth and institutional investors, including pensions, insurance portfolios, endowments, etc.

What do they need to join the market?  

I believe they need good infrastructure and good products.  On the infrastructure side, there are a number of things that are necessary.  First is the regulatory framework. This is set up in the US to a certain extent, but has not progressed in other major financial markets as of yet.  Second, they need products that are issued in a regulatory compliant manner, which some of the current platforms, like Securitize, are starting to do.  Third, they need a custodian to hold the investment, and recently there have been a number of players that have become qualified custodians in the US, such as BitGo, Coinbase Custody, Kingdom Trust, etc.  Finally, they need liquidity that will be provided by having security token exchanges, which can handle trades in a regulatory compliant manner, such as OpenFinance Network, SharesPost, etc.

On the product side, illiquid products that generated strong returns are great candidates to be packed into security tokens, including illiquid portfolios of bonds or real estate.  It is not surprising that the first few deals in the security token space are VC funds, like Blockchain Capital, SpiceVC, and 22x, in addition to deals in the real estate space.

As the infrastructure and products mature, institutional and high net worth investors will consider capturing the returns and benefit of liquidity by adding either security tokens into their existing allocations or setting aside a slice of allocation in their alternative investment portfolio for cryptocurrency.  Even a small allocation will represent significant demand for the security token market.

Benjamin Tsai is the Managing Partner of Wave Financial Group. Tsai has 15 years experience developing and marketing global investment solutions in Tokyo, Hong Kong, Singapore, and Taipei. Previous work includes positions as CEO of Merrill Lynch Singapore Commodities (Bank of America) and Senior Vice President and Head of Alternative Investments Asia for AllianceBernstein.