STO Roundtable Discussion (Part I)

December 17, 2018

Omer: Good evening, and good morning depending on where you are in the world.

I want to thank everybody for joining us here. This is something that’s a little bit pioneering because it is cross-Pacific, and in the past when we do our LEX view articles, it is in written form only. This time, we are having a live round table discussion.  

I want to welcome everybody to this latest edition of RockTree LEX View. Today we are conducting part three of our series on STOs. We will be having a STO roundtable discussion with some of the leading figures in STOs today. We are very fortunate to have SharesPost’s Chief Executive Officer of the Digital Assets Group, Mr. John Wu, and also the Co-Founder and Chief Executive Officer of Securitize,Mr. Carlos Domingo, with us.

Let me start by introducing RockTree LEX to our audience. LEX is a blockchain professional service platform specializing in providing international legal compliance, transaction execution, global execution and overseas finance solutions for blockchain projects. We have offices in Beijing, New York and Toronto, and we provide legal and finance expertise and complete solutions for blockchain projects on a global basis.

Today we are talking about Sto and we have some of the pioneers in the STO market with us. Let's begin the discussion by having John introduce SharesPost.

John: Omer, thank you very much for hosting this call and thank you Carlos. Both RockTree and Securitize are partners of SharesPost. I want people to know that we think highly of both companies. The Digital Assets Group at SharesPost is creating a secondary trading marketplace for security tokens. We are also creating what we call the GLASS network, the “Global Liquidity And Settlement System”, that is a B2B network of settlement providers and exchanges. This network will allow settlement providers across the globe to be able to outsource their settling, clearing and compliance capabilities to exchanges overseas in other countries and allow them to conduct trades compliantly, without having the necessary local licenses.

For instance, if Huobi in China wants to trade a security token or any token, and there is a U.S. buyer, they can disaggregate the message or the details of the trade from the asset flow, and they will take the buyer information, the seller information, the issuer information and then send that to the GLASS network. The GLASS network will route it to the right jurisdiction. In this case, if it is a U.S. buyer of that token, the SharesPost Marketplace being an alternative trading system (ATS) will be the node that is responsible for certificating this trade and confirming if this is a compliant trade in the U.S. If it is, we will certificate it and send that message back to Huobi instantly, and while we do all the post-trade activities like the annual and quarterly reporting to the SEC that's required, Huobi gets the instant approval for this trade and they actually technically settle and clear the trade with their own customers and move the assets and the currency or the token. In other words, Huobi has now traded in a compliant way on this token or this asset without meeting or needing the necessary jurisdictional requirements because the GLASS network has figured out the right network partner and provided certification of a compliant trade in the applicable jurisdiction on that asset class.

That is what we are doing at the Digital Assets Group and for background we are able to do this because SharesPost the parent company, has been around for nine years, we are the largest marketplace for private securities such as Uber, Lyft and Airbnb. We provide a marketplace for people to trade and transact those assets. To do that, you have to have a settling and clearing broker-dealer as well as an alternative trading system in the U.S. Those are registrations and licenses that are not easy to get these days, especially the ATS license.

Our ATS is actually fitted or formatted properly and operational for security tokens, probably in a manner better than most of our competitors, because the underlying assets that we were always trading, the private equity stock has the same characteristics - uncertificated and unregistered. So, when we refiled the Form ATS with the SEC, we were very clear with what we were doing, and we are ready to launch the product with our partners such as Securitize and Carlos.

Omer: Thanks John. Let's move over to Securitize Co-Founder and CEO, Carlos Domingo. Carlos can you give some background on Securitize?

Carlos: Thanks for the invitation and welcome everyone in the audience. My name is Carlos Domingo and I’m the Co-Founder and CEO of Securitize. Securitize is basically an issuance and lifecycle management platform for security tokens. We handle the process for when a company wants to issue a security token. We will set up an instance of our platform where they will have all the tools to be able to onboard investors in a compliant way for that particular security. We will also handle the KYC/AML and accreditation process and help decide whether the person is suitable for investing in that particular security depending on the compliance rules of the particular issuance.

We will also handle everything from taking fiat to crypto from investors as well as signing the subscription agreements required to legally issue the security. Once that happens, we will issue the actual tokens on the blockchain and create a contract that represents the security depending on what the security is, whether it is equity, dividend or revenue share, or an LP interest in a fund. These contracts are for ERC-20 tokens but are issued with a particular set of smart contracts that control the compliance of the security throughout the lifecycle of the security. We call this protocol the Digital Securities Protocol. We control the transfer restrictions related to what the security can and cannot do on the secondary market. For instance, if a company is restricted from having more than a certain number of U.S. investors to avoid triggering certain filing requirements with the regulator, we will make sure that this security is never owned by more than this number of U.S. investors. We have a number of smart contracts for controlling compliance and we integrate with marketplaces and exchanges like SharesPost and several others where tokens are being traded. We guarantee trading compliance across multiple exchanges.

The other thing we do in terms of lifecycle management for the securities is that we will handle the relation with the token holders, such as how the company can communicate with them, conduct a proxy vote, issue dividends or other pay outs. They could do all of this with our platform and protocols.

Omer: Excellent. OK gentlemen thank you for joining today. Let's start off with a basic question on STOs. We are near the end of the year and we are looking forward to 2019. What does the current ecosystem for security token offerings look like today, and what developments do you anticipate over the next 12 months?

John: In 2018 the security token space was a growing nascent market. We have seen in the U.S. alone somewhere between 40 to 60 potential issuers trying to raise on the primary side, which is a great start. These are all different types of security tokens, with a lot of tokenizing of assets such as real estate, securities, such as private securities, and funds. Those were all happening in the U.S. in 2018, probably starting in the back half of 2018. What I think we are going to see in 2019 is a lot of these primary raises require a 12-month holding period in the U.S. before they can trade hands, among other restrictions. Companies like Securitize have it made it so that it is possible to put these restrictions into the tokens. Once you have a lot of these compliance issues automated and embedded into a security token, it will make my job as a secondary marketplace a lot easier and trades can be conducted with comfort knowing they will be done in a compliant way. And in 2019 we will see a lot of these tokens in the U.S. start to trade on these secondary marketplaces and we are looking very much forward to that.

Carlos: John summarized the current state of the market in a great way. This is a very early stage market. The first security token that was issued was issued by Blockchain Capital and was called the BCAP Token. This was issued in May 2017. But throughout 2017 there were actually very few tokens issued. The ones we are aware of are Science [Blockchain], which is in L.A., and Protos, which is a fund in Europe. In 2018, the fourth security token that we are aware that was issued was SPiCE VC, which is a fund that I co-founded, and it is where we initially developed the technology for tokenizing a VC fund. This year there have been other security token issuances, but very few. You can count them with the fingers of your hands. In the case of Securitize we’ve actually issued SPiCE VC, 22X and Augmate. We have migrated Blockchain Capital from the old issuance platform and we are in the process of doing the same thing with Science [Blockchain]. We are going to see a handful of tokens being issued from other companies in the tokenization space. Harbor just launched their platform yesterday for the first time, but their first token is not going to be issued until May of next year. Companies like Polymath have not actually issued a live token yet, so this is still very early days. There are very few security tokens out there. I think one of the reasons is that people are still waiting for to the secondary markets to launch to have liquidity. As John said, there is a bit of a chicken and egg problem especially in the U.S. When you issue a security token, you have a one-year lock-up unless you can use a registration exemption like [section] 4(a)7 [of the Securities Act] which allows you to sell in 90 days but requires a lot of company disclosures and causes regulatory burdens.

I think what is going to happen in the next few months is first we are going to see the development of the secondary market. Yesterday, OpenFinance launched for the first time in the U.S. They are now currently trading SPiCE VC tokens of non-U.S. investors. The U.S. investors are still within the lock-up period. SharesPost will be launching very soon as well, and we are going to see a number of other secondary markets launching, which will create more demand for security tokens. We are targeting launching or being in the process of launching 100 token offerings in 2019. This year we have already launched four token offerings and expect to launch another four by the end of the year. We have 20 customers signed up and in the process of launching. These are tiny numbers if you consider that about 40,000 private placements of securities were completed in the U.S. last year and likely around 200,000 worldwide. I think that the security tokenization process is just starting, and the pace will accelerate significantly in 2019.

Omer: Let me just comment on China. China has in some ways traditionally been a little bit behind the United States in blockchain trends but from my experience being in Beijing and New York, my belief is that Beijing and China move very, very fast. From a STO and security token standpoint it really is something that emanated from the United States largely due to some of the pronouncements by the SEC. I would say that China is about five months behind the U.S. market and what John and Carlos just described but it is going to be coming on very strong and will also start to see a lot of activities from China very soon and I think in a very big way as well. Everybody in North America should anticipate this.

John: Omer let me add onto that. I was a technology investor in my previous career before I became a blockchain CEO trying to create the infrastructure for security tokens. What I have seen in other industries that are nascent, such as the peer to peer market, is that you have companies in the U.S. who are very much thought leaders that come up with innovative technology and regulation. And then what follows is a very quick emergence of similar companies in Asia, especially China. I remember when I was studying these P2P companies for possible investments, looking at companies like Lending Club in the U.S. and OnDeck, I would go and look at the equivalent ones in China, meet these companies and ask them what kind of lending volumes they are seeing there. These companies were a year or two younger than their American brothers and they would tell me their volume numbers and I would listen and ask: Was that last year and is that in RMB? And their answer would be no, that is in U.S. dollars and that was just last week.

So, I think Omer’s point is correct. The Chinese community, once they grab onto something, will move very fast and come on very strong. In fact, at SharesPost we and the GLASS network pride ourselves in being very global, not only on the private equity side (such as the trading of Uber and trading of Didi) and the cross-border capabilities we have on that side of the business, but also the security token side, where we are building that business in the same way. We are affecting cross-border trading of security tokens, hoping to take advantage of supply in Asia and demand in the U.S. and vice-versa. The supply of great companies and tokens in the U.S., and allowing interested buyers in China to participate. We anticipate a fast start in China and we want to help service that as well.

Omer: Great comment John. We share the same view. It is hard for people to understand the scale and speed of China without actually being here but to make this layer of global digital assets issuance and trading successful it really requires China and the United States to cooperate. That is why we really value our partnership with SharesPost and Securitize which allows us to be able to develop a cross-Pacific practice for STOs. The scale and the speed of this will be immense.

Carlos: Omer, if I can just jump in to something related to China that we are noticing. We have a service where every day we get an e-mail summarizing where Securitize or security tokens have been mentioned in online press and articles everywhere in the world and on social media. Three months ago, there was no mention of us or security tokens in the Chinese press. Now the number one source of mentions is actually the Chinese press. To see this change within the last three months is quite amazing, because I was in Hong Kong in June and back then there was not much attention paid to this space. But I have seen within a few short months how quickly attention and mentions in the press about us and security tokens has grown. I have seen how this has completely changed. So, I do realize that when China moves, it moves at a pace that is not comparable with anything else.

Omer: Absolutely. We hope after this STO roundtable, those hits will double within a month. And that is the type of scale that we are talking about. How do you see the security token market develop over the next 2 to 3 years and in the long run of 5 to 10 years?

John: As we said earlier than next year or so in the U.S., we are going to see the beginning of real trading of security tokens. What I mean by real trading is, you are not going to see the nascent 2 or 3 tokens that are trading right now. We are going to have 40, maybe 60, tokens trading in the U.S. in the next year or so. And then we're going to see in two years, a marquee name, whether it is on the equity side or in a real estate type capacity, or perhaps maybe some debt product. Some marquee names will become interested in STOs after seeing some success from the early trading in the security token space. What I mean is a marquee issuer, someone who is going to be like Facebook was for SharesPost back in 2009, who decides that a token format is better for them to raise money than the traditional methods, and they decide to do it as an STO.

When that happens in the next 2 to 3 years, you're going to see a tidal wave of other marquee names following. And if I just use the U.S. as an example, in 2017 companies raised about US$150 billion through private placements and about US$150 billion in proceeds raised by companies in through IPOs. I think the security token raise fits somewhere in between. It is not necessarily a private placement type of raise, and it is definitely not an IPO raise. It provides more liquid than a private placement, but without the costs and reporting requirements that makes it hard for a startup company or a nascent company to do an IPO. That's US$300 billion of annual capital raising that I can see in the U.S. through traditional methods. I can see in 3 to 5 years the security token offering in the U.S. taking up to 20 percent of that. And if and when that is the case, we have a gigantic market, and it is no longer a nascent market. That is how I see the next 1, 2 and 3 to 5 years playing out.

Omer: Let me add to that. I think things happen faster than what people outside of the blockchain industry anticipate, because we in this industry all know the speed at which it moves. And to your point John, I think in terms of the premier issuers, we may see some even earlier from China, such as Chinese high growth companies. RockTree LEX is partnered with ZhenFund, which is the top angel fund in China, with over 600 investments in high growth companies. LEX is also the co-founder of China's version of WeWork called UCommune. You were talking about the speed of China growth - within three and a half years we are at 200 locations globally. We went really fast, that's much faster than even WeWork managed to accomplish within their first seven years. We have 8,000 high growth companies in Ucommune locations and it is very hard for them to get listed on the A-share market domestically within China, and listing overseas is also difficult. You may see some really high-quality companies, with high growth, great management team and scalable, coming to the STO market in the United States from China.

Carlos: I think that one of the main things needed is for liquidity to happen and for the marketplaces to launch. I think that is one of the things holding back the promise of security tokens. When that happens, we will see a radical change in the number of people who want to issue security tokens. I agree with John the moment that a famous company does a security token issuance might not be that far away, it might not be a famous issuer but an asset that is tokenized and I see it happening in the real estate industry, where some marquee building or hotel everyone knows gets tokenized and opens up people’s eyes about the tokenization space.

But I think that the other piece that is very important as well is when we finally get an institutional investment bank underwriting a security token. I think that may be the other event that will trigger a change in the market, because that is the moment that they realize that security tokens at the end of the day are digitized securities and use better technology that provides a lot of advantages in terms of not just capital formation, but also amalgamation, transparency, automated compliance, liquidity, etc.