The early promise of blockchain as a disruptive force has not been fully realized. Instead of using the technology to drive change, many companies entering the space are seeking merely to profit from it. During the last year, however, a new use case is emerging: a disrupted stock market, or stock market 2.0.
Utility vs. security: what’s the difference?
Most ICOs issue utility tokens, coins issued for a specific purpose, such as accessing the service that a company provides. Because utility tokens are not designed to be investments, they are exempt from securities regulations. Security tokens, in contrast, derive their value from an external, tradeable asset. This can include shares or units of ownership in the issuing company.
The need for change
In July 2017, there was an upheaval in the ICO landscape, as the SEC issued a report stating that a cryptocurrency issued by a prominent ICO was a security, and as such, was subject to federal securities laws.¹ Although some ICOs had recognized the value of regulation prior to this, this SEC report was unsurprisingly the impetus for many ICOs to reconsider their position. Further disruption followed on February 6, 2018, when the Chairman of the SEC stated, “I believe every ICO I’ve seen is a security.”²
At first glance, the development of securitized tokens and a blockchain enabled market does not seem especially revolutionary. For many investors, trading in cryptocurrencies is roughly equivalent to trading on a traditional stock market: it offers the investor a chance to make a profit, the investment serves as a source of motivation for emerging companies, and cryptocurrencies are seen to represent fractional ownership of a blockchain company. However, this last statement is valid only if an ICO issues security tokens.
A new type of market?
A stock market based on cryptocurrency offers some clear advantages. It allows for easy access to global markets. It allows for early investment in emerging companies, without the need to be an accredited investor (a requirement in the US for investment prior to listing on an exchange). It also offers no restrictions on the number of trades that day or pattern traders can make.³ It is immediately obvious, however, that these advantages also bring with them some serious disadvantages. First and foremost, the most common form of tokens, utility tokens, are not always liquid, and so a market based on utility tokens may not offer the same benefits to investors as a traditional stock market. In addition, and more importantly, without regulation, investors face risks from wild fluctuations in the markets, as well as scams, and insider trading.
Impending regulation prompts new use cases
In the last year, several innovative — and regulated — platforms have emerged that attempt to address these disadvantages. The decentralized storage solution Filecoin is illustrative of some of the hurdles that must be overcome as companies negotiate new concerns about regulation and compliance. Seeking to meet regulatory compliance standards, Filecoin opened its ICO to accredited investors only, a move that alienated many members of the blockchain community.⁴
More promisingly, the past year has also seen the emergence of securities token platforms such as Polymath, Sharevest, and Desico. Polymath, for example, is building the first decentralized protocol that will “empower corporations to launch their own security token by simplifying the technical and legal challenges of a compliant token launch.” The Polymath platform will enable the transformation of equity and share units into programmable tokens that are “more accessible, liquid, and secure than traditional forms of asset ownership.”⁵
Another promising development is the emergence of the Gibraltar Blockchain Exchange, which launched in July 2018. Accessible to the public, and offering fiat onboarding, the exchange “aims to be a world-leading institutional-grade token sale platform and cryptocurrency exchange coupled with a comprehensive listing process, AML/KYC best practices and public consensus within a governed environment.”⁶
These are only a few examples of the innovation that is currently emerging in the blockchain space. Surely, it will only be a matter of time before the promise inherent in organizations such as Polymath and the Gibraltar Blockchain Exchange results in the emergence of a new market: the stock market 2.0.