Be Patient with Security Token Expectations, says HyperLink Capital

Be Patient with Security Token Expectations, says HyperLink Capital

In a recent publication, the team behind HyperLink Capital has explained why they believe the liquidity which tokenization claims to bring to securities will take some time. Only after several phases in the future will there be a modification to existing securities laws, followed by institutional-grade entities joining the industry, which will subsequently unlock the current barriers to liquidity.

The Quick Progress in the Security Token Industry Explained

Security tokens involve a variety of ownership claims concerning real-world assets. Such assets have had an existing ‘securities’ status, but the digital wrapper provided by tokenization offers a wealth of benefits.

Tokenization has already experienced implementation in the traditional financial securities sector, to include luxury property, REITs, equity, investment funds, and fine art ownership.

In addition, a multitude of security token standards have been created on the Ethereum blockchain.

Such an atmosphere has created a significant buzz around security tokens. Many perceive they will go on to seriously disrupt the capital markets industry in the near-future.

In a recent article however, HyperLink Capital laid down a few reasons why the expected disruption will take some time, and what they plan to do in the meantime.

How Regulations Impact the Security Token Industry in the US

One aspect requiring patience is the need for regulatory compliance in security tokens. Tokenization offers a unique innovation to traditional securities, but it does not eliminate any of the existing regulatory obligations.

In the United States, the Securities and Exchange Commission (SEC) has suggested that security tokens must abide by existing securities laws.

For companies, this means they can issue securities on the US market under either a ‘fully registered’ status, requiring adherence to the Securities Act of 1933, or under a ‘private’ status, which would entail an exemption from the act.

Being fully registered requires lengthy reporting, full disclosure and financial auditing, an issuance cost of somewhere around $2-6 million, and a timeline of typically 6-9 months for approval. Once approval is granted, companies are free to work with both accredited and non-accredited investors with tokens that can be traded in secondary markets immediately after release. HyperLink Capital has noted that tZERO is one of the few blockchain-related projects to potentially pursue this route.

Those exempt from the Securities Act have less expenses, but must be classified as ‘low-risk’ due to government or financial institution support, non-profit status, restriction to a certain state, severely limited solicitation, or an offering that is primarily available only to accredited investors. The majority of US-based STOs have followed this path.

There is also the Regulation A+ offering, which was created as part of the 2012 Jumpstart Our Business (JOBS) Act to help small businesses raise capital. It enables companies to raise a maximum of $50 million in a public offering, available to both accredited and non-accredited investors. While StartEngine is currently pursuing this path, it has been noted to feature difficulties, with a successful Reg A+ STO yet to be seen.

When it comes to investors, those who are accredited see significant advantages compared to those who are not. Accredited investors have more opportunities and increased information available to make more informed investment decisions.

The reasoning for accreditation status, says the SEC, is to “identify persons who can bear the economic risk of investing in […] unregistered securities”.

In the US, the SEC defines an accredited investor as someone who earned income which exceeded $200,000 (or $300,000 together with a spouse) in each of the previous two years, and reasonably expects the same for the current year, OR has a net worth of more than $1 million, excluding the value of the person’s primary residence. Of course, a number of additional steps must also be fulfilled, but the aforementioned tends to be the primary.

What we see here then, is a long history of regulatory requirements. SEC Chairman Jay Clayton has recently stated he is “not going to change rules just to fit a technology”. Hence, regardless of the amount of added liquidity that security tokens aim to bring to the financial securities sector in the immediate future, regulatory compliance will remain an obstacle in providing such liquidity, says HyperLink Capital:

“Similar to electric cars not being suddenly accessible to unlicensed drivers, this wave of security tokens will not change the rules of the game — but only upgrade the technology used which will lead to cutting costs and improving market efficiency. On the other hand, to remove the unnecessary barriers, eliminate the middlemen, close the execution-settlement gap and create worldwide liquidity it will take more patience and much more work.”

The Future Point of Modification to Existing Securities Laws

Concerning any change to existing securities laws, the team at HyperLink Capital believes this is likely to come after several additional steps of implementation in the future.

“[The] final step will be the famed institutional acceptance, removal of unnecessary frictions and processes, full embracement of superior technology, integration of tokenization, and the gradual replacement of classic paper issue securities. This step will be a result of modification of existing laws and adaptation of established rules and guidelines to new realities brought upon by technology.”

That’s why HyperLink Capital is not focusing on security token standards, or current competition. Their protocol, the open source SFT protocol, wants to rebuild financial markets in a collective manner. That’s why they recently became founding members of a consortium aimed at security token interoperability: the Millbrook Accord. As their team explains,

“With SFT protocol, we are not even competing with other technological providers or issuing platforms. As founding members of the Verified Token Network and the Millbrook Accord, we are working on introducing standards and procedures that can be utilized by market participants worldwide to issue, invest and trade in security tokens. We are creating an interoperable framework for security tokens, and streamlining the issuance process to avoid mutual incompatibility between platforms, and ensure that the tokens adhere to jurisdictional restrictions and safely reach a global investor audience.”

What do you think of HyperLink Capital’s remarks on the security token industry? Do you agree that patience will be key, and that interoperability will lay the foundation for future implementation? Let us know what you think in the comments below.

 Image courtesy of HyperLink Capital.

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