Exchanges for Security Tokens: Which STO Exchanges do Already Exist? Which Follow Soon?
Authors: Philipp Sandner, Jonas Groß, Christoph Impekoven, Christian Labetzsch
In the previous year, security tokens have been identified as the next gamechanger within the crypto world. They are claimed to revolutionize the traditional form of security issuing and investing. First exchanges have already started in January 2019 to list security tokens. Thus, it is now possible on few exchanges to emit security tokens and to trade them. This article will demonstrate the importance of security tokens and the progress of platforms made with respect to listing these tokens.
What are security tokens?
First, let’s start with an explanation what security tokens are. Security tokens are issued as Security Token Offerings (STOs) and are equipped with security-related features. Via security tokens, real-world assets can be transformed into digital tokens. This process is called “tokenization”. Tradable assets as stocks, bonds or other financial instruments can thus be converted into digital assets via blockchain technology. Security tokens can be distinguished from standard utility tokens, which offer the holder of the tokens (future) access to services and products. Utility tokens are not permitted to promise financial rewards since they are not regulated. Security tokens, in contrast, are asset-backed and incorporate financial incentives. Hence, holders can directly participate in the financial development of the company value and are even entitled to ownership rights, if they are structured accordingly. If the issuer of the tokens wants to provide an opportunity to participate in the company’s development and promises regular crypto payments to the token holder — comparable to dividend payments of a security in the finance world — the tokens are issued as security tokens. Hence, the innovation of security tokens is the crypto sphere’s way of dealing with financial claims on the blockchain. Importantly, security tokens are expected to challenge the business of traditional securities while STOs are claimed to have the potential to threaten traditional security issuance via Initial Public Offerings (IPOs).
The status quo of security tokens
One consequence of classifying a token as a security token is that it is regulated under the respective security laws. Therefore, issuers and buyers have to act according to the regulatory environment. Hence, appropriate Know-Your-Customer (KYC) and Anti-Money-Laundering (AML) processes have to be established as well as a security prospectus has to be provided. Besides, aspects about the origin of the tokens or how one can proof the token ownership have to be tackled. Additionally, questions about the responsible institution to contact in case a transaction was not satisfactory need to be addressed. However, the regulatory environment is not yet ready for security tokens since these questions are not finally clarified.
In the US, there have been cases, in which issuers have been suited because they did not act according to security laws. In the EU, there is not even a consistent definition of a security token. Furthermore, it lacks clear national rules with regard to STOs including duties with respect to STO reporting and documentation.
Since regulatory questions for STOs and security tokens have not been sufficiently answered, crypto exchanges are reluctant to list security tokens. They behave cautiously since they fear negative consequences due to unclear regulation. Besides, it is not even clear yet who can potentially invest into security tokens. Similar to stocks, a regulatory environment has to be established for investors. If the regulatory framework was clear, it would remove uncertainty and could motivate institutional investors to invest into the tokens. This would constitute a milestone for establishing this new form of financing for corporations .
However, financial authorities are already engaged with companies that intend to issue security tokens. The FMA in Austria for instance approved a fully compliant prospectus for a profit participation right to be issued on the Ethereum blockchain at the end of 2018 and further STOs in other jurisdictions such as in Malta, Gibraltar and Liechtenstein are expected to take place soon.
Why do security tokens matter?
The refinancing form of STOs has plenty of advantages compared to the classical form of security financing via IPOs. First, security tokens can be issued and transferred in a digital form. This cuts out the middlemen as banks or brokers. Hence, cost savings could be realized for the process of issuing a token (primary market) as well as for buying an already issued token (secondary market) since the intermediary would become reluctant.
Small or medium-sized companies do not use IPOs as instruments of financing very often because the costs appear to be too high. Typically, high fees have to be paid to bankers who supervise the IPO process or for the exchanges for listing services. Conducting a STO, most of these fees become reluctant. Therefore, more companies are expected to participate in the security issuance process. Additionally, it is possible to trade issued stocks 24/7 because the protocol operates any time. Hence, specific opening hours of stock exchanges in case of stock trading are not necessary anymore and transactions can be processed faster.
As previously described, a security token is roughly speaking a digital security. Hence, it can represent different types of securities. The most common type, is a stock. As an example, CONDA issued security tokens representing shares to all existing shareholders. Every token represented a non-par share. If the token is transferred from one person to another this process can be transparently seen on the distributed ledger and is resistant to manipulation. Blockchain provides then information to record the transaction in the share register.
However, there are no consistent frameworks for the identification, classification and analysis of different token types. This leads to a high level of uncertainty, which lowers investments into these tokens. To address this issue the International Token Standardization Association (ITSA; https://itsa.global/) develops and implements a standardized approach for the identification, classification and analysis of DLT-based tokens.
The role of exchanges
Up to now, exchanges are cautious with listing security tokens. This is mainly due to the unclear regulatory environment which has to be further developed. However, more and more exchanges have started to include security tokens. In 2018, no exchange was permitting security tokens. This situation will heavily change in 2019. Some exchanges have already began or at least announced that they will list security tokens further this year. In the following table, it is shown which exchanges plan to allow security tokens in 2019.
A few platforms have already started the trading of security tokens.
The DX.exchange platform (https://dx.exchange/) was launched in January 2019 and permits to buy bluechip stocks traded on NASDAQ on blockchain indirectly via security tokens. Tokens are backed by “real” shares of the company and holders are allowed to claim the same dividends as shareholders. DX stated, that the tokens are classified as derivatives and regulated under the European Union’s MIFID II directive.
The Swiss company Lykke (https://www.lykke.com/) announced as the first player its regulated security token platform. They developed the platform which offers companies the opportunity to issue equity and bonds in cooperation with startup Nxchange.
Open Finance (https://openfinance.io/) provides security token services in the United States and works under SEC compliant standards. Access to the platform is granted for accredited as well as non-accredited investors both from the United States and abroad.
Besides, the Gibraltar-based exchange currency.com (https://currency.com) has launched its platform in January 2019. Currency.com has announced that it plans to issue more than 10,000 tokenized securities in 2019. It will engage in services with respect to tokenized commodities, tokenized indices, tokenized shares and crypto currencies. The platform will authorize new customers in steps. At this moment, according to the website 125,000 users are waiting for joining the platform.
The Philippines-based CEZEX (https://cezex.io/) operates a security token exchange in Hong Kong to allow companies to tokenize their assets. It was launched in January 2019 and it provides opportunities to trade fiat and crypto currencies, security tokens backed by assets such as stocks, bonds, commodities and real estate, and derivatives including CFD and commodities.
Blocktrade (https://blocktrade.com/) is another exchange for security tokens, crypto assets, crypto traded indices™ and other tokenized assets. It is located in Liechtenstein and it also operates under the MIFID II directive.
Already a few further exchanges have announced, that they will also provide security token services from Q2 2019 on.
The Malta based exchange LXDX (https://www.lxdx.co/) has signalized that they will issue security tokens, which will be traded on its platform. The tokens will be designed to represent a 10% stake in the company combined with dividend rights. They claimed that 10% of adjusted gross revenue will be allocated to holders every quarter.
Gibraltar has initiated its Blockchain Exchange (GBX, https://gbx.gi/) already in 2017, which is a subsidiary of the Gibraltar Stock Exchange (GSX). The platform has applied for regulatory approval from the Gibraltar Financial Services Commission to extend its services for both listing and trading security tokens. It is expected to start its security token business in Q2 2019.
Desico (https://www.desico.io/de) is another platform which offers the issuance and trading of tokenized securities. It is based in Lithuania and acts in full compliance with EU law. The tokenized securities can be solely traded by retail investors. The trading plattform is expected to be launched in February 2019.
The Liechtenstein Cryptoassets Exchange LCX (https://lcx.com/) also intends to provide a trading platform for security token. However, the access is expected to be restricted to professional investors.
Switzerland’s Stock Exchange (SIX) plans on offering an own security tokens plattform in the second half of 2019. Recently, it has been stated that the platform will support tokenization of existing securities and other non-bankable assets.
Besides, the Swiss Crypto Exchange (SCX), which was founded in Juni 2018, also plans to provide security token-related services within this year. However, the exact starting date has not been announced yet.
As further players, the Stuttgart Stock Exchange and the Malta Exchange (LXDX) plan to provide platforms for the issuance and trading of security tokens. The business is expected to start in Q3 2019.
Additionally, London-based exchange Archax will offer institutional investors to engage in the trading of asset-backed tokens (digital securities, security tokens, etc.). Archax intends to launch its services during 2019.
In North America, the Canadian Securities Exchange (CSE) announced in February 2018 to offer a blockchain-based platform also for the trading of security tokens. However, the exact date of launch is not clear yet.
2019 — The year of security tokens
To summarize, more and more exchanges provide a primary market for issuing security tokens and a secondary market for trading them. Up to now, only a few platforms offer security token-related services. Since regulatory aspects get more and more clear, the risks for platforms related to security tokens will more and more decrease. Hence, it can be expected that this was just the beginning and that more exchanges will allow security tokens. The more listings, the more investors have access to this new form of financing for corporations. The first step is made into this new type of finance and 2019 it is expected that the trend will further accelerate. The opportunities for startups to issue security tokens is now given and will be further extended during this year.
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Prof. Dr. Philipp Sandner is head of the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance & Management. In 2018, he was ranked as one of the “Top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belongs to the “Top 40 under 40” — a ranking by the German business magazine Capital. The expertise of Prof. Sandner in particular includes blockchain technology, crypto assets, distributed ledger technology (DLT), Euro-on-Ledger, initial coin offerings (ICOs), security tokens (STOs), digital transformation and entrepreneurship. You can contact him via mail (firstname.lastname@example.org), via LinkedIn (https://www.linkedin.com/in/philippsandner/) or follow him on Twitter (@philippsandner).
Jonas Groß is a research assistant of the Frankfurt School Blockchain Center (FSBC). His fields of interests are primarily security tokens. Besides, in the context of his PhD he analyzes the impact of blockchain technology on monetary policy of worldwide central banks. He mainly studies innovations as central bank digital currencies (CBDC) and central bank crypto currencies (CBCC). You can contact him via mail (email@example.com), via LinkedIn (https://www.linkedin.com/in/jonasgross94/) and via Xing (https://www.xing.com/profile/Jonas_Gross4).
Christoph Impekoven and Christian Labetzsch are founders and managing directors of Blocksize Capital located in Frankfurt. You can contact them via email (firstname.lastname@example.org) or via LinkedIn (https://www.linkedin.com/in/christian-labetzsch-b97b9bb1/, https://www.linkedin.com/in/christoph-impekoven-a5b440109/). Blocksize Capital is a Frankfurt-based service provider specializing in crypto assets established in 2018 by the experienced Fintech founders Christian Labetzsch and Christoph Impekoven. With its four-member management team, Blocksize Capital provides infrastructure for bank and retail customers on the buy side as well as services in the primary market business for security tokens. Today, several institutional clients use the startup’s trading infrastructure, which is specifically designed for crypto assets.