The underlying idea made sense: creating digital versions of paper documents like private real estate investments and company stock would make them more portable and liquid, driving up demand. Many called it the next “mega-trend” in crypto. Conferences sprung up entirely focused on security tokens.
But fast-forward a year and a half, and progress has stalled. More than 100 security tokens have been created, according to Polymath, a startup that helps companies mint coins. But they’re not liquid. In the U.S., just two exchanges exist where these assets trade, and volume is tiny. Openfinance trades only four assets with daily transactions of less than $1 million a day, we estimate. Overstock’s Tzero exchange trades a single asset, its own “Tzrop” token.
Many of the barriers to adoption are regulation-related. For U.S. companies to build a trading venue for security tokens, they must register as a broker-dealer with the SEC and get a license for either an exchange or an alternative trading system (ATS), which requires a long and costly process. One crypto CEO says the SEC is dragging its feet on evaluating and granting new ATS applications to digital asset companies. Holding periods are also a delaying factor: After a brand new security is formed and purchased by an initial buyer, it typically can’t change hands for a year due to regulations.
In theory, security tokens could allow for a “global IPO,” says Olga Feldmeier, founder and CEO of Swiss security token exchange Smart Valor. Ideally with these tokens, U.S. investors could just as easily invest in a public company based in Mumbai as they could a New York company, which is far from the case today. But all participating nations would need to agree on a common framework. For example, in Switzerland, securities settlement can already happen on the blockchain, Feldmeier says. In the U.S., it’s controlled by the DTCC, a New Jersey clearinghouse that handles 90 million transactions daily.
Over the past year, while the crypto market dropped steeply, it became clear that simply converting an illiquid paper security into a digital asset wouldn’t boost interest. Many people had underestimated the difficulty of generating investor demand for securities. Dovey Wan, a crypto investor and cofounder of blockchain holding company Primitive Ventures, says, “A real estate security token offering should be led by an existing real estate or REIT firm, where supply inventory can be guaranteed, and demand can come from existing channels.”
Josh Stein, CEO of San Francisco security token platform Harbor, agrees. “People have realized that yelling the word token is not a substitute for a good investment or distribution channels.” In April, a $20 million security token offering led by Harbor was canceled after the participating real estate firm, Convexity Properties, couldn’t get favorable terms on the loan it was using to finance the deal. Today, Stein says Rhodium Capital Advisors will use Harbor to make $100 million worth of its real estate investments available through digital tokens. Polymath CEO Trevor Koverko believes his company’s new blockchain will provide better security than Ethereum—the platform where most security tokens live today—and will boost adoption.
The long-term benefits of security tokens remain compelling. Fred Schebesta, founder of Australian comparison site Finder and cofounder of crypto exchange HiveEx, says that faster settlement for banking transactions is the most important feature, since multiple parties can plug into the same shared ledger. That eliminates the need to send many messages back and forth and pass through various checkpoints, the setup in today’s banking system.
The short-term outlook seems dim. A year from now, we’ll be in “about the same place,” said Philippe Bekhazi, CEO of crypto trading firm XBTO, at the Consensus conference last week. Smart Valor’s Olga Feldmeier thinks it will take five to ten years to build the cross-jurisdictional infrastructure necessary for security tokens to trade across nearly every country. One thing is for sure: if adoption is contingent on regulators making a move, investors will be waiting longer than they’d like.