Tokenization: the future of entrepreneurial finance
As early as the 2000s, entrepreneurs sought innovative and dynamic methods of raising capital from the public. We have seen this evident in the surge of crowdfunding platforms attracting professional and retail investors that have been at the center of digital transformation.
At the height of the emergence of digital transformation having an incredible impact on entrepreneurship financing, tokens have emerged allowing entrepreneurs to receive capital easily, quickly, and efficiently. Entrepreneurs are able to raise capital by issuing tokens to token holders in a similar way as a company would issue shares to its investors, in exchange for consideration (the token price).
While tokens customarily are not representative of actual ownership in a company, token holders often seek to acquire tokens in anticipation that they will increase in value post their acquisition, and later be sold on a secondary market.
So what is a token?
A token is a digital representation of a right(s) to any tangible (financial or otherwise) or intangible assets, stored and recorded on a blockchain. There are different concepts of tokens: tokenized securities, security tokens, utility tokens, or payment tokens. Utility tokens are primarily focused on supporting and developing a community-based ecosystem by awarding consumptive rights to token holders, while payment tokens are a means of payment in a blockchain-based ecosystem.
Tokenized securities are customarily considered to be a traditional, regulated security type with a digital wrapper; that is, where the proof of ownership in the company is recorded on a distributed ledger. On the other hand, security tokens tend to have a much more expansive scope and inherent characteristics that are formulated to constitute or represent assets typically of an underlying financial type.
For example, participation in a company’s earnings streams, or an entitlement to dividends or interest payments, or a combination thereof packaged together. Such tokens may be classified as equities, bonds, collective investment schemes, or derivatives, dependent upon their economic functions and terms.
Modern times
In modern times, in order to take advantage of the heightened process efficiency and greater ability to access global liquidity pools, we have seen new alternative assets formulated as a result of isolating specific economic functions, such as tokenized cash flows from real estate projects or royalty cash flows from works of art. For the purpose of this article, we will focus on security tokens.
Security tokens introduce a myriad of benefits to entrepreneurs: first, they create an innovative new financing and capital raising model that leverages scalable efficiencies. They provide enhanced and easily accessible liquidity. Moreover, by removing third-party intermediaries traditionally involved in the post-trading process, tokenization offers significant cost-efficiency benefits.
Tokenization
A study by Ghent University concluded that tokenization could offer total cost savings of up to €4.6bn (£3.93bn) by 2030, provided adoption rates were high. Further, tokens provide customizable opportunities and bridge legacy finance with the new world of digitization, gleaning benefits from each.
Customizing and designing security tokens carefully can equip entrepreneurs with heightened abilities to raise more capital easily and quickly. In addition, a data flow free of friction, provided that there is a regulatory framework and adequate policies in place, permits greater transparency.
Tokenization takes place when a new blockchain monopolizing an underlying protocol of various cryptocurrencies is instituted by the company issuing the tokens, and thereafter the tokens issued by the company are sent directly to the token holder’s digital wallet address or through a crypto-exchange.
Blockchain is a “shared distributed ledger that facilitates the process of recording transactions or tracking assets in a business network”. Thus, blockchain is a distributed database for recording transactions. The word ‘distributed’ means there is no centralized storage location such as a central server or a cloud computing platform. Instead, the information and technical transactions are spread across a wide network of computers.
Blockchain concept
The blockchain concept was first discussed in a Bitcoin white paper, written by Satoshi Nakamoto, in which he referred to the distributed ledger as “a chain of blocks .”
In this white paper, Nakamoto suggested a peer-to-peer distributed ledger platform for the processing of financial transactions without relying on trusted third parties for their execution. The network is founded on a peer-to-peer distributed architecture which necessitates consensus calculations and/or algorithms to ensure that the transactions across the blockchain network are duplicated so that the ledger maintains its integrity.
What this means is that anyone with access to the blockchain network will be able to see the same information. Blockchain networks can be public and accessible by anyone, such as Bitcoin and Ethereum, or private and permissioned, such as a corporate network for asset tracking. Beneficially, trust is incorporated into the structure of the network.
Regulation
In some jurisdictions, tokens continue to be unregulated, while in other jurisdictions, regulatory guidance has been issued or a regulatory framework has been put in place to govern token offerings. In the past, some token issuers took the position that so long as the token being offered was not a security under the laws of the jurisdiction if its issuance, there was no need to consider whether the token constituted a security in any of the jurisdictions in which the token may ultimately be purchased or resold. It is clear that this reasoning is faulty.
Before issuing tokens, companies should ensure the requisite regulatory and legal analysis is undertaken to determine whether regulation would apply whether their tokens could be considered a token, and the steps that must be taken to ensure adequate compliance. If the primary goal is to raise money, rather than for example to build a network, legal and commercial arise are likely to arise that require consideration before conducting a token sale.
For example, in the United States, the Chairman of the Securities Exchange Commission (the SEC) has provided guidance to the effect that the SEC will apply the tests and standards that have been laid down by the Supreme Court in the well-established case, Securities Exchange Commission v WJ Howey Co (Howey — 328 US293). In Howey, the Supreme Court held that the offering by a token constituted a security offering subject to the Securities Act.
When determining this, the Supreme Court laid down the following four-prong test: Is there: (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit, (4) from the managerial efforts of others? Factors that are relevant to this four-prong inquiry center on the manner in which the token is offered and/or distributed. If a token offering is considered to be a securities offering, then it must adhere to all securities law requirements, which include requirements to register, cybersecurity requirements, AML and market manipulation requirements, among other regulatory requirements. Further, firms that are handling the token offering, including any exchange or intermediary trading, are also subject to such securities law requirements.
Four-prong
In applying the Howey four-prong test, the SEC has pursued a number of avenues for regulation. In 2017, the SEC applied the Howey test to digital assets for the first time, when it found that the sale of
Decentralized Autonomous Organisation (DAO) digital tokens were unregistered securities offerings.
The DAO was issued via a Swiss foundation, and the SEC’s report on the token offering confirmed that the existing US securities law framework applies to token offerings and must be considered even in the case of token offerings occurring primarily outside of the US. The SEC has also issued further regulatory guidance clarifying its view that the vast majority of token offerings are often structured as offerings of securities, for the primary reason that token holders acquired them very likely for the exclusive purpose of later profiting from an increase in its value, emanating from the company’s business model and strategies.
Read the full article: https://www.internationalinvestment.net/news/4055501/tokenization-future-entrepreneurial-finance
