Author：魏然@八维研究院
1. Long-term vision and industry distribution
The cryptocurrency industry may stay at the bottom right now if we look at our position from a point of view. However, The growth curve of an enterprise and an industry needs to be extended over a long period of time, such as half an year, one year or three years, before we can see the true tendency and the core force which can drive each round of the development.
When the new technology works together with some financial scheme, certain mechanism will occur to lead the next trend. In the wide Internet industry, giants like Google in search engine field, Alibab in e-commerce field, Meituan in O2O field, Didi in share economy field and BTC & ETH in cryptocurrency filed all come from the single point product and expand rapidly with the strength of capital. All these names become kind of concept and it supports the upstream and downstream industries, like BTC and fork coins, mining machine and mining pools, financial service providers, industry research institute, cryptocurrency wallet, leasing platform, exchanges, medias, communities and so on：
a）There will always be a new mechanism after the beginning of each wave.
b）When the wave arrives, the first outcome will be bubble.
c）Blockchain is not only technological innovation, but also institutional innovation, including financing model, business model and profit distribution model.
We believe that real-world industries, capitals and related service providers will be mapped into the digital world. Also, this digital world is parallel to reality and it certainly has cross-border and international characteristics. Thus, on the block-chain technology track, such as public chains, privacy, storage, smart contracts, we invest in the world’s top players who have opened a generation of technology paradigms；At the same time, we also have a deep layout of financial infrastructure, such as exchanges, stable currencies, Security Token, payment, lending platforms, etc.；in addition, building an industry ecosystem is necessary part of high-quality post-investment services. We form strategic alliances with many exchanges, medias, consultant services, and developer communities to support our investment portfolios with industrial resources.
2. Ebb and flow, grasp the Inflection point
If we look back, the blockchain industry has experienced several waves including couple of bull and bear markets in the cryptocurrency industry.
The first wave starts from payment & transaction because Bitcoin and other cryptocurrencies became kind of payment tool, which disrupted the mode that the transaction can only work depending on traditional financial institutions. On 3rd Jan 2009, Satoshi Nakamoto left one sentence in the Bitcoin Genesis Block:“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” It was the British Chancellor of the exchequer who was forced to consider the second attempt to relieve the banking crisis, and this is the headline of the Times at that day. So, It can be seen that Bitcoin, born after the 2008 economic crisis, echoes people’s discontent with the traditional financial system, and springs up a wave of “decentralization” thinking.
The second wave started from equity financing, and Ethereum, ERC20 tokens and the ICOs are kind of new financing mode. Meanwhile, at the “bull market”, It provides the venture capital institution with the exit mode which has high return rate and mobility. In 2017, the projects could get funding just with whitepaper, and get listed on exchange only with expectations. People from all the world could invest on their tokens which are actually without regulation. When there was no regulation, some projects could get funding from investors in different countries, and the demand was much larger than the supply. Thus, hundreds of times return on investment is also reasonable, this is the reason for the so-called “bubble”. It was second half year of 2017 that SEC came up with related laws and regulations for ICO and security tokens. On 4th Sep 2017, China decided to shut down the domestic exchanges and ban the ICO. At that time, the magnitude has reached US $10 billion.
Several years ago, when the Internet finance was born, Shengxi Huang pointed out,“There is no Internet Finance in the world, but seeing the financial world, bureaucratic habits and structural imbalances. It also has separate businesses and licenses. Just as it is, the Internet that pursues efficiency and equality can be deeply rooted in the hearts of the people.” Today, China is in the downward cycle of the real economy, with debt soaring, the central bank shrinking its balance sheets, tightly controlling financial risks at home and facing foreign exchange control and trade wars.
Besides China, global macroeconomic and cryptocurrency prices are also forming an increasingly close transmission mechanism. According to BlockVC strategy research, since Venezuela issued Petro Coin, cryptocurrency has been carrying the expectation of some emerging market countries to ease the currency crisis, the dollar debt crisis or circumvent economic sanctions. With the global withdrawal of cross-border capital investment, the fiats of Turkey, Brazil, Argentina, South Africa and other countries have sharply depreciated, asset bubbles have burst, vicious inflation has been carried out and financial flows have been transmitted to other countries.
Under tight supervision, people have enough impulse to bypass the shackles of the financial regulatory system through “technological innovation” in order to have a little room for improvement. Looking back on history, “factoring, small loans, trusts, guarantees, are all placed in high expectations, but all are chicken feathers. With the exception of a small number of shadow banks, the rest are either subordinate to power rent-seeking or jailed for financial crimes.
Different from the traditional capital market, block chain is an internationalized industry, facing the global capital market and tens of thousands of exchanges. Governments of different countries have different attitudes towards block chain, so they can not form collusion, which makes cross-border policy arbitrage possible. Projects can obtain legal and compliance documents from policy-friendly countries such as Singapore, financing from venture funds registered in Switzerland and Cayman, and listing on exchanges in Malta.
In response to this global policy arbitrage phenomenon, Tim Draper, a prominent American venture capitalist, said that the most exciting thing about Bitcoin to him is that it is a global currency, and that in the future governments will become public service providers that need to compete openly, rather than monopolies in specific countries. Virtual Citizens and entrepreneurs can vote with their feet, and I don’t like the way you can leave and turn to more geographically friendly government service providers. Because of this nature of the industry, countries, especially small countries, will have a FOMO (Fear of missing out) and want to overtake the bend mentality, so they choose to be friendly to the blockchain.
Although we can make excess profits by making time lag (before innovation, lagging regulation) and space lag (game between countries, cross-border arbitrage), with the influx of projects, the supply of admission funds is insufficient. When the supply of projects exceeds investment demand, according to the normal market law, a large number of token prices will inevitably collapse. Another point is that although the logic of traditional equity financing also has “bubbles” (such as profits for 50 years after the advance), there may be at least “P / E ratio” as a support for stock prices. However, the mainstream strategy for maintaining the stable rise of token value is “deflation model”, “currency management” and “community expectation”. “Management” is still too elementary.
Early adopters of a paradigm can be profitable, but only when they have become a well-known normality do they flood in, especially the bad imitators of the paradigm, often face greater losses. In this regard, the history of sharing bicycles can also be verified.
In order to survive, to stop losses, or simply because it is too easy to get, the project side sells the low-cost ETH from financing, and the ETH can not bear the selling pressure and then falls. The price of ETH and its associated token goes into a vicious circle. We are in such a vicious cycle that the so-called trough will continue as long as the bad currencies have not been cleaned up and new funds have not come in.
Referring to the evolution of the traditional financial market, from the first wave of transfer payment to the second wave of equity financing, accompanied by the payment of wallets (like third-party payment), secondary market platform (exchange), accompanied by equity financing of VC / PE-like investment banks (to provide investment, underwriting, market making, refinancing). Such a package of services, rating, research and other complete financial services industry chain.
The inflection point of a new round of trend will appear only when the block chain is incorporated or opened to a larger market.
In the last article reviewing the tenth anniversary of the financial crisis, we mentioned the world’s difficult problems facing the global macro-economy for 18 years. If a new model can inject new vitality into the traditional economy and allow higher liquidity and premium of high-quality assets, it may help us open the door to the stock market.
It is foreseeable that in the future, the debt financing / stock debt hybrid financing means will probably come into being.
3. The third wave — — Security Token（ST）
Most conflicts and misunderstandings in the world are disputes between concepts.
In China, Yuandao et al. put forward the concept of “Tokenization” in March this year. In “Token is the Key to the Next Generation Internet Digital Economy”, Token’s “Tokenization” can be circulated immediately, and the certificate is the certificate of rights and interests. It is defined as a negotiable encrypted digital proof of rights and interests. According to the original description of the Tokenization, “Tokenization enlightens and encourages people to take out all kinds of certificates of interest, such as tickets, points, contracts, certificates, point cards, securities, authority, qualifications and so on, to tokenize, to circulate on the block chain, to trade on the market, so that the market can automatically find its price, At the same time, it can be consumed in real economic life.”
In the United States, there is a similar concept called ST (Security Token), and another ST-based concept called STO (Security Token Offering). Simply, STO is the Tokenize of existing traditional assets such as equity, creditor’s rights, real estate, profits, works of art as collateral, which becomes a securitized certificate and must be applied to federal securities law.
Traditional bankers who believe in Buffett’s theory of value investments are not interested in Utility Token alone, and the undefined Token is still on the lookout for regulatory gaps. ST is equivalent to the transformation of traditional assets, which accords with their value investment theory.
With global equity assets of about $70 trillion, debt of about $100 trillion and real estate market of $230 trillion in 2017, the potential for these real capital jaws to enter the market would be beyond our imagination.
What exactly is Security Token (ST)? What are its strengths and weaknesses? In the future, will ST really lead a new wave of virtual and real assets, new money and old money?
We used to hear about Security Token a lot, but it often came with Utility Token. In order to avoid regulation, some projects often define themselves as Utility Token, which has only usage value but no investment value, not security. But in fact, when the standards are applied, the court will adopt the principle of “substance is more important than form”.
There are mainly two forms of identification of securities in the federal securities law of the United States：
a） stocks, bills, bonds, other forms of equity and debt instruments.
b）any form of investment contract (through Howey Test)
The latter, the definition of investment contracts, is derived from the 1946 Howey Test, which qualifies as securities if four specific conditions are met. At the Atlantic panel meeting of the Securities and Exchange Commission of the United States (SEC), it was proposed that “if a Notary can satisfy the Howey Test of an investment contract, it will be deemed to be a Securities Notary. A circular will be declared a functional one if it is used only within the platform after pre-sale and does not enter secondary market transactions.
It can be seen that if ST has the general attributes of traditional securities, it is essentially a new type of securities. According to The Five Dimensions of Security Tokens-The Third Wave of a New Financial Internet, there are two types of securities-based circulars from a legal point of view:
a）The first generation of ST is a regulated Token product. The “exemption” clause applicable to the Securities and Exchange Commission (SEC) means that financing for Reg D (US) and Reg S does not require registration with the SEC. Generally speaking, they are qualified investors and wealthy individuals. Reg D, Reg S and Reg a + are the main regulatory regulations of SEC. D is the main private equity law, S is the regulation of U.S. companies facing overseas investors, A + is equivalent to small IPOs, requires two years of audited financial information.
b）The second generation of ST is a new generation of ST that simplifies the authentication of qualified investors. Simplified authentication is the automation of KYC (knowing your customer) and AML (anti-money laundering) mechanisms through smart contracts. The regulatory rules of different countries will be compiled into intelligent contracts, and cross-border transactions will become simpler and easier.
It explains ST from its characteristic in “the Your Official Guide to the Security Token Space”:
a) ST is kind of digital asset regulated by federal securities laws and regulations. Popularly speaking, it is in the intersection of digital assets and traditional financial products.
b) Programmable ownership. If Bitcoin is called “programmable currency”, then ST can be regarded as “programmable ownership”. Any ownership assets can and will be Token.
Combined with the above articles, there are two driving forces behind the concept of ST.
First, reduce regulatory risks and strengthen due diligence. In the context of the United States, regulatory exemptions (such as Reg D or Reg S) are the first step towards compliance, and in the ST 2.0 era, automatic programmable compliance is expected by incorporating national KYC and AML provisions into smart contracts.
Secondly, it is global assets seeking higher liquidity, rate of return or alpha. ST is expected to reduce the circulation cost of assets and obtain a potential liquidity premium. “The rising trend of investment in emerging markets is supporting the trend of capital globalization, so Security Tokens can be very useful since they support cross-border transactions easily.”
According to LedgerZ Capital and Harbor, if Chinese Internet companies want to return to exchanges in other regions, such as A shares and Hong Kong shares, after listing in the U.S., they have to go through the process of privatization and delisting, dismantling the VIE structure, and then entering the IPO queue or backdoor, which is very complicated. Most private assets are illiquid and have high transaction costs. For example, private assets such as venture capital or LP equity of private equity funds, exit from positions before the liquidation of the fund often entails substantial discounts. But if we can atomize the assets in the form of ST, that is, trusteeship on the chain, transaction liquidation, code compliance, we can achieve T + 0 asset circulation, from a purely technical point of view, will improve the efficiency of resource allocation.
To sum up, changes brought by ST (not necessarily an advantage) include:
a)Intrinsic Value: ST must have real assets or earnings as value support, such as company shares, profits, real estate.
b)Programmable & Automated Compliance and Rapid Settlement: ST needs the approval and permission of the regulatory authority to automate the KYC/AML mechanism and achieve instantaneous clearing.
c)Fractional Ownership: Accelerate the division of property ownership and reduce the entry threshold of high-risk investment products, such as real estate and high-end works of art.
d)Democratize Risk Investment：Expanding the way to raise funds, Polymath, Harbour and Templum exchanges are trying this way.
e)Asset Interoperability：The Internet is essentially a bunch of protocols that enable many different types of software to exchange and utilize information (TCP/IP, SMTP, FTP, SSH, HTTP). A standardized agreement on assets will facilitate interoperability between heterogeneous assets and different legal currencies.
f)Increase liquidity and market depth: You can invest in illiquid assets through ST without fear of redemption, and the market depth will increase through the following channels: 1) The rise in the price of digital assets creates billions of dollars of incremental wealth that will be invested in the market. (2) a Bancor like procedural market maker has improved the liquidity of long tail ST. (3) asset interoperability agreements will facilitate cross-border asset flows.
However, technology is by no means omnipotent. The free flow of Global trade and capital depends not only on technical factors, but also on international political, financial policies and institutional arrangements. On the other hand, securitization is not a new proposition for finance. For financial innovation, it is more important to control risks than to improve efficiency, such as:
a. Excessive liquidity of assets may bring huge price fluctuations.
For startups, for example, it takes a long time to achieve an IPO, and it takes a while for their equity to be liquid. But STO may enable a start-up to become a public listed company directly, with many ST holders. Because startups face so many uncertainties and ups and downs, these uncertainties can cause sharp fluctuations in Token prices. After Tesla went public, for example, a Twitter tweet by Elon Musk triggered a plunge in share prices that made it eager to privatize the company again.
b. Financial innovation may just accumulate risks to the tail.
According to Mikko, Everything that adds to liquidity in good times pushes risk into the tail, The core function of financial institutions / markets as financial intermediaries is to configure the risk structure of each entity. For example, during the 2008 financial crisis, many shadow intermediaries in the value chain of real estate (underlying assets) appeared to be diluted through complex financial instruments, but in fact covered up liquidity risk, term risk and credit risk, making risk pricing fuzzy, and ultimately stimulated the irrational rise in asset prices.
c. ST is not a completely new concept. Asset securitization needs intensive cultivation.
The definition of security tokens reminds us of the Securitization in traditional finance. Asset Backed Securities (ABS) refers to the packaging of assets with or future cash flows into asset pools, the structured design of cash flows generated by asset pools, and the conversion of low-liquidity assets into high-liquidity asset-backed securities (ABS).
What is the difference between security token and traditional asset securitization? What is the connection between STO and small IPO? If we use block chain technology to improve the efficiency of the whole process and value chain of creditor’s rights and equity financing, and use technology to replace or enhance the functions of some main bodies, to what extent can we achieve?
