Welcome to this week’s edition of the RHIZOME Wire!
Note: Before we get into this week’s newsletter, I wanted to draw attention to the fact that I am now collaborating with ICON community member FezBox on a new podcast: Eye on ICON. We'll spend time going through recent news on the latest ICON developments and analyzing new projects. The first episode is LIVE! Listen wherever you subscribe to podcasts!
ICON dabbles into STOs
This week, Min Kim tweeted out an article that he co-wrote with Ricky Dodds entitled “Why Security Tokens will have a greater impact in 2021.” This came a bit out of the blue, as security tokens haven’t really been a focal point of ICON’s attention (at least publicly). The fact that two of the most notable leaders of the ICON project published a very public article on a blockchain media website implies to me that something may be brewing behind the scenes.
So of course, I decided it would be a good time to revisit the idea of security tokens and to speculate a bit on what ICON may be working on.
First, as a primer on what exactly STOs are:
According to an article on Investopedia, security tokens are “essentially digital, liquid contracts for fractions of any asset that already has value, like a house, a car, a painting, or equity in a company.”
So, let’s say you want to gain some exposure to real estate. This means you have to have enough money to buy a property. And now you have to run and operate it and deal with tenants and repairs and all the other headaches that come with it.
Or, you could purchase an STO, giving you a share of ownership of that piece of land. And all you have to do is hit “buy” on exchange to do so. Since you’re only owning a fraction of the asset, you’d only pay a fraction of the cost.
See, look: here’s a token giving you exposure to a piece of real estate outside of Detroit. For less than $200 you can own 1/3,800th of this apartment!
Now, let’s talk about STOs and compare them to ICOs.
If you’ve been in crypto for any amount of time, you’ve likely heard the term “initial coin offering,” which was all the rage during the 2017 bubble (and the tool that ICON used to launch ICX).
At a fundamental level, an ICO is technically a contribution to a project. In exchange for this contribution, you are given a number of tokens, which are almost always utility tokens. As a contributor, it’s your hope that the value of these tokens will go up over time if demand for using the protocol goes up.
Meanwhile, security tokens are an actual investment and ownership in a financial asset. They entitle a holder to profits, potential dividends, and direct exposure to the underlying asset.
Ultimately, utility tokens promise a product or a service; security tokens promise a profit (but it’s important to note that in both cases a promise is not a guarantee).
In 2017, most ICOs were backed by just a whitepaper and a prayer (and sometimes the crafty marketing of a scammer). ICOs were the best path for new projects to take, as they were an easy way to avoid the stringent regulations that a security offering requires. ICOs were just a fast way to raise money.
As a result of these rules and this structure, an ICO participant is not an investor. There are no rights conferred and there is no actual ownership of an underlying asset.
Meanwhile, with an STO, all tokens that are sold are sold as securities. Everyone who owns one is considered an investor, with all the rights that term bestows. However, the issuance of an STO requires a lot more heavy lifting when it comes to regulatory and legal compliance.
This “heavy lifting” is where ICON hit a wall in their prior exploration of the STO space. Here’s an excerpt from Min and Ricky’s article:
In 2018, we looked into creating a tokenized security fund on the ICON blockchain network. We’d participated in other tokenized funds before such as Blockchain Capital’s BCAP offering and found the process straightforward from an investor standpoint. But when we started to go through the process ourselves, it was evident that the cost-benefit economics did not make sense. We and many others discovered that starting and operating a tokenized fund would be more costly than starting a traditional fund. For example, the hours racked up quickly on legal due diligence because this was new territory with high regulatory risk. There were also technical development and operational costs that wouldn’t apply to a traditional fund.
So not only were there high operational costs, but the demand for these products wasn’t significant. They were a lose-lose proposition.
Fortunately, over the past year or so, there have been some changes to regulations making it more practical to issue security tokens:
In 2020 the SEC announced plans to streamline the application process for investment companies, paving the way for blockchain companies to gain faster approval. And in November, the SEC increased its limits on how much capital companies can raise before registering from $1.07 million to $5 million, making it much easier for startups to conduct STOs with fewer restrictions.
U.S. regulators are showing clear progress toward a better understanding of digital assets and their various use cases, setting the stage for blockchain firms to offer security tokens with greater clarity, transparency, and trust to investors in the coming months and years.
So what might ICON have in store?
In May of 2020, we got some news that the ICON Foundation had reached a partnership with LCX, a crypto assets exchange based in Liechtenstein:
The security token sector just got a little more competitive thanks to the work of the ICON Foundation. This week, the group announced a strategic partnership with the Liechtenstein crypto assets exchange – LCX. Now, the two companies seek to share valuable insight on security token infrastructure, compliance solutions, and regulation technology. The news demonstrates further growth in the STO sector, as well as, rising tokenization interests in the EU.
According to company executives, the firms inked a memorandum of understanding (MOU) this week. Now, the groups will focus on research within the market. The team seeks to gather enough data to help it develop a variety of new standards for tokenized assets. If succesful, their work could prove to play a pivotal role in the EU’s STO market development moving forward.
According to the company, “LCX is a secure and compliant platform for buying, selling, transferring, and storing digital currency.” More pertinent is the fact they focus on “tokenization of assets, utility and security token offerings and advanced trading tools.”
Here’s how the CEO of LCX described their vision in an AMA:
LCX is on a mission to redefine finance as we know it and to democratize financial services and bridge the gap between the traditional banking world and the new crypto-industry.
Similar to Coinbase and Kraken, we have invested heavily in compliance and regulatory structures to ensure our users have a safe, secure and reliable environment to buy, trade and manage their digital assets. Our LCX crypto compliance suite has been built from the ground up and sets new standards in the industry.
Furthermore, in the announcement of the partnership released by ICON, they listed the specific benefits of the partnership:
exchange of knowledge and sharing of insights on security token infrastructure, compliance solutions, and regulation technology.
working closely together to develop new standards for tokenized assets and how it could interconnect with other blockchains participating in the ICON network.
sharing of operational infrastructure in Liechtenstein and South Korea.
You can see why LCX may have selected ICON as their partner (and based on their website, ICON is the only partner (along with Chainlink)—among an impressive list of partners—that is a blockchain organization). It appears they’re primarily looking at utilizing ICON’s interoperability features for security tokens.
I think it’s also important to note that less than a month ago, LCX announced they had “secured the approvals of eight registrations of the Token and Trusted Technology Service Provider Act (TVTG). This makes us one of the first cryptocurrency platforms to achieve these regulatory milestones in Liechtenstein allowing us to offer the broadest scope of blockchain services.”
Among the services they are permitted to provide are “token generator, token issuer on its own, and token issuer on behalf of the clients.”
More notably, these approvals don’t mean they’re only able to serve clients based in Lichtenstein. Here’s another quote from the recent AMA conducted by the LCX team: “Even if the project is based in Singapore, Netherlands or USA – we can issue the token for them combining our legal tool kit, regulatory setup and our token sale manager technology platform.”
Meanwhile, ICON has released it’s own standard for issuing security tokens on the ICON public chain:
The security token standard describes how to represent full ownership or split ownership of a particular asset. Through this standard, ownership of certain assets can be issued, represented, tracked, viewed, divided, privately owned and transferred. It may also be entrusted to a third party provider and may be controlled under strict authorization.
The standard supports assertion of legal documents, partition management with partially fungible tokens in tranche, and interfaces for managing operator privileges.
Additionally, for regulatory compliance regarding fraud or loss of private keys, token control by operators is enabled in the standard.
This ultimately means ICON has created the infrastructure to create and launch STOs on the ICON network, just like they have with NFT tokens and the ability to create other IRC-2 tokens.
Now, what makes ICON compelling from an STO standpoint? Well, we know LCX already cited the interoperability features that are soon to launch ICON.
But remember, ICON also has a close working relationship with dozens of banks and other financial companies throughout South Korea, along with a history of receiving regulatory approval for financial services.
If you were interested in the security token space, wouldn’t it make sense to utilize a blockchain with significant ties (and use cases) with the financial industry and financial regulators?
So, here is what we know:
ICON was deeply interested in the STO space as early as 2018
ICON created the technical capability to launch security tokens on the ICON public chain in a way that allows legal backing and regulatory compliance.
ICON has deep connections with financial industries and regulators, and has a groundbreaking interoperability platform (BTP) launching later this year
ICON has forged a partnership with a company (LCX) aiming to be a financial gateway of sorts to be able to launch, trade, and store security tokens. Oh, and they also have the regulatory approval to do so.
Out of nowhere, Min and Ricky write an article touting the promise of security tokens.
What does this add up to? Well, this is speculation on my part, but I could envision a scenario where ICON and ICONLOOPs many financial partners express an interest in the security token market to digitize traditional assets. Just look through the many MyID Alliance partners with the word “securities” in their name or description.
And don’t forget, with a decentralized identification already approved by financial regulators that exists on the ICON blockchain, it’s now a lot easier to conduct the KYC process—a key component of issuing STOs to investors.
I would think these factors would make ICON the default blockchain for any and all security token offerings in South Korea.
Meanwhile, it’s important to have the infrastructure necessary to roll out these STOs and ensure they have a presence on secondary markets. The partnership with LCX provides a potential pipeline to a regulatory approved exchange for trading STOs.
Furthermore, with ICON’s promise of interoperability, it may be possible to utilize these assets on other blockchains. Perhaps, for example, it may be possible to use a tokenized asset such as real estate as collateral for taking out a loan on a DeFi platform on another blockchain (or you could always use one of ICON’s soon-to-launch platforms!). And of course, at a basic level, ICON’s interoperability promises “cross-blockchain payment capabilities” as Monty C. M. Metzger, CEO, and Founder of LCX pointed out in the partnership announcement.
All of these seem to be possibilities in my view. Ultimately, I could be wrong, and none of this may materialize, or it may materialize but never live up to these grand expectations.
That being said, toward the bottom of their article, Min and Ricky did state that “the ability to safely and securely invest in tokenized real estate properties is one thing we’re working toward rolling out in 2021.”
So with everything else ICON has in the works for 2021, we can now add another potential milestone to the list.