Who Are the People Investing in Tokenized Securities?

The question posed in the title is one we have in mind every time we read about a new security token offering or the launch of a new tokenization platform. According to a recent STOblock report, there were 11 offerings in Q2 2019, a 175 percent increase from the same period last year.

At the same time, as of November 2018, at least 18 security token issuance platforms were already up and running, as stated by The Block. Although no formal research has been conducted in 2019, this number has by now almost doubled.

The entire infrastructure for investment in digital securities and the number of offerings keep growing. But where are the investors - and more importantly, who are they?

This article is based on interviews we hosted at the Value.Tokenized podcast with STO investors, companies who have successfully raised funds in a tokenized format, and lawyers who made these deals possible.

Infrastructure investment first

When we ask investors to share their opinion on STOs, the first topic that comes up is investments in infrastructure projects, namely issuance platforms, digital securities exchanges, and custody solutions. The fundament for the future of a tokenized economy seems to be more appealing to VCs and corporations than security tokens themselves.

We have seen plenty of significant deals in the last 12 months, such as Euronext (the leading pan-European exchange in the Eurozone) investing in tokenization platform Tokeny Solutions, SPiCE VC's investment in a forthcoming institutional digital securities exchange Archax, Collaborative Fund's investment in MakerDAO, and more.

So, what exactly drives this interest? Demelza Hays, a Junior Fund Manager at Incrementum AG (Switzerland) explains: “That’s a whole another investment strategy - to invest in the companies that are trying to compete with the stock market,” she says, mentioning SIX exchange, NASDAQ and New York Stock Exchange as their rivals.

“It could be a good investment in the sense that these companies might be able to completely cut costs and make stock issuance and stock trading much more streamlined, affordable, controlled by algorithms. It’s a long bet, but if it does come to fruition, you are going to have fantastic returns.”

Matthew Graham, the CEO at Beijing-based Sino Global Capital said that his firm is “looking for projects that are consistent with our thesis that a lot of value is going to accrue around the concept of programmability. We’re going to use tokenization to add intelligence to traditional securities.”

Venture investment in STOs

A lot of investors agree that the future of a tokenized financial infrastructure is bright, and are willing to place their bets around it. But when it comes to investing directly in tokenized shares of companies today, there is more controversy.

This year, we have seen a few promising cases on the STO market. Provenance, one of the most successful STOs of 2019 so far, raised $20 million in a Reg D offering that “saw participation from both Blockchain and traditional technology investors” according to The Tokenist.

And earlier this year, Abu Dhabi based Blue Rock Capital and Blue Stone Capital signed $10 million intentions each to invest in Sumner Group's $100 million STO.

This is a good sign for the industry, but it is still it’s a very small number compared to the dozens of existing issuance platforms. And it’s a tiny percentage of the entire venture capital market.

What stops the capital from flowing into tokenized securities? To start with, a lack of good investment opportunities. Most companies that are looking to raise capital are most likely to turn to traditional fundraising methods due to the novelty of the instrument and lack of trust in it.

Those few who are adventurous enough to do a security token offering to raise funds, often offer their investors the option of traditional settlement - and a lot of investors choose it.

Patrick O’Meara of Inveniam Capital Partners said that his firm “had a $38 million bank loan, twenty-some banks looking at it, eleven bids. The final four bidders were very big banks here in America, and none of them would take it tokenized. We can’t say to the client 'sorry, we’re not going to get the money for you,' so we physically settled the trade.”

O’Meara explains that Inveniam Capital Partners currently offers deals that can be partially settled physically and partially in a tokenized form.

Those technologically advanced investors, who do understand the benefits of tokenized instruments, still tend to refrain from such investments, until all the Liquidity promises are fulfilled. And it cannot happen without the necessary infrastructure, which takes us back to the discussion of infrastructure investments.

It takes a while for traditional investors to change their opinion on the industry of tokenized assets. Meanwhile, there is a massive worldwide movement underway to democratize capital markets by providing retail investors with access to tokenized investment opportunities.

Retail investment in tokenized assets

To this day, the majority of security token offerings have been conducted under private placement exemptions, meaning that these deals were available to a limited number of accredited investors only. Up until now.

On July 10, the US financial regulator SEC approved the first-ever token offering under Reg A+ exemption, allowing Blockstack to raise $28 million via an equity crowdfunding campaign.

Reg A+ is known as the alternative to Initial Public Offering for startups and smaller companies, introduced in 2012 by the JOBS act. In the course of the past two years, multiple companies filed for Reg A+ approval for their STOs, but Blockstack pioneered to receive it.

This marks a new step for the tokenized securities market, which is now becoming more accessible to a wider audience of retail investors.

The US is not the only jurisdiction to bring this forward - the same tendencies have been unfolding in Europe, to a large extent facilitated by the new prospectus regulation. It enables companies to raise up to 8 million EUR without having to file a prospectus.

The first European public STOs started to emerge even before it came into force. in December 2018 Mt Pelerin - a Swiss blockchain banking startup - raised over 2 million EUR from investors in 30 countries.

Quite remarkably, Berlin-based blockchain startup Fundament has just received approval from German regulator BaFin, allowing it to offer its real estate-backed tokenized bond to any retail investor with no minimum investment restriction.

“The main challenge remaining is to see if sufficient investors can be found to invest in this.” says Richard Lohwasser, the CEO of Lition, “Investors in last German STO, Bitbond, will most likely lose the majority of their funds.”

“Tokenized assets combine tolerable risk and decent returns,” says Ivan Bolonikhin, Head of Business Development at Stobox. “It is a way out for investors who were traditionally limited to choosing between safe but extremely low-yield assets like bank deposits or investing in extremely risky endeavors like ICO scams and Ponzi Schemes.”

During the ICO boom, the format prevailed over the product: many people invested in coins regardless of the product and the business plan. Although many investors are bullish on security tokens in general, the motivation to invest is never limited to the tokens.

"Investing in a tokenized security just because it is such one sounds like buying a random stock without knowing the company behind,” said Max Kops, STO Advisor and Author of the book Assets on Blockchain, who recently invested in an STO of a fintech company. “Hence, I would never invest in a tokenized security for its own purpose. The product matters."

Simon Enwia, who invested in SEC qualified public STO, says that the investment format mattered to him as an investor, as “tokenized investments have the capability of liquidity” and potential of liquidity across marketplaces was as appealing to him as the product.

Masha and Xenia Vyazemskaya (also known as the Crypto Twins) are Co-founders and co-hosts at Value.Tokenized and creators of the Security Token Club.