Security tokens are still the Next Big Thing, and industry players say they're poised for huge growth in 2020

In early 2018, security token offerings (STO) seemed to be the next big thing, and then suddenly, they weren’t. Big-ticket projects began to fade away as the price of bitcoin waned until later in the year. Then came the institutions. 

Industry players from companies like Vertalo, OpenFinance and Arca say the space is back on the rise, in large part due to increased interest from large institutional players. Now, the security token market is poised to be bigger than the crypto market by the end of 2020, according to Dave Hendricks, CEO and co-founder of Vertalo. 

A game of regulation

Mason Borda, CEO and co-founder of TokenSoft, said the first real influx of interest was in February 2018, coinciding with Securities and Exchange Commission (SEC) Chairman Jay Clayton’s testimony, in which he said initial coin offerings (ICO) have largely been viewed as securities. Interest in compliant STOs grew as it became clear ICOs wouldn’t be exempt from securities law.

"That's when the first wave came where everyone began to adopt the mindset of, 'let's make these securities, and we should perhaps undertake further regulatory diligence prior to proceeding' and so February 2018 was when we saw the first large influx of potential clients,” said Borda.

But that influx would slow down. Borda pointed to declining crypto prices as a major driver, since the interest in STOs is heavily tied to interest in the digital asset space as a whole. Similarly, Juan Hernandez, CEO of OpenFinance, said the lag was part of the greater “crypto winter” at the time. 

The winds of crypto winter

Another piece of the slowdown was a lack of regulatory clarity. Though the space initially jump-started with an understanding that most token sales would be viewed as securities, it wasn’t entirely clear how to conduct token sales, and the guidance surrounding alternative trading systems (ATS), according to Lawson Baker, head of operations at TokenSoft.

“People tend to want to raise money when the price is going up, just like the stock market,” said Baker. “Combined with essentially a little bit of muddy waters of like how to do these sales really kind of put a lot of pause on most of the sales.”

Regulatory hurdles mean increased costs, according to Arca Capital Management president Jerald David, which also likely put a damper on the market. As David put it, a compliant STO is expensive, similar to a traditional securities offering with the added complexities of custody and manipulation concerns.

“Most people didn’t realize that at first and when it became obvious, these hurdles made many offerings too risky from a return standpoint,” said David. “People thought that you can just make some disclosures and ‘off to the races’ you go when, in actuality, it is a much more time intensive and complex process.”

Growing strong

But regulatory clarity is on its way, according to David, Hernandez, Baker and others. The next year will be telling, according to David, since the SEC is slated to rule on the federal status of stablecoins.

“If stablecoins are deemed a security, then the trading market will be turned on its head because there currently isn’t an SEC regulated stable coin and stable coins have dominated trading as of late,” he said.

David said he expects regulations to tighten, and the space will subsequently grow as more teams with regulatory experience enter the space. Still, he says the quality will increase because it won’t resemble the “land-grab” mentality surrounding ICOs.

In fact, lack of regulatory clarity remains the main pain point for the industry, according to Hernandez. Questions remain on how to custody tokenized securities, and Hernandez said although the technology is there, much of the space is watching and waiting for the SEC to flesh out what it’s looking for in a custodial solution. 

This has kept institutional players from fully engaging in the space, according to Hernandez, but it’s not keeping them on the sidelines. 

Wall Street is coming

Hernandez, Borda and others say most of the interest is being driven by larger institutions, like Franklin Templeton. Borda said most of TokenSoft’s clientele is institutional clients, and Baker said much of the next year will probably see a similar client base.

I think over this next year we're going to see continued as they keep saying ‘Wall Street is coming,’” Baker said. “Everyone likes to use the Wall Street metaphor, but I would classify it is people with reputations and a lot to lose are coming into the space.” 

That's not just Wall Street, according to Baker, the broader financial global market is entering the space. He said these players are beginning to want to put their reputations on the line in the tokenization space now that a few years have passed since the 2017 bull run. In that time, Baker said many of these institutional players have educated themselves on the space, and subsequently decided that it won’t fade away. Now, they’re fleshing out their strategies.

Hendricks explained that tokenized securities can expedite direct listings, or taking shares directly to an exchange. By allowing accredited investors to trade a token on a private exchange prior to listing it on a public exchange, stabilizing the price for a company before going public. 

But looking forward, When much of the crypto nature of tokens is abstracted, Hendricks said they’ll reach their full potential.

“The STOs will be more successful once investors don't need to understand how to operate wallets or how to deal with private keys for their tokens,” he said. “Wallets and private keys are one of the biggest impediments to the success of security token offerings.”