Security Token Offerings Just Grew Up

STOs = ICOs + Securities Regulation + New Exchanges

As a long time participant in capital markets, it is always fascinating to watch the same critical ingredients recombine into new and useful products and tools. I would go so far as to propose that financial market innovation takes the form of a loop rather than a linear progression. Each time through the loop, we break down our preconceptions and habits, keep what works and apply the cool new tools we have invented to come up with something that is both old and new at the same time.

Tim Draper has put a $2m bet on a company called Fairmint (article), a company which has broken through conventional wisdom, looped through the financial innovation cycle and put together a platform that will come to dominate small company financing. If entrepreneurs and investors grasp the implications of what Fairmint is doing, we could see a revolution in the corporate life cycle as the CAFE replaces much of the round system that dominates Venture Capital thinking.

A Token offering, you say? Haven’t we seen these before?

The answer is yes and it supports my supposition above that financial innovation is more loop than linear progression. Initial Coin Offerings or ICOs exploded onto the scene in 2017. Mastercoin and Ethereum are recognized as pioneers in the space before 2017 but it was really the boom and bust cycle of the ICO frenzy that helped to associate that acronym with scammy operators. The key obstacle was that many of the ICOs looked, smelled and “quacked” like digital IPOs and, as such, fell under the scrutiny of the SEC in the US and any number of other regulators around the world. Calling them “utility tokens” was a very small fig leaf which failed spectacularly as regulators cracked down and many investors fled the field (although not everyone left).

So what has changed?

The only two things that matter in corporate finance: the primary and secondary markets.

The secondary market innovation has led this latest STO charge. Token trading is learning a trick or two from traditional financial markets. Check out the top 10 users of ETH Gas at https://ethgasstation.info/. While you have Tether and USDC stable coins, note that current #1 is Uniswap. This is an exchange which amongst other features allows you to stake and run a market making bot of your own. And there are several similar players crowding the top 10.

For investors, this means that when the regulatory lock (one year for most Reg S/Reg D deals) comes off an STO token, there is already a place to trade. No extra steps required. The distinction between an unlocked token trading on Uniswap and a listed equity on the NASDAQ comes down to custody and settlement distinctions.

On the primary market side, Fairmint has built a platform on Ethereum which closes the gap between entrepreneurs and investors. For entrepreneurs, all the critical details of a Reg D 506(c) offering are baked into the software. The key Identity, Anti Money Laundering and Investor Accreditation imperatives are handled smoothly and correctly. For the investor, the automation allows one to concentrate primarily on the value proposition. And automation means that minimum deal sizes can drop to include investors who might never hear about deals otherwise.

What is so great about the CAFE that Fairmint has invented?

Firstly, it takes all the things that investors and entrepreneurs have agreed upon in their deliberations over the years and packs them into a simple agreement that results in tradable tokens (subject to Reg D and Reg S restrictions noted above). The regulations around a Reg D/Reg S offering offer an incredible amount of flexibility to the entrepreneurs and, thanks to the magic of the internet, an incredible amount of transparency and reach to prospective investors.

Secondly, as a continuous offering, the CAFE uses a bonding curve to allow the market to determine valuations after the initial allocation has been sold. That means that each new investment after the initial tokens have been allocated amounts to a mini up-round. It also means that the CAFE holders, as a class, are given excellent protection against both dilution and dissolution.

As a result, the STO can serve as a useful vehicle through the entire corporate life cycle. In the early stages it can serve as a useful and accessible funding tool. In the middle stages, it can offer liquidity to early investors and/or a valuation tool to judge the performance of one’s investment. And in the later stage, the STO is ready-made for an underwriting onto a traditional stock market or as a valuation tool to facilitate an acquisition.

We are excited to be offering the FLUX CAFE on the Fairmint platform. Check out our offering at https://invest.fluxfinancial.net