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Is the Security Token a Creditor’s Dream?




Thought Leaders are articles that are contributed by respected members of the fintech & digital assets community. They may or may not necessarily reflect the views held by the team.

Rethinking Bankruptcy Loss Recovery Using This Proven, Versatile and Regulated Digital Asset 

The 2008 downfall of Bernie Madoff after his $65 billion Ponzi scheme shook Wall Street to its core. In fact, nearly 15 years after the first headline appeared about the crimes committed, investors in Madoff’s fund are still looking to recover losses. From pension funds to grandparents, those nest eggs may be lost forever.

While the creditors and the court-appointed trustee in the Madoff case still work to recover more of the losses, the process has been slow, complex and inefficient – with many investors only receiving a fraction of what was stolen from them.

What if those same people had had access to security tokens enabling the recovery of their losses and potentially even profit from recovery of the business post-bankruptcy? Whether it's Madoff or Celsius, security tokens may be the next go-to solution to democratize and simplify bankruptcy recovery efforts for creditors and investors alike.

Security Tokens are the New ‘Fail-Safe’ Tool in the World of Finance

To fully understand the usefulness of security tokens, you must first understand what they are and what they are not. Security tokens are regulated tokenized assets issued on the public blockchain that represent an investment in an enterprise providing a profit share or equity stake from such enterprise to the holder.  Security tokens mimic the market for traditional equities, they are publicly traded on a SEC regulated market, which provides price discovery, but unlike traditional equities markets, the security tokens market is available to trade 24 hours a day, every day of the year.  Trades settle instantly and directly to the investor’s wallet.

Because of their design flexibility, automation and efficiency afforded by the blockchain technology which significantly lowers costs, and the regulatory oversight of this product, security tokens may be the answer to bankruptcy recoveries that investors (and creditors) have been looking for and long-awaiting.

Bankruptcy Doesn’t Mean It's Over in the Tokenized Ecosystem

In a typical corporate bankruptcy proceeding, creditors are likely left with a shortfall on their initial investment and seek to be paid back as assets are recovered by the trustee and the courts over time. Traditionally, the bankruptcy estate available for distribution to creditors is established as of the filing date and the creditors don’t have any rights to the new and restructured enterprise.

However, instead of the status quo, which shuts investors out of future profits, what if creditors leveraged the power and versatility of SEC-regulated security tokens as an instant tool in the hands of the token holder to participate in the possible future equity appreciation and profits of the bankrupt and then restructured enterprise? A classic fail safe instrument for every creditor or investor.

More likely than not, businesses that file bankruptcy today, prove profitable over time. Why should creditors and investors be blocked from a company’s rewarding future? Why shouldn’t blockchain technology offered under a securities regulatory framework be utilized as a fail safe instrument, offering an opportunity to recover losses upon bankruptcy through profit distribution or an equity stake?

Issuing security tokens to investors allows them to participate in future cash flows or revenue of the company, but doesn’t necessarily lead to voting rights. Additionally, the token can be designed to act like preferred equity – giving certain token holders priority on profit distribution and aligning it closely with preferred shares of a traditional company.

This scenario isn’t somewhere far off into the future. It can happen today and every creditor should carefully consider it as an option.

Tokenized Profit Sharing: How it works

While issuing the security token, the issuing company either registers the token with the SEC as a private offering or becomes an issuer of a publicly-traded equity token.  The issuer of the security becomes a public company under the oversight of the SEC, as applicable for all other public entities. After the company completes the ICO/placement, tokens are deposited directly into the wallet of each token holder participating in the ICO/placement, and trading begins on a public market offered by a SEC registered broker-dealer. Any token holder is free to offer his/her tokens for sale or accumulate more from the market.

The registration process is well established and follows the traditional SEC-approved protocol used for many years by issuers of equity. As with traditional registrations, each company must present a prospectus that properly reflects the nature of the entity, risk factors and characteristics of the token offering. Once this documentation is completed, the issued security instrument (the security token) provides the same regulatory protections offered by the SEC to any holder of a public security. Transparency and required disclosures by the issuer combined with the self-custody of the security token by each token holder create a very powerful regulated instrument with the highest level of ownership and control.

Minting and distribution of security tokens itself has a successful track record and is not only registered on a public blockchain, but it is also recorded and monitored by a SEC regulated transfer agent. The transfer agent maintains the official record of every security token transfer and holding for each holder, which provides additional protections, including safeguards against the loss of security tokens. If that wasn’t enough, every security token holder must complete Know Your Customer (KYC) onboarding facilitated by the broker-dealer, ensuring that only KYC approved parties participate in this process.

Ignorance is Not Bliss When Profitable Recovery is Possible with Proven, Regulated Solutions

Security tokens are no longer new and have been proven as secure and effective digital financial solutions in a variety of use-cases. It has also been proven time and time again that an initial token offering provides the same regulatory protections as a traditional securities offering and yet the token issuance process and the secondary market offering are superior over a traditional IPO in many ways. Of course, security tokens carry similar risks to traditional securities in that their prices will move based upon investors’ perception of value, potentially impacting liquidity. However, because of the efficiency of the peer-to-peer ecosystem, where the issuer is connected directly with the security token holder on a fully-regulated, end-to-end trading platform for issuing, minting and instant settlement, the process is simplified by orders of magnitude and the token holders achieve the highest level of ownership and control.

As the traditional market structures continue to evolve through automated blockchain technology offered within a regulated environment, new digitized solutions are becoming more effective and essential. Instead of the door closing in creditors’ faces from shortfalls in bankruptcy, security tokens give them access to a public and regulated market for their share of unpaid debt – providing an opportunity to recover losses through an equity stake in the restructured company.

Renata Szkoda is the Chief Financial Officier of INX and Chair of Global Digital Asset & Cryptocurrency Association.