“We are extremely, extremely bullish on tokenization,” is what Richard Luftig of Castle Placement has to say about the latest trend in the maturing crypto space.
Echoing this enthusiasm and to further discuss the hot topic of raising capital with security tokens, how this differs from traditional raises, and its future, the Security Token Market (STM) brought together industry experts at its inaugural TokenizeThis Summit, held last week.
Hosted by Peter Gaffney, head of research at STA, the flagship conference took place from October 11 to 13 to cover the different aspects of tokenization.
This event comes at a time when the crypto industry has been going through a bear market, and the macro environment is also painting a gloomy picture. As Gaffney noted, even as the industry continues to expand, we're seeing a big challenge of raising capital as a whole. However, things are not the same in the capital raising market, which is simply massive.
“It's just such a gigantic opportunity marketplace that we don't think about competition at all. In other words. every one of our competitors can 5x their business, and there would still be massive opportunities for Castle Placement,” said Luftig, managing partner at a licensed broker-dealer that also raises private capital for companies and funds.
A couple of years back, the company jumped into reg A equity crowdfunding & built an ATS, which got approved a few months ago to facilitate secondary trading of private securities.
During the online conference, Luftig noted that while other industries have razor-thin margins, and everyone's competing in a very small pond, in the capital raising industry, it's the exact opposite, “so, it's nice to be able to root for other people in your industry as opposed to trying to crush them,” he said.
Talking about this abundance, Etan Butler, founding chairman at Dalmore Group, pointed out that there are 30 million private companies just in the US alone. Dalmare is a FINRA and SCC registered broker-dealer investment bank and technology company developing tools to assist issuers in raising capital online at scale globally.
What it essentially focuses on is fractionalization, where the issuer decides the price per share of an asset. “You don't necessarily have to tokenize it to achieve that,” before offering these shares to the masses, said Butler, adding, “We're seeing a lot of growth in that area and bullish on that continuing.”
As for tokenization, Butler noted that the clients have been approaching with a lot of questions about tokenization and blockchain.
“We recognize the tremendous benefits that blockchain and tokenization present and believe, ultimately, that whatever's most efficient and cost-effective is gonna succeed,” he added.
Despite this, investors today are much more selective than they were two years ago. Private equity venture capital has reduced its investment volume, and equity crowdfunding is about flat, though Lutwig expects it to “grow tremendously.”
However, Castle is having a lot of success in contrarian strategies, roll-ups of industries that are in distress, and balance sheet lenders where they're making private loans where banks used to make loans.
Retail & Institutions Involvement
When it comes to raising capital with security tokens, there are a lot of elements involved in it. Much of the responsibility here rests squarely on the issuer to create that emotional connection between what they're raising capital for and the investment community they're targeting and supporting them, as per Butler.
However, “they're not necessarily suited to going out and promoting a security token offering and speaking the right sort of language,” as such, there is a need to focus on having this distribution mechanism. For that to succeed, there need to be collaborations with key players, such as broker-dealers, to figure out the right way to promote this new investment opportunity within traditional investors, like accredited investors, crowds investment groups, and so on, Butler explained.
And while security token offerings expand your investor base, there's only a subset that typically would be interested in specific types of investments. As such, one needs that community, deal flow, and a marketplace with exciting products to filter, choose, and look at these various investment opportunities, which calls for a concerted effort.
Talking about the operation of raising capital with security tokens, Claus Skaaning, CEO of DigiShares, also chimed in, stating that tokenizing the asset in itself doesn't really make it worth more right; rather, the asset has to be of value in itself.
Tokenization is just an infrastructure add-on to make it easier to onboard investors, add liquidity, automate, and reduce cost, but it is also, of course, about fractionalization and democratization — that's one of the key value propositions of tokenization, said Skaaning.
DigiShares is one of the leading providers of technology and infrastructure solutions, with 150 clients globally. The company has a transfer agent license and is planning to get a crowdfunding license, too. There's also a plan to launch an exchange in the US, especially for real estate trading based on blockchain technology, in Q4.
According to Skaaning, retail adoption needs to grow for tokenization, but it “is coming quite slowly.” Not to mention, in many countries, it is almost impossible for retail investors to participate. But we do see the trend going in the right direction. The other trend is that of wallet adoption because, as Skanning noted, an organization is not going to succeed if not enough people use wallets, and that's luckily also increasing every year.
“So, with those two trends increasing, it will see tokenization in a sweet spot in a few years,” said Skanning.
But while retail has been increasingly adopting tokenization, the question, as asked by Gaffney, is, is it really possible to raise capital from larger credits or even qualified purchasers just at lower levels?
“There's clearly institutions out there that embrace technology, the investment opportunity,” said Bob Ejodame, VP of Capital Markets at INX, a broker-dealer that has nabbed several money transmitter licenses that allow it to run a crypto trading platform.
According to Ejodame, institutions that are looking to get exposure well before the rest of their peers and understand wallet management, have institutional grade wallets and are comfortable with managing self-custody of their assets is “a niche, target group that could easily pivot into investing in security token offerings in various other industry verticals.”
To Ejdome, it's still potentially the education thing about pushing these product offerings in front of them and going through that process of demonstrating that while they “already have exposure to cryptocurrencies, there are security token offerings which are poised to actually dwarf the cryptocurrency market.” However, for that to happen, there needs to be a concerted effort. Otherwise, it will only be a handful of them and still not fill those races.
Hence, to attract institutions, “it needs to be a group coming together and identifying a strategy that works and then working together to push that in that direction,” said Ejdome.
Obstacles to Overcome
Raising capital with security tokens has been gradually gaining traction. However, there's still a challenge from the infrastructure side, especially in terms of crypto wallets.
As Luftig points out, for an investor to commit to an investment, everything has to align. They have to love the opportunity, industry, management team, strategy, and the track record. And if the investor doesn't currently have a crypto wallet, the probability of them investing in this is very, very low.
This, Luftig explained, is a “huge obstacle,” which isn't anything new either. But while over the past five years, things have gotten better than an overwhelming majority of investors not having a wallet, it isn't anywhere near close to being solved.
“We were having discussions with clients that wanted to do token issuance. And we said, you know, 99% of our investors don't have a wallet. Do you want to play those odds? And that was five years ago. Is it better today? Yes. But is it a hindrance? Absolutely, yes,” said Luftig.
But this is not all. The regulatory aspect is the biggest one. After the collapse of crypto companies like FTX, Luna, Celsius, and BlockFi, the crypto industry has been seeing increased scrutiny from regulators all over the globe. And this, according to Luftig, doesn't inspire confidence in the space.
“I would say that it's kind of unfortunate the way this has all played out over the last few years because starting with the ICO nightmare, companies just raise capital with complete disregard for securities, laws, and regulations,” said Luftig, further pointing out how most of the media headlines regarding crypto today are focused on trials, criminal activity, fraud, and regulatory problems. “So, that's not an inducement for people to jump into the pool.”
Agreeing with Luftig, Ejodame noted that against this backdrop of everything that's happened, on the regulatory front, we are seeing the strong-handedness of the US regulators. But while regulation is needed, maybe the approach and the way things are being done could be off-putting to new entrants into this space, he added.
However, this doesn't mean tokenization isn't the next big way. “The opportunity is massive,” said Luftig, who believes corporation assets, without question, are going to be tokenized. And while it may not happen in the near future, it is going to happen.
“Not tomorrow, maybe in a year, maybe in 3 years, maybe in 5 years. But it's going to happen. It's inevitable. Everything comes together — Web3, general Internet connectivity, equity crowdfunding, payment rails, and marketing strategies, it's all coming together to help investors get access to different asset classes and they want it. They want it in their regular accounts. They want it in their self-directed IRAs. And you know the people on this panel are going to deliver it. So it's going to happen. But it takes time,” said Luftig.
For Ejodame, there are a lot of things that need to happen first, and that's what the companies are working on, whether that is UI and UX, support for multiple wallets, blockchain agnosticism, the ability for assets to move across chains and live on different chains, or the gamification of the entire experience — it's all critical.
“I think that's just this cycle that we're gonna look back one day and be like, well, there was a positive initial phase, and then we went through the challenging phases with the trials, and then we hit the next bull run, and a lot of shops that raised capital during the last bull market they're quietly working and developing products and solutions and bridges. We'll definitely look forward with a lot of excitement,” said Ejodame.
So, much like Luftig, Ejodame is of the view that “this is all inevitable.” But of course, the adoption is going to take some time, but there are many things that are happening not just within crypto firms but also at the large institutional traditional finance such as Citibank, which is creating a tokenized way to represent assets across all of their different business units. And this “will continue to happen, that will just propel us in that direction,” Ejodame said.