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Tokenisation, the blockchain and liquidity

Tokenisation, the blockchain and liquidity

Raising capital by issuing tokens is an increasingly attractive financing model. 

In 2017, blockchain-based financing really took off with a bang in the form of Initial Coin Offerings (ICOs). However, due to the lack of sufficient legal provisions, ICOs were sometimes abused and have since taken on a rather negative reputation. The concept of Security Token Offerings (STO) is different from that of ICOs. Since security tokens confer rights equivalent to those of a security, STOs are usually subject to regulatory and capital market regulations, and in turn, the scope for abuse is much reduced. Now, arrangements dubbed ‘Initial Exchange Offerings (IEOs)’ are anticipated to be a secure alternative to ICOs, in addition to STOs.

So, what is an IEO? In contrast to an ICO, an IEO is a token issue that is not carried out by the company issuing the token itself. Instead, it is handled via an exchange, namely, a platform that allows its users to trade cryptocurrencies (such as Bitcoin or Ethereum) for other assets such as other cryptocurrencies or FIAT currencies (e.g. EUR or USD). In short, an exchange is a trading platform that brings together buyers and sellers of listed assets. 

This means that the tokenisation project must meet the requirements and guidelines of the exchange in question for an IEO to be carried out. As the exchange (an independent stakeholder) monitors and reviews transactions, this ensures that investors are protected from abuse. This protection is also of great importance for the exchange itself because it does not want to run the risk of reputational damage within a highly competitive environment.

However, the crux of an IEO is the existing infrastructure, provided by the exchange. An exchange usually has established interfaces for trading, user-friendly wallets and, above all else, a large number of registered users. In contrast to an ICO, where successfully listing coins on an exchange is one of the biggest hurdles, in an IEO, tokens are quickly listed by the exchange and can then be purchased by all its users. Because the newly distributed tokens can be traded quickly and easily with other assets listed on the exchange, a company that issues its tokens through an exchange will be able to enjoy comparatively high liquidity from the outset. And of course, a liquid market has a positive effect on the amount and speed of sales and on pricing. This is not only advantageous for the initial issue: it also buoys up the secondary market for the tokens, too.

Implementing STOs by way of IEOs, i.e. issuing asset or security tokens via an exchange, would be a real tour de force. Assets that were originally non-liquid, such as real estate, would become a liquid and easily tradable asset class for the first time, via the issue of corresponding tokens. This would create a financing model with strong parallels to a conventional IPO, as it is possible to access a wide number of users via the exchange. Companies could finance projects, expansions or additional product lines by issuing security tokens to a broad audience of this nature. This offers an innovative alternative to financing via the third market or conventional loan financing for companies both large and small. 

Exchanges act like a traditional securities broker when they trade security tokens. They would also provide additional security as a result, as they would require appropriate licences (e.g. a licence as an investment firm) and be subject to strict conditions, as well. It is also conceivable that conventionally licensed companies could jump on this bandwagon, too, and ‘upgrade’ their technical infrastructure so it meets these needs. Consequently, it remains to be seen which platform will manage to establish itself first as a trading and financing platform for a dizzying array of assets. 

Authors:

Mag. Ronald Frankl, Managing Partner, Head of Corporate, M&A and Capital Markets and Head of Blockchain and Cryptocurrencies at LANSKY, GANZGER + partner
Mag. Peter Virtbauer, LL.B., Associate at LANSKY, GANZGER + partner

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