Tokenization of existing assets via security token offerings (STOs) offers a number of benefits, including the ability to fractionalize ownership rights, transfer paper-based property rights to the digital world, facilitate the emergence of a secondary market supported by the blockchain infrastructure, and access to a more global investor base.
A new report from Opimas managing director Axel Pierron-Security Token Offerings: Poised to Revamp Funding in the Private Markets-finds that STOs offer the greatest immediate potential for start-ups seeking early-stage financing(like ICOs before them, which they will replace),figuring most prominently at the Series A roundand could significantly improve the efficiency of private markets.
Findings of the report also include:
- While adoption of the STO mechanism by issuing companies will be incremental, accounting only for around 4% of early-stage financing deals in 2019,Opimas expects that by 2022 STO market value will reach US$19 billion, which is equivalent to 13% of the funds allocated by venture capital firms in 2019 alone.Post-2022, STO growth is likely to accelerate as the market matures and acceptance expands beyond early adopters.
- The STO market is relatively young, with only a few hundred issues. Even the ICO market, with US$7.9 billion raised in 2018, is tiny compared to the VC funding and IPO market that invested US$143.8 billion and US$145.1 billion, respectively. While STO volumes are still limited, they have been able to capture an impressive amount of volume for such a recent financing tool, attracting the equivalent of 5% of the value raised through established funding practices.
- The development of the STO market represents a clear opportunity for service providers in the digital asset space. Our conservative estimate is that,in 2022, roughly US$250 million in revenues will be generated by token issuance providers.
- Opimas expectsICO/STOtrading revenues generated by broker/dealers and digital-asset trading platforms to reach US$2.5 billion in 2020 and US$3.9 billion by 2022.
- Different from ICOs,STOs represent a share of a physical asset or of a company and give the holder explicit rights such as dividend payments. In addition to a real-life asset backing an STO issuance, this type of digital asset also fits into the existing regulatory framework, providing a much-needed level of certainty to investors regarding regulatory scrutiny aimed at reducing the potential for fraud.
- Trading these assets will require market-specific expertise and resources to ensure proper maintenance of real-world, physical assets.In certain cases, the token can be the asset itself (e.g., corporate securities or funds), but for tangible assets, it only represents a contractual right, as the asset itself cannot be digitalized (such as fine art or real estate).
- STOs are particularly well suited to the private markets becausethe asset to be tokenized is already a financial one; tokens have the capacity to embed shareholder agreements into self-enforcing smart contracts; the market is still very paper intensive, requiring significant manual labor in post-deal administrative and accounting tasks; and the time horizon of institutional investors in private markets, which tends to be mid-term, is consistent with the type of trading velocity that can be handled by the blockchain infrastructure.
- STOs will play an increasing role in early-stage funding. Aside from the occasional, very large STO issuances, we expect the market to operate in the current value size of former ICOs, which STOs will mostly replace. The average value of an ICO in 2018 was US$8 million, while the average deal size for IPOs was above US$145 million.
- STO issuance for a start-up does bear an increase in funding costs. We estimate that tokenizing a companys shares or debt, which includes the creation of the token, smart contracts, and cyber-security audit, will increase the cost of funding by 20 to 30%, likely making the process more applicable for start-ups at the series A funding stage, rather than the angel/seed investment stage.
- By 2022, if regulatory evolution supports STO adoption and greater standardization is implemented in the smart contract design framework, we could see tokenization revenue reach close to US$500 million in the next four years.
