SIX angles to profit from ICOs and DLT

When SIX announced its formal entry into the cryptocurrency makets in July, the exchange group’s chief executive, Jos Dijsselhof, said it was the “beginning of a new era for capital markets infrastructure”.

Since then, capital raising with cryptocurrencies, a method known as initial coin offerings (ICOs), has dropped off compared with last year. In August and July this year, $507m and $595m was raised respectively. Last year, the equivalent figures were $550m and $749m. 

Most entrepreneurs interested in ICOs have used the Ethereum computing platform to construct their own bespoke cryptocurrencies, with some promising revenues or rewards to investors holding the tokens.

Alternatively, the tokens can be used on a platform, such as Filecoin, which allows users to earn cryptocurrency by lending space on their hard drives to people on the internet. 

ICOs have become notorious for being largely unregulated, with investors losing millions to fraudsters and scam artists. The practice became so prolific,that the US Securities and Exchange Commission released a fake ICO websiteto help investors spot fraudulent ICOs.

But SIX aims to help companies raise capital with ICOs in a safe manner, with proper investor protections.

Valerio Roncone, head of product management and development at Six Securities Services, told GlobalCapital to look at ICOs as a middle ground between traditional initial public offerings and borrowing money to start a project or business. 

“In the middle, between IPOs and credit, you have nothing —there is a big gap,” he said. “Of course you have people now trying to enter into the space, doing ICOs. But today it is not regulated to the extent we believe is needed. The controls are not in place to raise capital in a structured way."

SIX want to create an environment in which investors can confidently invest in ICOs, knowing they are appropriately protected by anti-money laundering (AML) and know your customer (KYC) procedures. They also want to make sure that the Swiss Financial Market Supervisory Body (FINMA) and the Swiss National Bank are on board with the process. 

SIX will also provide custody for digital keys, which allow investors to access and spend their cryptocurrencies. 

Roncone believes there is a lot of demand from the buy-side to invest in a new type of instrument that may not be regulated and issued in the same way as an IPO, but that would have “very similar conditions” to make sure protections and regulations were still in place.

However, making sure that capital raising conditions are strict enough to protect investors but not too similar to the regulations applied to IPOs could be an important factor in keeping the market buoyant. 

Some participants involved in ICOs are not sure that issuance would remain strong if rules and regulations were equal across both IPOs and ICOs. Only once jurisdictions are comfortable with the level of regulatory oversight they have over ICOs will it become clear if ICOs have inherent advantages over IPOs that justify their existence. 

IPOs are generally used by more mature companies to raise capital while ICOs are used by start-ups. Their different use may hinge  on the fact that ICOs are not burdened with the same demand for transparency as IPOs. 

But Joshua Klayman, the founder and CEO of Klayman LLC, a boutique blockchain-focused law firm, told GlobalCapital that when it comes to token sales and digital assets "the genie is not going back into the bottle". 

"I continue to see this [ICOs] as a growing and exciting space, and I believe there has already been an impact on many areas of commerce and capital markets activity," she said. 

"If you just look at sheer numbers with dollars raised, just because you may see momentary dips doesn’t mean that the ecosystem or that the market is weakening. It could mean that it is actually strengthening and that bad actors have dropped out." 

She added that for investors looking to diversify their portfolios and who have an appetite for investments with a greater degree of risk, ICOs could fill that role. 

Another key aspect of SIX’s digital asset offering will involve tokenising existing assets, such as the shares of Nestle or Novartis, according to Roncone. In practice, this would likely mean the shares still existing in their current form, but that tokens could be issued representing the shares, allowing SIX to take advantage of distributed ledger technology. It is unclear how SIX's application of distributed ledger technology with tokenised securities will look in its final form. 

“Intraday settlement means that your exposure to counterparty is reduced to the max,” added Roncone.

"Since we have those securities already in our custody, we are free in terms of regulations to issue some tokens and do some processing within our area of responsibility. We don’t need to ask Novartis or Nestle to tokenise those assets, because it doesn’t change the capital structure of Novartis or Nestle if you’re talking about existing shares.”

Competitor Deutsche Börse has been attempting something similar this year, but using high quality liquid assets instead of shares in publicly traded companies.

Deutsche Börse's platform works by moving digital collateral records between counterparties while assets actually stay still, not bouncing between multiple custody accounts. The appropriate counterparty can access the collateral with a key on the block chain, which is exchanged.

Across the pond, exchange competitor Intercontinental Exchange has also entered the blockchainmarket, recently announcing a "global platform and ecosystem for digital assets", called Bakkt. 

Competitors CME Group and Cboe released Bitcoin futures last December. SIX has no plans to release derivatives on the platform. 

But at the end of the day, the platforms of all these exchanges will largely depend on regulation and the forbearance of regulators. In the United States, the Securities and Exchange Commission has taken a tough line against ICOs. Many startups have kept away from the US to avoid having their tokens being registered as securities. 

Meanwhile, in most of Europe, policy on the issue is relatively uncertain. France is angling to release a brand new framework for ICOs, with options to register with the financial markets regulator the AMF. But a brand new framework is relatively unusual, with most regulators issuing guidance that tokens and conventional cryptocurrencies fall under existing commodities and securities rules. 

"From our perspective, it cannot be that existing regulation is very different from the new one for digital assets," added Roncone. "We want to make sure that parallels still exist."